Cognex - Q1 2023
May 4, 2023
Transcript
Operator (participant)
Greetings, welcome to the Cognex first quarter 2023 earnings conference call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Nathan McCurren, Head of Investor Relations. You may begin.
Nathan McCurren (Head of Investor Relations)
Thank you, Shmuley. Good 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 and quarterly report on Form 10-Q 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 two of the press release. Any forward-looking statements we made in the press 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 the risks and uncertainties that are described in our SEC filings, including our most recent Form 10-K and on our Form 10-Q filed this morning for Q1. With that, I'll turn the call over to Rob.
Rob Willett (President and CEO)
Thanks, Nathan. Good morning, everyone. Thank you for joining us. As anticipated, we had a challenging first quarter of 2023. Revenue from our largest e-commerce customers remained low. We continued to see cautious investment by customers across many of our end markets. More projects in our sales funnel are being delayed by spending cuts and additional levels of executive approval at our customers amid concerns about near-term demand. You can see this in macro leading indicators that remain muted. Since our last call, new orders and manufacturing PMI have decreased slightly in our largest regions, partially offset by an improvement in China compared to the January lows. We've seen slow periods like this before. We've come out of them delivering meaningful growth. Our business is shorter cycle and not as backlog driven as many of our peers. It tends to inflect more quickly.
Additionally, we are comparing to an exceptionally strong Q1 of 2022, highlighted by large logistics projects and backlog catch up as the supply environment improved. Gross margin of 71% in Q1 was in line with our expectations, yet still below our mid 70% long-term target due to the elevated prices we paid to buy scarce components and replenish inventory through brokers. We believe that pressure is behind us going forward. Before I go into further commentary on the business and outlook for Q2, I'd like to turn the call over to Paul to walk through more of the results.
Nathan McCurren (Head of Investor Relations)
Thank you, Rob. Good morning, everyone. First quarter revenue was $201 million, which was slightly above the high end of our guidance range, yet a meaningful step down year-on-year. In addition to the drivers that Rob touched on, foreign currency translation reduced revenue by $8 million or 3% year-on-year on a reported basis. Let's now go into more detail about what we are seeing in our end markets in the first quarter. Turning first to automotive, our largest end market in 2022. The ongoing transition to electric vehicles is driving multi-year investments, and we continue to develop strong customer relationships worldwide with an industry-leading offering for EV battery inspection. Even so, automotive spending in the first quarter was tepid, driven by more cautious investment from our customers as they see demand for their products soften.
EV battery revenue can be lumpy and large project timing can be uncertain. We had a very strong Q1 of 2022 that resulted in a tough compare this quarter, but we continue to expect our EV battery revenue to grow substantially in 2023. Moving next to logistics. Declines at a few of our largest e-commerce customers accounted for over half of our total company year-over-year revenue decline. Outside of these few large customers, we saw growth in the remainder of our logistics business. Logistics is still in the early innings of adopting machine vision. Most companies rely heavily on labor, and very few warehouses globally are realizing the full potential of automation. E-commerce and omni-channel players beyond our largest e-commerce customers are investing as they strive to automate more, and we continue to make progress in parcel and post.
These customers are important for us going forward. While a few of our largest e-commerce customers have accounted for over half of our logistics revenue the past several years, these customers represent less than 5% of global warehouse space. The remainder of the logistics market, which is also much less automated, remains a significant growth opportunity for us over the long term. Shifting to consumer electronics. A significant portion of our consumer electronics business is related to the premium segment of smartphones and other smart devices. As many of you know, smartphone shipments were down in 2022 and expected to be down again in 2023, albeit less significantly in the premium segment. This weakened demand has led to conservative capital spending. Rob will go into more detail on what we expect from this end market going forward.
In other smaller end markets that we serve, revenue declined year-on-year, primarily due to the softer macro conditions compared to the strong business environment we were still seeing in the first quarter of 2022. Looking at the change in revenue for Q1 on a geographic basis, Europe was our best performing region with flat revenue growth year-on-year on a constant currency basis, or slightly down on a reported basis. Declines from our largest e-commerce customers were offset by growth in automotive and the remainder of our logistics customers. The Americas and Asia were our weakest performing regions. Revenue in the Americas was down 36%, driven by the concentration of large e-commerce customers. Revenue in Asia was down 35% or 28% on a constant currency basis.
This was consistent across both China and the remainder of Asia, with softness across the end markets, yet most pronounced in consumer electronics, which was also lapping a strong first quarter of 2022. In China, we had slowness in the beginning of the first quarter. Momentum began to pick up in March and April. Turning now to margins. Gross margin was 71% in Q1. Broker buy activity continued to pressure gross margin below our mid-70% long-term target. The flow-through of this higher cost inventory was an approximately 300 basis point impact in the first quarter, which was an improvement compared to the approximately 500 basis point impact in Q4. We've not made significant broker buys since early Q4. This higher-priced inventory has nearly worked its way through the P&L. Operating expenses increased by approximately $5 million or 4% year-on-year.
The majority of this was driven by investment in our emerging customer initiative. The remainder was primarily driven by personnel-related costs, including a typical annual increase in employee compensation, partially offset by the favorable impact of currency exchange rates. Operating margin of 11% was below both Q1 of 2022 and our 30% long-term target, due primarily to operating deleverage from softer revenue. The effective tax rate, excluding discrete tax items, was 16% in both Q1 of 2023 and 2022. Reported earnings were $0.15 per share in Q1. Non-GAAP earnings per share were $0.13, excluding discrete tax adjustments. Turning to the balance sheet, Cognex continues to have a strong cash position with $844 million in cash and investments and no debt.
