Greetings and welcome to the Cognex Fourth Quarter 2023 Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Nathan McCurren, Head of Investor Relations. Thank you. Please go ahead.

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

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

Thank you, Rob, and hello, everyone. Turning to results for the fourth quarter. Revenue declined 18% on a reported basis. This includes $7 million of revenue or a three percentage point contribution from Moritex. I'll also remind you that we're comparing against the fourth quarter in 2022 that included $20 million of revenue that shifted from the third quarter due to the fire at our primary contract manufacturer. From an end market standpoint, our biggest year-on-year declines remained in consumer electronics and semi. Broader softness continued across our other factory automation businesses such as automotive, medical-related, consumer products and food and beverage. The underlying business conditions we are seeing in each of these end markets remain consistent with what we reported in the past two quarters. These end markets were roughly flat sequentially, but declined year-on-year, mostly driven by the timing of 2022 revenue due to the fire. Within automotive, we continue to see softness across the internal combustion business and increasing demand from EV battery manufacturers. Logistics remained stable, contributing growth sequentially and roughly flat year-on-year. On a geographic basis, revenue in the Americas increased sequentially driven by growth in logistics. Revenue in China stepped down further in the quarter as we continue to see a challenging economic environment. Year-on-year, revenue declined across all regions with the steepest decline in China. Adjusted gross margin in Q4 was in line with expectations at 70.7% or 68.7% on a reported basis, including $4 million of acquisition costs and intangible asset amortization in the cost of sales. Compared to last year, favorability from the decline in broker buys was offset by volume deleverage, Moritex and unfavorable mix. On a sequential basis, adjusted gross margin was down slightly due to Moritex. Let's turn now to operating expenses. Adjusted operating expenses increased $5 million or 5% sequentially and $6 million or 6% year-on-year. The sequential increase is due to the timing of incentive compensation and other employee benefits and the addition of Moritex. The year-on-year increase is driven by the investment in the Emerging Customer initiative and Moritex, partially offset by continued diligent cost management and lower incentive compensation. Excluding the Emerging Customer initiative in Moritex, adjusted OpEx would have declined by $4 million or 4% year-on-year. As you'll see in our non-GAAP reconciliation tables, we had $8 million of acquisition costs and $2 million of amortization of acquisition-related intangibles in the quarter. Adjusted EBITDA was 13% in Q4, below Q4 of 2022 due primarily to operating deleverage and our investment in emerging customers. Adjusted diluted earnings per share was $0.11 in Q4, a year-on-year decline driven by lower revenue and margins, partially offset by a lower tax rate and share count. Turning to the balance sheet, Cognex reported a strong net cash position at the end of Q4 with $576 million in cash and investments and no debt. The $270 million quarter-on-quarter decline was driven by the closing of the Moritex transaction in the quarter. After acquiring Moritex, we believe we still have sufficient capital to support our growth plans and to continue to return capital to shareholders through stock buybacks and dividends. With that, I'll turn it back over to Rob to discuss the future growth drivers and the outlook.

