Greetings and welcome to the Cognex First Quarter 2023 Earnings Conference Call. [Operator Instructions] 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.

Thank you, Shmouli. 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 2 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.

Thanks, Nathan. Good morning, everyone and thank you for joining us. As anticipated, we had a challenging first quarter of 2023. Revenue from our largest e-commerce customers remained low, and we continue to see cautious investment by customers across many of our end markets. More projects in our sales funnel are being delayed by spending cuts and additional levels of executive approval at our customers amid concerns about near-term demand. 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, and we’ve come out of them delivering meaningful growth. Our business is shorter cycle and not as backlog driven, as many of our peers, so it tends to inflect more quickly. Additionally, we are comparing to an exceptionally strong Q1 of 2022, highlighted by large logistics projects and backlog catch-up as the supply environment improved. Gross margin of 71% in Q1 was in line with our 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.

Thank you, Rob, and 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 multiyear investments, and we continue to develop strong customer relationships worldwide with an industry-leading offering for EV battery inspection. Even so, automotive spending in the 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-on-year revenue decline. Outside of these few large customers, we saw growth in the remainder of our logistics business. Logistics is still in the early innings of adopting machine vision. Most companies rely heavily on labor and very few warehouses globally are realizing the full potential of automation. E-commerce and omnichannel players beyond our largest e-commerce customers are investing as they strive to automate more, and we continue to make progress in parcel and post. 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…

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 5x increase over what was announced last year prior to the passage of these subsidies. Cleantech 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 3 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 reinforced 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…

[Operator Instructions] Our first question comes from the line of Joe Giordano with TD Cowen. Please proceed with your questions.

Hey, good morning guys.

Good morning, Joe.

So you mentioned that the logistics decline is from large customers and that the smaller customers were growth – were still growing. And I know we’ve heard commentary from a lot of companies that those smaller players who are investing in logistics expect to kind of keep spending through a potential recession? I guess my question is, do you believe that 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, that they are saying that now?

I think if we strip out our very small number of large e-commerce customers, what we are seeing is that the rest of our customers continue to grow. So, that’s the good news. But I also don’t think that they are completely immune to the macro conditions that we are all seeing. So I visited some of those over the first quarter. I am hearing also pressures on costs generally within those companies too and more scrutiny of capital spend. So we see this as a great growth opportunity for us, the base logistics business. It’s growing, and we expect it to go on growing nicely, but it’s not immune to pressure would be my take on it.

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

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

And just sneaking one last question more at high level, you are hearing a lot of talk about RFID more recently. And if there’s a – what does that mean for you if there’s a more protracted move from barcode toward RFID or how do you even think about that progression? Is that an area that you are interested in or think about?

Yes. So been in this industry for about 25 years, and we’ve certainly seen RFID trials. We see them from time to time over a long period we have 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 will have probably seen some big quite high-profile RFID trials going on at a large parcel delivery company. So I think that’s what’s perhaps creating some noise. What I would say is I don’t see RFID and machine vision competing significantly with one another. I think they just offer very different 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. So I observed some of that, but I don’t see it taking any business from us currently nor have I over a long period, nor do I really expect to in future periods.

Thanks, guys.

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

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

I think we don’t really give guidance for the second half, but there is obviously quite a lot of noise we’re going to see when we compare to prior year. We had – as you and many of you know, we had logistics – big logistics customers really tapped their brakes as we went in – or put the brakes on firmly as we went into the second half of last year. And we also had a fire in our main contract manufacturer’s warehouse, which certainly caused some distortion. So we’re going to get much easier compares as we go into the second half of the year. In terms of seasonality, hard to call, but I think we – history tells us we can expect Q2 and 3 to be large consumer electronics quarter for us. And in Q4, it’s very hard to call that as we go out further. And it really depends on the overall environment, we can see a lot of year-end spending in different markets. We may have a better sense of how logistics is looking as we get into Q4, whether there is – as we can see some large year-end projects and committed coming through in our bookings. But that’s too hard to call at this point.

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

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

It’s mostly – the most growth, I’d say, excluding stock option, would be driven by the emerging customer initiatives that we’ve made. We are carrying some additional headcount beyond that, but really, the bulk of the headcount has been investment for that initiative. And then we do have merit and promotions and such sort of annual comp increases that you lap in any year-over-year comparison. So those are probably the biggest factors. I don’t know if this will hold in Q2, but certainly in Q1, travel was up a little bit versus a year ago, which we do is a very good thing that we’re able with COVID restrictions basically entirely behind us, we’re able to pay more customer visits and deepen those relationships, which we know pay off over time. But those would be the things I would call out.