Cash flows in Q1 reflected lower net income level. We returned $36 million to shareholders in the form of stock buybacks and dividends. Now I'll turn it back over to Rob.
Rob Willett (President and CEO)
Thanks, Paul. As our history demonstrates, Cognex can experience periods of softness in between periods of robust growth. We're excited about the growth drivers that we expect to materialize over the next few years, driven by both secular and regulatory tailwinds. In the U.S. alone, companies have committed more than $200 billion to manufacturing projects since Congress passed the CHIPS Act and the IRA, a five times increase over what was announced last year prior to the passage of these subsidies. Clean tech and semiconductor investments are beginning to ramp up now. We expect these will be medium to long term growth drivers for Cognex as manufacturers typically implement machine vision in the later stages of these capital projects. Significant investment is also happening beyond the United States. In the first quarter, I spent three weeks in Asia visiting Korea, Malaysia, Singapore, India, and Vietnam.
My time with customers, suppliers, and Cognoids confirmed that manufacturing investment is increasing in these countries, and there is a significant opportunity for further automation enabled by machine vision across both factory automation and logistics. In India, investments are being made in electronics to support large customers diversifying their manufacturing outside of China. One manufacturing facility I visited employs 25,000 people. They expect to double their workforce over the next few quarters. A large portion of these people perform manual visual inspection. This is just one example where Cognex products can help automate manual processes and drive improved process efficiency, product quality, and service levels for our customers. My time with executives from EV battery manufacturers reinforce this as an important strategic growth priority for us.
EV battery manufacturers are responding favorably to our industry-leading technology that combines the computational lighting products we acquired with SAC and our deep learning vision software. As EV battery investments accelerate over the next several years, we are well-positioned to capture a substantial share of the machine vision growth. I also spent time with Cognex's own contract manufacturers. Both our long-term partner and our new supplier are among the 10 largest contract manufacturers in the world. We are on track at our second contract manufacturer to ramp up production across many of our largest unit volume products by the end of Q2. Deepening relationships and diversifying our supply is helping us professionalize and scale our operations. Let's shift to an update on product innovation. Our reorganization in 2020 led to a product development process centered on common products and platforms.
This has teed us up for more efficient and rapid product launches with a focus on ease of implementation and ease of use. The In-Sight 3800 is a great example of this. Just 12 months after launching the In-Sight 2800, our first Edge Learning-enabled vision system, we launched a second generation that offers similar capabilities at more than twice the processing speed. The In-Sight 3800 is the fastest embedded smart camera in the market today. It can perform tasks such as automated inspection on high speed production lines in as little as 10 milliseconds, which is less than one-third the time of a blink of an eye. This accommodates the fastest line speeds to maximize throughput while delivering the high accuracy that customers have come to expect from our In-Sight product line.
Cognex Edge Learning technology offers ease of use that enables customers to independently and quickly set up the In-Sight 3800 to solve a wide range of manufacturing applications. After launching this product at the beginning of April, we're getting very positive responses from customers, and we've already seen meaningful orders. In addition to new platforms, our new approach to innovation is resulting in the launch of many platform extensions. For example, the DataMan 282, which launched in March, extends the Cognex DataMan 280 series of fixed mount barcode readers to increase throughput and improve worker safety in manufacturing and logistics. The DataMan 282 provides accurate hands-free reading of complex barcodes, including difficult to read codes on curved, shiny metal surfaces such as EV components, consumer electronics, and medical devices.
Expanding our product portfolio with easy to use products is positioning us well to broaden our customer base. With our emerging customer initiative, we're investing to address smaller or less technically sophisticated customers who are looking for reliable, high-performance automation solutions that are easy to implement and use. We've made strong progress on this initiative in Q1 and are encouraged by the KPIs we have seen for our initial pilots. Representing up to 10 times as many customers as our current customer base, we're excited about the potential contributions these customers can make towards our target long-term growth. Turning now to our outlook. As we look to the remainder of 2023, there is considerable uncertainty about the potential operating environment. As many of you know, revenue from consumer electronics has an annual cadence that we typically talk about in our Q1 call.
For 2023, we believe our customers will not make heavy investments in new capabilities. As a result, we expect annual revenue from consumer electronics will be modestly lower this year after growing in the mid-teens on a constant currency basis in 2022. Overall, in the second quarter, we expect revenue of between $225 million and $245 million. This step up from the first quarter is relatively in line with our typical Q1 to Q2 seasonality. We expect gross margin in the mid-70% range, in line with our long-term margin target as we move beyond the elevated costs from premium broker buys and expect a more favorable revenue mix. Operating expenses are expected to increase by low single digits on a sequential basis as investments in the company's emerging customer initiative will be partially offset by lower stock-based compensation.
Lastly, I remain confident in our team and their ability to execute. Cognoids tend to be long-term minded, so morale and retention remain strong as we look ahead at our growth opportunities. Voluntary attrition of our employees remains about half that of our peers. Additionally, with the layoffs and low morale at some of our peers and at big tech companies, we are recruiting some exceptional talent. While this quarter did not represent the performance that we aim for, we have the right ingredients in place to get back to our long-term growth model. We will open the call up for questions. Operator, please go ahead.
Operator (participant)
At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. 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 your handset before pressing the star keys. We also ask that all participants to please limit themselves to one question and one follow-up prior to getting back into the queue. One moment, please, while we poll for questions. Our first question comes from the line of Joe Giordano with TD Cowen. Please proceed with your question.
Joe Giordano (Analyst)
Hey, good morning, guys.
Rob Willett (President and CEO)
Morning, Joe.
Joe Giordano (Analyst)
You mentioned that the logistics decline is from large customers and that the smaller customers were still growing. I know we've heard commentary from a lot of companies that those smaller players and who are investing in logistics expect to kind of keep spending through a potential recession. I guess my question is, do you believe that? You know, because we're not really feeling necessarily the major impacts of a recession yet. Once we start feeling that, do you think that these customers will still continue to spend even if they're saying that now?
Rob Willett (President and CEO)
I think if we strip out our, you know, very small number of large e-commerce customers, what we're seeing is, you know, the rest of our customers continue to grow. That's the good news. But I also don't think that they are completely immune to, you know, the macro conditions that we're all seeing. I, you know, as I visited some of those over the first quarter. You know, I'm hearing also pressures on costs generally within those companies too, and more scrutiny of capital spend. We see this as a great growth opportunity for us, the base logistics business, and it's growing, and we expect it to go on growing nicely, but it's not immune to pressure, would be my take on it.
Tommy Moll (Analyst)
That, that's fair. When you look at the sequential uptick in the Q2 here, would you say that's reflective of end demand, or is this kind of a delivery of backlog that maybe had been maybe past due or delayed a little bit?
Nathan McCurren (Head of Investor Relations)
Hey, Joe, this is Paul. I think the biggest driver is just sort of seasonality in our consumer electronics business. You know, that's the biggest piece. We did call out that, you know, China is improving given, you know, where China started the year. That's another factor. Otherwise, you know, overall demand, you know, is weak, as Rob sort of mentioned, and is, you know, no real further commentary on that right now, I would say.
Tommy Moll (Analyst)
I'll just sneak in one last question, more high level. We're hearing a lot of talk about RFID more recently. What does that mean for you if there's a more protracted move from barcode toward RFID, or how do you even think about that progression? Is that an area that you're interested in or think about? Thanks.
Rob Willett (President and CEO)
Yeah. You know, been in this industry for about 25 years, and we've certainly seen RFID trials. We, we see them, you know, from time to time, over a long period. We've seen them at some major customers of ours, and generally they haven't got great traction because RFID is an expensive technology, and it doesn't work in certain environments. I think we've all probably seen, you know, some big, quite high-profile RFID trials going on at a large parcel delivery company, you know. I think that's what's perhaps creating some noise. What I would say is I don't see RFID and machine vision competing significantly with one another. I think they just offer very different attributes.
Machine vision is very powerful, for over a whole range of applications, and RFID, I think is a more specific technology around very high value, often smaller, slower moving assets. I observed some of that, but I don't see it taking any business from us currently, nor have I over a long period, nor do I really expect to in future periods.
Tommy Moll (Analyst)
Thanks, guys.
Operator (participant)
Our next question comes from the line of, Guy Hardwick with Credit Suisse. Please proceed with your question.
Guy Hardwick (Analyst)
Hi. Yeah, good morning. Joe kind of asked my main question. It does seem that it's returned to kind of normal seasonality. Would you also say that's gonna be the, from what you can see from now, that the second half will also reflect normal seasonality?
Rob Willett (President and CEO)
I think it. We don't really give guidance for the second half, but there's obviously quite a lot of noise we're going to see when we compare to prior year. We had, you know, as many of us and many of you know, we had our logistics big logistics customers really tap the brakes, you know, as we went in, or put the brakes on firmly as we went into the second half of last year. We also had a fire, you know, in our main contract manufacturer's warehouse, which, you know, certainly caused, you know, some distortion. We, we're gonna get much easier compares as we go into the second half of the year. In terms of seasonality, you know, hard to call, but I think we.
History tells us we can expect Q2 and Q3 to be large consumer electronics quarter for us. Q4, it's very hard to call that as we go out further, and it really depends on the overall environment. We can see a lot of year-end spending in different markets. We may have a better sense of how logistics is looking as we get into Q4. You know, whether there is as we can see some large year-end projects and committed coming through in our bookings. That's too hard to call at this point.
Nathan McCurren (Head of Investor Relations)
Yeah. I would just add, I think the sell-
Guy Hardwick (Analyst)
Sorry.
Nathan McCurren (Head of Investor Relations)
Oh, sorry, Guy. I think the sell side understands this really well, but for others listening, I think our year-over-year comparisons in 2023 are much more of a function of the 2022 base than they are, you know, our business trajectory. I think kind of the seasonality is it does look sort of relatively normal this year especially compared to last year.
Guy Hardwick (Analyst)
Just, Paul, just one more. In terms of the operating expense guidance, it does seem to benefit from lower stock option expensing. If you have to exclude stock option expensing, compare what you're projecting for Q2 versus Q2 last year, what would it be in terms of growth?
Nathan McCurren (Head of Investor Relations)
It's most growth, I'd say, excluding stock option, would be driven by the emerging customer initiatives that we've made. You know, we are carrying some additional headcount beyond that, but really the bulk of the headcount has been investment for that initiative. You know, we do have, you know, merit and, you know, promotions and such, those sort of annual comp increases that you lap in any year-over-year comparison. Those are probably the biggest factors.