Thank you.

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

Good morning, and thank you for taking my questions.

Hi, Tommy.

I wanted to stay on the topic of the emerging customer initiative. So per the guidance, it looks like the level of investment is up sequentially in the 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? And then as you think about harvesting the return on this investment, what kind of timeline should we be thinking about in terms of being able to flip from margin dilutive to potentially margin-accretive here? Thank you.

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 detail. But just to get it to a level set, so Cognex traditionally has been very, very successful with the most sophisticated manufacturers of discrete products. And they love our technology, and it’s remarkable, very strong relationships, but there is a whole part of the market. If we serve 30,000 customers today in the sort of top of that segment, we think there are as many as 300,000 customers further down the pyramid that really can benefit from our technology, but we haven’t had the ease of use and ease of implementation with our products that was needed to make those customers absorb our technology and for us to serve them profitably. That’s really changed over the last couple of years and probably one of the main things or definitely one of the main things that’s changed is edge learning, right? This is products that allow very easy training so we can look at a technology component or a closure on a bottle or all kinds of applications in markets, consumer products would be a good example. And with relatively low scale and low automation capability, we can take machine vision and apply it to customers there. So that’s been a real trigger for us. We talked about it at Analyst Day back in September. And we’re in 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, and we would see substantial growth over long periods. We’re starting it now. So right now, we’re building out those capabilities. We’re recruiting and training salespeople to go into the field. And I think we can expect that to ramp as we move forward. It will ramp as we move through the year. And if all goes well, I would expect it to ramp into next year as well and in subsequent years. And I think we would expect those salespeople to be selling very profitable products, similar to our current gross margin profile and operating margin accretive once they are selling volume in the field.

Yes. And Tommy, just to add some expense color there. We communicated this in February. We expect this to be a roughly $25 million to $30 million OpEx investment on the full year for 2023. And it is ramping up from Q1 to Q3. And think about it consistently as it’s primarily an investment in headcount that’s following a campus recruiting cycle in the different geographies we serve. So Q2 will be up from Q1, and we would expect Q3 to be up from there. So the run rate is going to be a little higher than if you took $25 million to $30 million divided by 4 as we – given kind of the ramp-up period is sort of thinking about going into future years. And then in terms of the return, as Rob said, we’re really excited about this. We’re in pilot mode and learning a lot and seeing great initial traction. But we are tempering expectations from a timing perspective. If you just think about hiring folks primarily on a campus recruiting kind of timeline, quite a long training period because they are starting from scratch, unlike most of our salespeople, which we’re hiring with several years of experience from competitors or distributors or other participants in our market. And then just the natural ramp-up period of how effective a salesperson is in their first 6 months versus their second 6 months, their second year versus their first year and even their third year versus their second year. So I think we will have a lot more to share next year on the progress we’re making and sort of the results. But I think in the near-term period, we’re really in investment, hiring, training and pilot mode right now.

That’s all very helpful. I appreciate the insight. And as a follow-up, I wanted to ask about some recent news flow regarding OLED screens and tablets. Noted your commentary on the broader consumer electronics end market looking like a down year for 2023, but maybe not specific to this year, just in general, how big of a commercial opportunity do you see that at? Thank you.

Well, we’ve done substantial business over the last 10 years really on screens as they – and whether it’s micro LED, OLED, those complex products to manufacture. So generally, when there is a major capital investment to ramp up production of new screen technologies, and that can be very beneficial for Cognex, we saw that most pronounced in 2017. As I look at electronics, there are road maps that are under development that we have pretty good insights with our major customers. And then as we move through the year, we see whether these technologies actually scale, right? So any new technology, whether it be that or virtual reality type technology that perhaps may be under development, we can find that can inflect as we move ahead. And I’m not sure exactly what you’re referring to, but I would say, certainly, very high definition micro LED and more importantly, OLED type technology, I think, is a very interesting area as it relates to a screen very close to the eye, which is, of course, key for virtual reality, augmented reality type products. And I’m very bullish on that long-term, but I wouldn’t be banking on necessarily reaching large-scale commercialization this year.

Thank you. I will turn it back.

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

Hi, good morning, everyone.

Good morning.

You talked quite a bit about the opportunity in the EV battery space, and we’re certainly seeing some eye-popping numbers, I guess from the spend that’s going there. But I think from the outside, always it would to be hard to know what that really means in terms of machine vision content. I think it’s quite an automated process, but maybe I’m wrong, maybe just speak to what that – how the content compares in EV battery versus some of the other big verticals that you still on some?