You know, I don't know if this will hold in Q2, but certainly in Q1, you know, travel was up a little bit versus a year ago, which we view as a very good thing that we're able, you know, with COVID restrictions basically, you know, entirely behind us, we're able to pay more customer visits and deepen those relationships, which we know pay off over time. But those would be the things I would call out.
Guy Hardwick (Analyst)
Thank you.
Operator (participant)
Our next question comes from the line of Tommy Moll with Stephens Inc. Please proceed with your question.
Tommy Moll (Analyst)
Good morning, thank you for taking my questions.
Nathan McCurren (Head of Investor Relations)
Hey, Tommy.
Tommy Moll (Analyst)
I wanted to stay on the topic of the emerging customer initiative. Per the guidance, it looks like the level of investment is up sequentially in the second quarter. I'm just curious, do you have any visibility beyond Q2? Do you expect to continue to layer in incremental investment there, or does Q2 feel like a full run rate? Then as you think about harvesting the return on this investment, what kind of timeline should we be thinking about?
Jake Levinson (Director – Multi-Industry Research)
In terms of being able to flip from margin dilutive to potentially margin accretive here. Thank you.
Rob Willett (President and CEO)
Hey, Tommy. I'll paint the sort of high-level picture on this and give you some thoughts, and then I'll hand it over to Paul for some more details. Just to get a sort of level set. You know, Cognex traditionally has been very successful with the most sophisticated manufacturers of discrete products, and they love our technology, and it's remarkable, right? Very, you know, strong relationships. There's a whole part of the market, you know, if we serve 30,000 customers today in the sort of top of that segment, you know, we think there are as many as 300,000 customers further down the pyramid that really can benefit from our technology.
We haven't had the ease of use and ease of implementation with our products that was needed to make those customers absorb our technology and for us to serve them profitably. That's really changed over the last couple of years, and probably one of the main things, or definitely one of the main things that's changed is Edge Learning, right? This is products that allow that allow very easy training. We can look at a technology, a component or a closure on a model or all kinds of applications in markets. Consumer products would be a good example. With relatively low skill and low automation capability, we can take machine vision and apply it to customers there. That's been a real trigger for us.
We talked about it at Analyst Day back in September. We're on a process to build out a sales network in order to reach those customers and develop more and more products so we can go to and sell to them profitably. If this goes well, I could see this being a very long-term initiative where we continue to build out our sales force. We would see substantial growth over long periods. We're starting it now. Right now, you know, we're building out those capabilities. We're recruiting and training salespeople to go into the field. I think we can expect that to ramp as we move forward. It'll ramp as we move through the year. If all goes well, I would expect it to ramp into next year as well, and in subsequent years.
I think we would expect those salespeople to be selling, you know, very profitable products, you know, similar to our current gross margin profile and operating margin accretive once they're selling volume in the field.
Nathan McCurren (Head of Investor Relations)
Yeah. Yeah, and Tommy, just to add some expense color there, you know, we communicated this in February, but we expect this to be a roughly $25 million-$30 million OpEx investment on the full year for 2023, and it is ramping up from Q1 to Q3. Again, think about it consistently as it's primarily an investment in headcount that's following a campus recruiting cycle in the different geographies we serve. Q2 will be up from Q1, and we would expect Q3 to be up from there. The run rate is gonna be a little higher than if you took 25-30 divided by four, you know, as we given kind of the ramp-up period and sort of thinking about going into future years.
In terms of the return, you know, as Rob said, we're really excited about this. We're in pilot mode and learning a lot and seeing, you know, great initial traction. We are tempering expectations from a timing perspective. If you just think about, you know, hiring folks primarily on a campus recruiting kind of timeline, quite a long training period 'cause they're starting from scratch, unlike, you know, most of our salespeople, which we're hiring with several years of experience from competitors or distributors or other participants in our market. Just the natural ramp-up period of how effective a salesperson is in their first six months versus their second six months, their second year versus their first year, and even their third year versus their second year.
I think we'll have a lot more to share next year on the progress we're making and sort of the results. I think in the near-term period, we're really in investment, hiring, training, and pilot mode right now.
Jake Levinson (Director – Multi-Industry Research)
That's all very helpful. I appreciate the insight. As a follow-up, I wanted to ask about some recent news flow regarding OLED screens and tablets. Noted your commentary on the broader consumer electronics end market, looking like a down year for 2023, but maybe not specific to this year, just in general, how big of a commercial opportunity do you see that as? Thank you.
Rob Willett (President and CEO)
Well, we, you know, we've done substantial business over the last 10 years really on screens as they, and whether it's MicroLED, OLED, you know, those are complex products to manufacture. Generally, when there's a, you know, a major capital investment to ramp up production of new screen technologies, you know, that can be very beneficial for Cognex. We saw that most pronounced in 2017. As I look at electronics, there are roadmaps that are, you know, under development that, you know, we have pretty good insights with our major customers. Then as we move through the year, we see whether these technologies actually scale, right?
Any new technology, whether it be that or virtual reality type technology that perhaps may be under development, you know, we can find that can inflect as we move ahead. I'm not sure exactly what you're referring to, but I would say certainly, you know, very high definition MicroLED and more importantly, OLED type technology, I think is, you know, is a very interesting area as it relates to a screen very close to the eye, which is of course key for virtual reality and augmented reality type products. You know, I'm very bullish on that long term, but I wouldn't be banking on necessarily reaching large scale commercialization this year.
Joshua Pokrzywinski (Equity Analyst)
Thank you. I'll turn it back.
Operator (participant)
Our next question comes from the line of Jake Levinson with Melius Research. Please proceed with your question.
Joshua Pokrzywinski (Equity Analyst)
Good morning, everyone.
Rob Willett (President and CEO)
Good morning.
Joshua Pokrzywinski (Equity Analyst)
You talked quite a bit about the opportunity in the EV battery space. We've certainly seen some eye-popping numbers, I guess, around the spend that's going there. I think from the outside at least it can be hard to know what that really means in terms of machine vision content. I think it's quite an automated process, but maybe I'm wrong. Maybe just speak to how the content compares in an EV battery versus some of the other big verticals that you're selling to.
Rob Willett (President and CEO)
Yeah. Thanks, thanks for the question. It's a, it's an area we've been, you know, very focused on currently. I've spent quite a lot of time walking and spending time with some of the major line builders and also the key technology providers in this space. There's very substantial capital investment going in to build out EV lines, planned over the next few years. It's hard for me to see also how that wouldn't continue to scale for a very long period, just given the appetite that seems to be existing for conversion from internal combustion engine to EV going out into the future. The commitments that, you know, governments and auto OEMs seem to be making to transform their fleets and general population of cars, right?
I see that. As I visit line builders and I visit end users and I meet with senior executives at large EV battery manufacturers, and that's really where the opportunity primarily is for us. It's in companies that are scaling up production of EV batteries. There are three general types. I mean, a cylindrical, a prismatic, some of the ones that you read about. There's a lot of investment. If you walk one of these lines, they can be 1,000 feet long. They can have multiple fixtures the products move through. Many of those fixtures, perhaps, you know, if there are 30 fixtures on a line, more than half would have potential for machine vision content, be it as simple as barcode reading or alignment.
But for us, where we see some of the most advantage of our technology is more inspection of the battery material and the finished battery as it moves through production, inspection for damage, such as scratches and dents that can result in fires, right? I read an article recently in talking to Cognoids in China. I think it's an interesting statistic that about seven cars per day in China, which has the, I think the most EV battery intensive fleet of cars on the road, seven cars a day catch fire, right? This is a, you know, very serious problem for companies making EV batteries. A real root cause of those problems is dents and scratches and defects in manufacturing.
We have two pieces of technology that are coming together for us really nicely in that space. One is the computational optics business, lighting business that we acquired late last year that really gives us the best image acquisition of these types of things. It gives us sort of almost 3D light accuracy at very high speed that can look at the depth of a dent or the nature of a scratch and determine whether it's dangerous or not, whether it needs to be rejected or not. Then we have a business we've been developing, you know, for about seven years now, deep learning, intense deep learning vision technology that really allows us to inspect those scratches and dents and determine which ones are problematic and which are not, right?
That's an area where we're really excelling. My expectation and hope is that that technology leadership we have in the inspection area can lead to lots of other opportunities throughout those 28 or so fixtures in a normal EV battery line.
Joshua Pokrzywinski (Equity Analyst)
Okay. That's super helpful. Just on, on a related topic, I guess the tide certainly seems to have gone out in a pretty dramatic fashion in the tech startup world, and you've done a couple interesting acquisitions that you mentioned over the last couple of years. Maybe you can speak to the M&A funnel and, you know, whether we've got some things that may be closer to getting over the finish line today given the, environment out there.
Rob Willett (President and CEO)
Yeah. I think it is one of the most target rich kind of environments we've been in for M&A for quite a long time. I think we see we see a lot of companies coming up for sale currently where perhaps their business models about how quickly they would turn cash positive or how much they would grow haven't really come to pass, right? We see quite a lot of those. We're pretty selective as we look at them. We definitely like to look at excellent technology or excellent engineering teams who would integrate well into our businesses.
We've done very successfully over longer periods of time. There are other types of acquisitions that are, you know, larger companies perhaps that have had owner founders that are looking to retire or, you know, changes of ownership, and we're also seeing some of those more coming to market. I think we're very good evaluators of those types of businesses and pretty selective. You know, we're finding ourselves going to many more management presentations and seeing much more activity than we have in the past. I do think probably there's still some expectations about valuation, which may be a little outdated, which may lead to some, you know, deals being a little bit more difficult to get done, I think. It'll be interesting to see kinda how that progresses.
It's certainly a very, fruitful environment right now, and we're very active.
Nathan McCurren (Head of Investor Relations)
Happy to have a very strong balance sheet at a time when, you know, the external new funding environment for non-profitable startups is terrible.
Joshua Pokrzywinski (Equity Analyst)
All sounds encouraging. Thank you, guys. I'll pass it on.
Operator (participant)
Our next question comes from the line of Joshua Pokrzywinski with Morgan Stanley. Please proceed with your question.
James Ricchiuti (Senior Analyst)
Hey, good morning, guys.
Rob Willett (President and CEO)
Good morning.
James Ricchiuti (Senior Analyst)
Rob, you mentioned the consumer electronics environment, you know, maybe being down a little bit this year. I know that typically has a little bit more second half seasonality for you guys. I just wanna level set since the next time we'll all talk is, you know, when you'll give Q3 guidance. Respecting you don't really wanna talk about the second half and kinda specifics, maybe just a reminder with all the comps and, you know, supply chain interruption last year, maybe, you know, where you see kinda the toughest real comp in consumer electronics in the second half, Q3, Q4, you know, or anything one time you'd call out?