Yes. Thanks for the question. It’s an area we’ve been very focused on currently. And I spend quite a lot of time working and spending time with some of the major line builders and also the two key technology providers in this space. It’s – there is very substantial capital investment going in to build out EV lines planned over the next few years. And it’s hard for me to see also how that wouldn’t continue to scale for a very long period, just given that appetite that seems to be existing for conversion from internal combustion engine to EV going out into the future and the commitments that governments and auto OEMs seem to be making to transform their fleets and general population of cars, right? So I see that. And as I visit line builders and I visit end users and I meet with senior executives at large EV battery manufacturers. And that’s really where the opportunity primarily is for us. It’s in companies that are scaling up production of – and EV batteries. There are three general types. I mean cylindrical, prismatic, some of the ones that you read about and that there is a lot of investment. If you walk one of these lines, there – they can be 1,000 feet long. They can have multiple fixtures the products move through and many of those fixtures, perhaps if there are 30 fixtures on the line, more than half would have potential for machine vision content, be it as simple as barcode reading or alignment. But for us, where we see some of the most advantage of our technology is more inspection of the battery material and the finished battery as it moves through production inspection for damage such as scratches and dents that can result in…

Okay. That’s super helpful. And just on a related topic, I guess, the tide have certainly seems to have gone out in a pretty dramatic fashion in the tech startup world. You’ve done a couple of interesting acquisitions that you mentioned over the last couple of years is – maybe you can speak to the M&A model and whether we’ve got some things that may be closer to getting over the finish line today given the environment out there.

Yes. I think it is one of the most target-rich kind of environment we’ve been in for M&A for quite a long time. I think we see a lot of companies coming up for sale currently where perhaps their business model is about how quickly they would turn cash positive or how much they would grow haven’t really come to pass, right? So 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. Then there are other types of acquisitions, larger companies perhaps that have had owner founders that are looking to retire changes of ownership, we’re also seeing some of those who are coming to market. We’re very – I think we’re very good evaluators of those types of businesses and pretty selective. And we are finding ourselves going to many more management presentations and seeing much more activity than we have in the past. I do think probably there is still some expectations about valuation, which maybe a little outdated, which may lead to some deals being a little bit more difficult to get done, I think. But it will be interesting to see kind of how that progresses, but it’s certainly a very fruitful environment right now, and we’re very active.

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

All sounds encouraging. Thank you, guys. I will pass it on.

Our next question comes from the line of Josh Pokrzywinski with Morgan Stanley. Please proceed with your question.

Hey, good morning, guys.

Good morning.

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

Yes. I’ll sort of give you some big picture perspective on that and then invite Paul to comment. So generally, for us, consumer electronics is a Q2, Q3 phenomenon, right? And so I’d say that’s generally been the case in recent years. It was pretty much the case last year. Paul will fill in on the Q3 question because I’m wondering about fire and how it impacted that. But I think we see something similar this year, right? Our consumer electronics business was a little lower than prior year and Q1, right? So there were some things going on last year related to some larger specific projects. And then what can tend to happen as we move through the year, there can be changes. Last year, we – at this stage, we were thinking it was sort of mid- to high single digits type growth opportunity for us in consumer electronics. So it ended up being perhaps 10 points higher than that once we got through the year, just ballpark numbers. So things can change. But this year, we’re expecting Q2, Q3, probably relatively evenly balanced. Q4 will be a wildcard basically, I think, more around how companies are ramping up for their 2024 plans.

Thanks, Rob. 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 product gets shipped before the revenue gets recognized. So it was a little more isolated from events that happened as of the second week of June last year. So last year, consumer electronics was pretty balanced Q2 versus Q3, Josh. And this year, we’re expecting the same. 2021 and 2020 were a little more Q3 weighted. 2020 was very specific. COVID really delayed the ramp-up of line for quite some period of time and so on. So we are expecting things to be a little more balanced in Q2 and Q3, and that’s reflective of our guide. The only call out I’ll make is there is a lot of large project timing here that can be quite lumpy. So we’re doing our best at any time to predict that, but there are always going to be slight shifts depending on delays in supply, a COVID outbreak that might shut down a factory for a week or 2 and so on. So we’re doing our best. But right now, that’s what we’re seeing kind of pretty balanced between Q2 and Q3.

Got it. Super helpful. I appreciate that color there. And then just on the logistics market. I apologize, I missed the start of the call, lots going on this morning. But any additional comment or I guess rate of change that you would point out, maybe just kind of separate from 2Q specifically more in aggregate, I guess. In March, we saw some of the big integrators seeing another step down in orders, some industrial or I guess, warehouse REITs see lower utilization. Is that something you guys are seeing as well? Or is it just a little too early to calibrate that yet?