Rob Willett (President and CEO)
Yes. I'll sort of give you some big picture perspective on that and invite Paul to comment. Generally for us, consumer electronics is a Q2, Q3 phenomenon, right? I'd say that's generally been the case in recent years. It was pretty much the case last year. Paul will fill in on the Q3 question 'cause I'm wondering about the fire and how it impacted that. I think we see something similar this year, right? Our consumer electronics business was a little lower than prior in Q1, right? Where there were some things going on last year related to some larger specific projects. Then, you know, what can tend to happen as we move through the year, there can be changes.
Last year, we at this stage, we were thinking it was sort of a mid to high single digits type growth opportunity for us in consumer electronics. It had ended up being perhaps 10 points higher than that once we got through the year, just ballpark numbers. Things can change. This year we're expecting Q2, Q3, probably relatively evenly balanced. Q4 will be a wild card, basically, I think more around how companies are ramping up for their 2024 plans.
Nathan McCurren (Head of Investor Relations)
Yep. Thanks, Rob. No, I think last year, electronics was one of the only areas that really wasn't impacted by the fire. It's a little more software-intensive. The predictability of the build and the lead-up. Actually, the, you know, the product gets shipped before the revenue gets recognized, so it was a little more isolated from, you know, events that happened as of the second week of June last year. Last year, consumer electronics was pretty balanced, Q2 versus Q3, Josh. This year we're expecting the same. You know, 2021 and 2020 were a little more Q3-weighted. 2020 was very specific. COVID, you know, really delayed the ramp-up of line for quite some period of time and so on.
We are expecting things to be a little more balanced in Q2 and Q3, and that's reflective of our guide. The only, you know, call-out I'll make is, you know, there's a lot of large project timing here that can be quite lumpy. You know, we're doing our best at any time to predict that, but there always can be slight shifts depending on, you know, delays in supply, a COVID outbreak that might shut down a factory for a week or two and so on. You know, we're doing our best, but right now that's what we're seeing, kinda pretty balanced between Q2 and Q3.
James Ricchiuti (Senior Analyst)
Got it. Super helpful. I appreciate that color there. Then just on the logistics market, I apologize, I missed the start of the call, lots going on this morning. Any additional comment or I guess, you know, rate of change that you would, you know, you would point out, you know, maybe just kinda separate from Q2 specifically more in aggregate, I guess? In, you know, March, we saw, some of the big integrators, you know, see another step down in orders, some industrial or I guess warehouse REITs, see lower utilization. Is, is that something you guys are seeing as well, or is it just a little too early to calibrate that yet?
Rob Willett (President and CEO)
Yeah, I don't think I see a real change compared to what I saw at the last earnings call on this. We see kind of the large e-commerce type businesses have, you know, really pared back spending. You know, I think all of us are kind of trying to understand when that comes back. I don't think there's much real clarity on that at the moment. I think smaller customers continue to, you know, to invest and build out, although, as I mentioned at the start of the call, there's perhaps additional caution there too, where companies are just reading the macro environment and perhaps some of the consumer spending sentiment that might impact their businesses. I think that's what I see overall.
I think, you know, it's important to note that some of the larger integrators, perhaps the ones that talk more publicly, these can be large businesses that are implementing projects over a very long period of time. Some of them have had very high levels of inventory that they're really still working through. When they purchase from us, you know, some of that may take time for them to absorb and fulfill. I, you know, I would kind of point to that as a potential dynamic.
Nathan McCurren (Head of Investor Relations)
Understood. Super helpful. Best of luck, guys.
Operator (participant)
Our next question comes from the line of Jim Ricchiuti with Needham & Company. Please proceed with your question.
Chris Grenga (Equity Research Associate)
Hi. Good morning. This is actually Chris Grenga on for Jim. You had mentioned that you're beginning to see some indications that clean tech could be ramping. What applications is Cognex's portfolio best suited for or most differentiated within clean tech? How are you thinking about the potential content, the potential Cognex content in one of these typical clean tech fabs, for lack of a better word? Thank you.
Rob Willett (President and CEO)
Yeah. I think when we think of clean tech, we think of EV batteries. It's the big play for us, right? We've talked a bit about that. Certainly building out large lines, you know, to manufacture EV batteries, we see as going to be perhaps the big driver of growth. That said, you know, certainly we do see more spending and investment and levels of interest in the solar market currently in the United States. You know, not just panels, but things like inverters, for instance, you know, certainly are. One can see that the level of investment and plans ramping there.
You know, I, you know, I think there are sort of secondary benefits, but nowhere on the order of EV batteries, which I think will be the big clean tech mover for Cognex with my expectation over a long period.
Chris Grenga (Equity Research Associate)
Got it. Europe held up well. Could you elaborate a little bit more on what you're seeing there and discuss the current competitive landscape?
Rob Willett (President and CEO)
Yeah. Europe performed better than the Americas and Asia in Q1, but still below kind of the target growth rate. I'd say that the softness we saw in Europe related quite a lot to large customers in logistics that buy products from us. You know, I think most of us on the call understand that Cognex is, has a larger percentage of its business in the Americas and logistics than it does outside of the Americas. Europe was less impacted by that. Automotive in Europe grew year-on-year over what was a relatively tepid quarter a year ago. You know, the PMI doesn't look that strong in Europe, so it's, it performed better, but I wouldn't say it performed well.
Chris Grenga (Equity Research Associate)
Thanks very much.