Yes, 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 really pared that spending. And I think all of us are kind of trying to understand when that comes back. I don’t think there is much real clarity on that at the moment. And I think smaller customers continue to invest and build out, although, as I mentioned at the start of the call, there is 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. So I think that’s what I see overall. I think it’s important to know that some of the larger integrators perhaps the one that talked 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 are really still working through. And when they purchase from us, some of that may take time for them to absorb and fulfill. So I would kind of point to that as a potential dynamic.

Understood. Super helpful. Best of luck, guys.

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

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

Yes. I think when we think of cleantech, we think of EV battery. It’s just the big play for us, right? And we’ve talked a bit about that is certainly building out large lines to manufacture EV batteries, we see as going to be perhaps the big driver of growth. That said, certainly, we do see more spending and investment and levels of interest in the solar market currently in the United States, not just panels, but things like inverters. For instance, certainly our – one can see that the level of investment and plans ramping there. So I think there are sort of secondary benefits but nowhere on the order of EV batteries, which I think will be the big cleantech mover for Cognex with my expectation over a long period.

Got it. And Europe held up well. Could you elaborate a little bit more on what you’re seeing there and discuss the current competitive landscape?

Yes. So Europe performed better than the Americas and Asia in Q1 but still below kind of the target growth rate. I’d say that any – the softness we saw in Europe related quite a lot to large customers in logistics that buy products from us. So I think most of us on the call understand that Cognex is – has a larger percentage of its business in the Americas and logistics than it does outside of the Americas. So, Europe was less impacted by that. Automotive in Europe grew year-on-year over what was a relatively tepid quarter a year ago. And the PMI doesn’t look that strong in Europe. So, it performed better, but I wouldn’t say it performed well.

Thank you very much.

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

Yes. Good morning. It’s quite clear that your large customers put on the brakes abruptly last year, e-commerce customers and logistics. I am just curious, as we now stand a year from that, has they reached a base level of spending that you can tell a floor, so to speak?

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

Yes. And certainly, Rob, from a sort of full year basis, 2022 versus 2023 in logistics, just given kind of what we have already shared about Q1, right. We were down about $80 million in revenue for the whole business. Our few largest e-commerce and omnichannel customers were responsible for more than half of that decline in the quarter. I would say on a full year basis, logistics this year versus logistics last year, it’s very hard to model in growth right now with just what we have already done in Q1. But I think on a quarter-to-quarter basis now that we are past that tough compare and we have had a few quarters, things are looking a little more steady.

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

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? And if that’s the case, is that any change in the view that you may have had from the discussions, we had three months to go on the call, and you talked about just kind of the regional diversification efforts were slowing some of the deployments, if anything has changed there and strong year-over-year growth this year?

Yes, Rob. So yes, definitely, we see EV as a strong source of growth for Cognex this year and perhaps for many years to come, right. And we – yes, so we are very, very positive about that. Certainly, there is large investments, some of the IRA type investments I referred to in my prepared remarks, are good examples of that. And I think we do see some of that spend getting pivoted towards America, right. And that has caused some projects to get delayed, right, which I believe referenced in previous conference calls, right, but that will be happening. And as I think of that EV market, I think there are perhaps 10 major companies, technology providers and investors in this space or so. So, that means the business can be a little lumpy, right. We – the business was not – is growing as quickly as perhaps we would have expected on a revenue basis in Q1, mostly because of prior year’s business we have seen with some large China suppliers. But all of those customers, I am thinking of are – of those big 10 companies are Cognex customers evaluating our technology, have ambitious rollout schedules. And certainly, we see as a market for great growth. But I think we can expect some variable growth within quarters based on these projects getting deployed.

Understood. Thank you.

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

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

Yes. I will start off and Paul might want to come in also. So yes, we saw a relatively slow start to the year in China prior to Chinese New Year, slower than one would normally expect. I think that was probably a result of COVID there and the difficult time coming in through the start of the year. But then after Chinese New Year, we did see some positive improvement in the business, perhaps at or beyond our expectations. So, we are seeing some better outlook there. And then I think it’s worth pointing out that our business in China is broad, but it does have a significant consumer electronics component to it. So, certainly that normally and I would expect this year also should see some nice sequential growth for us as we move into Q2 and then with Q3 also being positive for us.

Yes. And I would just call out. I think we have had sort of our sequential increase from Q1 to Q2 in revenue. Two factors we have called out. One is the seasonal ramp-up of our consumer electronics business. And that’s by far the bigger factor. Now, the way we report our geographies, a lot of that is going to play out in China next year – this quarter, Q2. And then the second is just a general ramp-up and improvement in business conditions in China from Q1 to Q2. So, both of those signs point to a strong China in Q2. But of the factors, we really I 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.

Okay. Thanks. And I just had a longer term question on your – I think your operating margin target of 30%. So, given the emerging customer initiative, do you see kind of underperforming the target in the near-term, of course the revenues are having an impact, but how should we kind of look at that return to 20% operating margin? Could it take longer?

Right. So, yes, so I think you said at the beginning 20% or 30%, 30% is our operating margin target and that we are very confident in that over the longer term, right. I think as you think about our operating margins this year, I think much more of it’s going to be driven by volume, really. And I think we are – as we said, we are through the challenge we had around broker buys, as that goes away. So, that’s going – should help. But I think if we can’t get the sort of volume that – due to the slower market conditions, that’s likely the line in our operating margins. And certainly, our emerging customer investment with full size for you, I think between $25 million and $30 million, will weigh on our operating margins. But I think as we – so this year, there are challenges that I think we all understand as we move into next year, I think that the emerging customer segment should start to contribute and we will see some good performance there. We expect gross margins in that business to be strong, similar to the current profile of our business. And then we will be investing in sales heads to reach more and more customers. And so that will weigh potentially on our operating margin. But I still feel very positive about getting it up to 30% as we had, particularly if we see our overall business bounce back.

Yes. I think if we look at last year, Jairam, we delivered GAAP operating income of about 24.5% on a full year basis. And obviously, that was with about $1 billion of revenue. And I think about the levers there that would have taken us to 30% or very close. Our gross margin was about 300 basis points below our mid-term – midyear target, right, rounded to 72% versus a mid-70% target. And then we had about a $20 million loss from the buy. So, I think of that as about a 2% drag on operating income. I think if we look at this year, we are not going to – we are expecting the gross margins to improve as we have communicated in our Q2. But on a full year basis, we will still obviously have the Q1 there. We have sized the emerging customers’ investment, which again, we are not seeing any payback this year. So, that’s just a pure investment this year. And then the rest is really a function of how our revenue performs relative to our sort of fixed cost. But overall, it’s not a difficult path with a bit more revenue growth and emerging customers starting to become an investment that’s paying off versus a pure investment to – and gross margin problems behind us to be back at our target.

Okay. And 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?

We are thinking of it in global terms. And we don’t really want to disclose too much at this point for competitive reasons.

Okay. Thank you. Thanks a lot guys.

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

Good morning guys. I appreciate the opportunity here. In terms of the demand environment that you are seeing out there, we are hearing a lot of pauses and delays. But 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?

So, I think there are different pieces of our business, right. Probably let’s size at roughly two-thirds is a relatively short-cycle business. So, customers are identifying and executing products and placing orders within their 60-day window or so. And it’s worth pointing out that we generally supply very quickly. And we have – with the distributors we have or the end users don’t hold inventory of products. So, I think we – you are going to see our business inflect more quickly in that kind of environment. Then we have – the rest of our business might be much larger customer related, and we spent a lot of time talking about that in e-commerce, and there are some customers also in consumer electronics, big smartphone businesses. And to some degree, some of these EV battery businesses we are talking they have a longer timeframe, so they may be implementing an automation project that’s 18 months in duration. We would be in discussions with them and they may be placing orders then for – they turn into revenue over a longer period, possibly six months in nature, right, as they commission bring up their lines and we recognize revenue. But I would say two-thirds short cycle, one-third kind of longer cycle in a normalized business for Cognex over the last few years or so.

Okay. That’s helpful. And as a follow-up, we are hearing also obviously delays in longer sales cycle in the decision-making process. But how is the pipeline, I guess before you get that process? Is the pipeline growing as you have seen more of these deals kind of being delayed?

Yes. We have implemented Salesforce.com over the last few years, and we really – we are very pleased with the progress we are making on kind of our CRM and understanding of our business. And we are – we see large opportunities in a big funnel, but I think the expectation is that, that’s going to shift to the right as projects get delayed and customers – although there is lots of things they want to do with Cognex vision, we all know that, and the payback can be very good. Definitely, we see that tightening going on. I have been to a few customers over the last few weeks, who are definitely seen that from the automation engineers who are struggling to get projects approved that have great paybacks. So, lots of opportunity, lots of caution is how I would describe it.

Great. Thank you.

And we have reached the end of the question-and-answer session. I will now turn the call back over to Rob Willett for closing remarks.

Well, thank you for joining us this morning. We look forward to speaking with you again on next quarter’s call and may force be with you.

And this concludes today’s conference. And you may disconnect your lines at this time. Thank you for your participation.