Operator (participant)
Our next question comes from the line of Robert Mason with Baird. Please proceed with your questions.
Robert Mason (Senior Research Analyst)
Yes. Good morning.
Operator (participant)
Morning.
Robert Mason (Senior Research Analyst)
It's quite clear that your large customers put on the brakes abruptly last year, e-commerce customers and logistics. I'm just curious, you know, as we, you know, now stand a year from that, have they reached a base level of spending that you can tell, a floor, so to speak?
Rob Willett (President and CEO)
Rob, I think, you know, think it's a good question, and we're talking about a few customers there. I would say broadly I'm hopeful that the answer is yes to that question, but I, you know, I can't say definitively it is. As I look at our funnel, and business that we're doing with some of these large customers, there's, you know, a good base of kind of, you know, productivity and improvement, related projects that I think will certainly should keep us moving along at the level we are.
I think when they start to lean into more investment, and then there are more distribution centers, you know, big new investments in automation coming, which, you know, I see can potentially come back next year, you know, then I think we're really gonna see an inflection. That would be my take on it.
Nathan McCurren (Head of Investor Relations)
Yeah. Certainly, Rob, from a sort of full year basis, 2022 versus, you know, 2023 in logistics, just given kind of what we've already shared about Q1, right? We were down about $80 million in revenue for the whole business. Our few largest, you know, e-commerce and omnichannel customers were responsible for more than half of that decline, you know, in the quarter. You know, I would say, you know, on a full year basis, you know, logistics this year versus logistics last year, it's, you know, very hard to model in growth right now with just what we've already done in Q1.
I think on a quarter to quarter basis now that we're past that tough compare and we've had a few quarters, things are looking a little more steady.
Rob Willett (President and CEO)
Yeah. To pile on to that, I think, you know, when I was answering you, I was thinking about kind of orders and, I was thinking about sales funnel and, you know, projects, right? Obviously, there's a bit of a tail to revenue for where you see, when you see through our financial results the business turning down. I think there's cause for hope that it's bottomed and will be coming back over many quarters.
Robert Mason (Senior Research Analyst)
Sure. Sure. Just as a follow-up, Rob, in your earlier commentary, you talked about EV, and I thought you said you still, or you expected strong growth this year. I just wanted to clarify that, did I hear that correctly? If that's the case, is that any change in the view that you may have had from the discussion we had three months ago on the call and you talked about, just kind of the regional diversification efforts were slowing some of the deployments? If anything's changed there in strong, you know, strong year-over-year growth this year?
Rob Willett (President and CEO)
Yes, Rob. Yes, definitely we see EV as a strong source of growth for Cognex this year and perhaps for many years to come, right? Yeah, we're very positive about that. Certainly, you know, there's large investments, some of the, you know, the IRA type investments I referred to in my prepared remarks, you know, are good examples of that. I think we do see some of that spend getting pivoted towards America, right? That has caused some projects to get delayed, right? Which I believe referenced in previous conference calls, right? That will be happening. You know, as I think of that EV market, I think there are perhaps 10 major companies, technology providers and in-investors in this space or so.
That means the business can be a little lumpy, right? We, the business is growing as quickly as perhaps we would've expected on a revenue basis in Q1, mostly because of prior year's business we'd seen with some large China suppliers. All of those customers I'm thinking of are those big 10 companies are Cognex customers evaluating our technology, have ambitious rollout schedules, and certainly we see as a market for great growth. I think we can expect some variable growth within quarters based on these projects getting deployed.
Joshua Pokrzywinski (Equity Analyst)
Understood. Thank you.
Operator (participant)
Our next question comes from the line of Paul Chung with Daiwa Capital Markets. Please proceed with your question.
Paul Chung (Analyst)
Hi. Thanks. Thanks for taking my question. Just I wanted to focus a little on the ex-China numbers. They were down. You talked about CE and maybe to the earlier question, EV batteries, EV reductions, and with China improving, do you see some sequential growth there going forward?
Rob Willett (President and CEO)
Yeah, I'll start off, and Paul might want to come in also. You know, yes, we saw a relatively slow start to the year in China prior to Chinese New Year, slower than, you know, one would normally expect. I think that was probably a result of, you know, COVID and their, you know, the difficult time coming in through the start of the year. After Chinese New Year, you know, we did see some positive improvement in the business, perhaps, you know, at or beyond our expectations. We're, you know, we're seeing some, you know, better outlook there. I think it's worth pointing out that our business in China is, you know, it's broad, but it does have a significant consumer electronics component to it.
Certainly that normally, and I would expect this year also should see some nice sequential growth for us as we move out, you know, into Q2, and then with Q3 also being positive for us.
Nathan McCurren (Head of Investor Relations)
Yeah. I would just, I would just call out, you know, I think we've said sort of our sequential increase from Q1 to Q2 in revenue. You know, two factors we've called out that one is the seasonal ramp up of our consumer electronics business, and that's by far the bigger factor. The way we report our geographies, a lot of that is going to play out in China next year, this quarter, Q2. The second is just a general ramp up and improvement in business conditions in China from Q1 to Q2. Both of those signs point to a strong, you know, strong China in Q2.
Of the factors, we really think the consumer electronics is the bigger driver of the sequential ramp up than kind of the improvement in broader factory automation business right now.
Paul Chung (Analyst)
Okay, thanks. Inside a longer term question on your, I think, your operating margin target of 30%. Given the emerging customer initiative, do you see kind of underperforming the target in the near term? Of course, the revenues are having an impact, but how should we kind of look at that return to 30% operating margin? Could it take longer?
Rob Willett (President and CEO)
Right. Yes. You're correct. I think you said at the beginning 20. 30% is our-
Nathan McCurren (Head of Investor Relations)
30%. Yeah.
Rob Willett (President and CEO)
operating margin target. You know, that we're very, you know, confident in that over the longer term, right? I think, you know, as you think about our operating margins this year, I think much more of it's gonna be driven by volume really. I think we're, as we said, we're through the challenge we had around broker buys as that goes away. That should help. I think if we can't get the sort of volume at that, you know, due to the slower market conditions, that's likely to weigh on our operating margins. Certainly our emerging customer investment, which full size for you, I think between $25 million and $30 million, it will weigh on our operating margins.
I think this year, you know, there are challenges that I think we all understand as we move into next year, I think, you know, that the emerging customer segment should start to contribute, you know, and we'll see some good performance there. We expect gross margins in that business to be strong, you know, similar to the current profile of our business. We'll be investing in sales heads to reach, you know, more and more customers. That will weigh potentially on our operating margin. I still feel, you know, very, very positive about getting it up to 30% as we have, particularly if we see our overall business bounce back.
Nathan McCurren (Head of Investor Relations)
Yeah. Yeah, I think if we looked at last year, Dharam, you know, we delivered GAAP operating income of about 24.5% on a full year basis. Obviously that was with about $1 billion of revenue. You know, if I think about the levers there that would have taken us to 30% or very close, you know, our gross margin was about 300 basis points below our mid-year target, right? Rounded to 72% versus a mid 70% target.
Rob Willett (President and CEO)
Then we had about a $20 million loss from the fire. Think of that as about a 2% drag on operating income. I think if we look at this year, you know, we're expecting the growth margins to improve as we've communicated in our Q2, but on a, you know, on a full year basis, we'll still obviously have the Q1 there. We've sized the emerging customers investment, which again, we're not seeing any payback this year, so that's just a pure investment this year. Then, you know, the rest is really a function of how our revenue performs relative to our sort of fixed cost.
Overall it's not a difficult path with a bit more revenue growth and emerging customers starting to become, you know, an investment that's paying off versus a pure investment and gross margin problems behind us to be back at our targets.
Paul Chung (Analyst)
Okay. Just quickly, which region do you think you would start seeing this, the benefit from the emerging customer, first initially, or is that difficult to say?
Rob Willett (President and CEO)
We're thinking of it in global terms, we don't really wanna disclose too much at this point for competitive reasons.
Paul Chung (Analyst)
Okay. Thank you. Thanks a lot.
Operator (participant)
Our next question comes from the line of Keith Housum with Northcoast Research. Please proceed with your question.
Keith Housum (Managing Director, Research Analyst)
Good morning, guys. I appreciate the opportunity here. In terms of the demand environment that you're seeing out there, you know, we're hearing a lot of, you know, pauses and delays. Can you help me understand, like, when is the decision made to buy a Cognex product versus, like, when the CapEx spending happens? Is there a long lead time between the two events?
Rob Willett (President and CEO)
I think there are different pieces of our business, right. Probably, let's size it, roughly two-thirds is a relatively short cycle business. You know, customers are identifying and executing products and placing orders within a 60-day window or so. It's worth pointing out that, you know, we generally supply very quickly and we have, you know, some with the distributors we have or the end users don't hold inventory of products. I think you're gonna see our business inflect more quickly in that kind of environment. We have the rest of our business might be much larger, customer-related, and we spend a lot of time talking about that in e-commerce and there are some customers also in consumer electronics, big smartphone businesses.
Then, you know, to some degree some of these EV battery businesses we're talking about, they have a longer timeframe. They may be implementing a, an automation project that's 18 months in duration. We would be in discussions with them, and they may be placing orders then for the turn into revenue over a longer period, possibly six months in nature, right? As they commission bring up their lines and we recognize revenue. I'd say two-thirds short cycle, one-third, you know, kinda long-longer cycle in a, in a normalized business for Cognex over the last few years or so.
Keith Housum (Managing Director, Research Analyst)
Okay. That's helpful. As a follow-up, you know, we're hearing also obviously delays in, you know, longer sales cycle in the decision-making process. How is the pipeline, I guess, before you get to that process? Is the pipeline growing as you're seeing more of these deals kind of being delayed?
Rob Willett (President and CEO)
Yeah. We've, you know, we've implemented Salesforce.com over the last few years and we really, you know, we're very pleased with the progress we're making on, you know, kind of our CRM and understanding of our business. We are, you know, we see larger opportunities in a big funnel, but I think the expectation is that that's gonna shift to the right as projects get delayed and customers, although there's lots of things they wanna do with Cognex vision, we all know that, and the payback can be very good. Definitely, we see that tightening going on. I've been to a few customers over the last few weeks who are definitely seeing that, you know, from the automation engineers who are struggling to get projects approved that have great payback.
Lots of opportunity, lots of caution is how I would describe it.
Keith Housum (Managing Director, Research Analyst)
Great. Thank you.
Operator (participant)
We have reached the end of the question and answer session. I'll now turn the call back over to Rob Willett for closing remarks.
Rob Willett (President and CEO)
Well, thank you for joining us this morning. We look forward to speaking with you again on next quarter's call. May the fourth be with you.
Operator (participant)
This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.