Thanks, Paul. And thank you, Paul, for being a valued member of our executive team over the past four years. As previously announced, Paul will be leaving Cognex on March 15. He's made significant contributions to Cognex's success, including enhancing Cognex's planning and budgeting process and overseeing investments in Cognex's CRM platform. The external search for our next CFO is progressing well. I am pleased with the quality of candidates we're seeing, and we will update you with developments as they become available. Now let me spend some time discussing how we continue to invest in the future despite near-term macro challenges. Last year, Cognex worked hard to release more products than in any previous year in Cognex history. Our portfolio of new products leverages the best rule-based vision while incorporating more human-like inspection capabilities made possible by advances in deep learning and edge learning artificial intelligence technology. As with many industries, developments in AI have profound implications for industrial machine vision. We were early to identify major advancements in AI technology, leading to the acquisition of ViDi Systems and Sualab in 2017 and 2019. These acquisitions jump-started our innovation around the use of convolutional neural networks, the technology now powering our deep learning and edge learning products. AI makes our products easier to use and sell and makes machine vision more human-like, enabling Cognex to expand its applications where human inspectors have previously been the only viable option. Increases in the cost and specialty of labor continue to be a problem for our customers. We estimate that 35 million people across the globe are manually completing vision inspection tasks, such as examining products for scratches, dents and defects. One of our customers estimates that they spend over $1 billion per year on human visual inspectors. AI-enabled machine vision can complete this work more cost-effectively while helping to improve quality and productivity. Our deep domain knowledge allows us to leverage the best of rule-based deep learning and edge learning technologies to address the full spectrum of customer needs. We remain dedicated to helping the world's most sophisticated manufacturers and logistics providers achieve their goals while also bringing Cognex machine vision technology to more markets and new customers. To reach the broader customer base that can now be served by our new easier-to-use edge learning technology, we launched our Emerging Customer initiative, a sales force expansion that drove $28 million of OpEx in 2023. Our initial Emerging Customer sales class is now trained and has started to sell. We expect this initial class of Emerging Customer sales representatives to generate over $50 million of incremental revenue and positively contribute to operating income in 2024. Early orders reinforce our belief that this initiative can be gross margin accretive. Now equipped with the right products and with a defined process for hiring and training, we are well positioned to welcome our second class of Emerging Customer sales representatives this year. We have budgeted approximately $25 million of additional OpEx for this initiative in 2024. I'll turn now to our outlook for the first quarter, along with a few thoughts on the full year. In the first quarter, we expect the following results: revenue between $190 million and $205 million, which represents flat year-on-year and sequential growth, reflecting another challenging quarter. I will note that this is narrower than our normal $20 million range as we continue to see a relatively stable operating environment. Moritex should contribute 6% to 8% of revenue in Q1 and for the year. Adjusted gross margin in the high 60% range. Gross margin continues to be below our long-term targets given volume deleverage and negative mix. A full quarter of Moritex is expected to be an approximately two percentage point drag on gross margin, an incremental 100 basis point headwind compared to Q4. Our gross margin guidance also includes an approximately two percentage point drag from a strategic logistics project with a large customer. The project has higher upfront costs but includes high-margin recurring revenue enabled by our edge intelligence software. We expect adjusted operating expenses to increase mid-single digits on a sequential basis due to investment in our Emerging Customer initiatives, higher incentive compensation and the impact of a full quarter of Moritex operations. For the full year, we expect the incremental $25 million of Emerging Customer OpEx to ramp throughout the year, similar to the investment we made in 2023. We also expect incentive compensation to be a $15 million to $20 million year-on-year headwind. While we continue to see a challenging operating environment in the first quarter, we are more optimistic about the back half of the year. We have started to see signs in longer cycle businesses that momentum could be building. For the full year, we expect logistics to grow as we start to see infrastructure investment plans materializing, though logistics growth this year will likely still be below the long-term market growth we expect. We expect our EV battery business to be a strong growth driver long term, but we are seeing more tentativeness from these customers, driven by uncertainty around end-user demand and the political environment. The semi landscape is improving, as you have heard from the leading semi equipment manufacturers, with more optimistic 2024 outlooks. Consumer electronics has positive long-term trends, but the timing and in-year contribution remains uncertain. As usual, we expect to have more visibility by next quarter and to give you more clarity for the year on our next earnings call. While we expect to deliver below target growth in the first half, we remain confident in our 15% annual revenue growth target over the medium to long term. Based on double-digit market growth, expansion of our served markets, our pipeline of new products and our reputation with leading manufacturers, we believe the progress Cognex has made last year on several promising initiatives positions us well for the future. Now we will open the call for questions. Operator, please go ahead.

Our first question is from Andrew Buscaglia of BNP Paribas. Please proceed.

Hi, good morning, guys.

Good morning.

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

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

Yes. Okay, okay. And then just to clarify the Q1 guidance for margins, it seems reasonable to say that excluding the two-point dilution from Moritex and the two points from this logistics project, you're closer to 70%. Additionally, could you explain how this initiative is expected to improve gross margins? Can you share details about some of the pilots you've conducted or provide additional information that would give us confidence that these efforts will positively impact margins?

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

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

Okay. Thanks for the answers. Appreciate it.

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

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

Yes. Thanks, Jim. I've spent a lot of time in the last two quarters out meeting with a lot of EV battery manufacturing companies. So, I can tell you that there's a huge investment going on in that industry, particularly in Europe and America. It's so Cognex has two really kind of vectors, I would say, on that growth. One is just building lines. These customers are building EV production lines to coat and cut in the line and stack and inspect EV batteries, right? And I've visited just in Europe last week, two companies that are investing over $1 billion to do that, right? Not all of it in automation, obviously, but real momentum. That is not a short-term thing, right? So - and machine vision is key to them doing that. So there's new lines, new builds where, as one would expect, Cognex is one of the preferred suppliers for what is quite a challenging machine vision kind of a task that goes on. The second - so I think that's sort of the, if you like, the new build greenfield type scenario that we might be familiar with from other industries at Cognex. But there's a second thing going on, which is manufacturing of EV batteries is very competitive on the innovation side, but it's also pretty dangerous and legally concerning thing for these companies. So they're very concerned to inspect in quality. And we've been developing technology in that market that is very advantaged both through the computational imaging company we bought last year, SAC - actually, I should say in 2022. And then our deep learning technology, which helps - those two technologies together allow us to image with incredible speed and definition scratches, dents, problems. And then diagnose them with deep learning technology to see whether that's a problem or not. I visited a number of companies in the last six months, who have just said what an extraordinarily challenging and expensive task that is for them, where they're scrapping huge numbers of good batteries that they're just concerned can become problems, cause fires, etc. for them later. So there are those two things going on, Jim, which is really, I would say, the sort of sweet spot of what Cognex is doing. On the downside, and I think this is what you're hearing and I think we're hearing it too, is there's anxiety. There's anxiety about will EVs be successful as we think? Are they perhaps niche kind of products for wealthy customers, or are they broadly going to cannibalize a lot of the internal combustion engine business that's out there? And I've so that's kind of one issue. On the one hand, we will see the slowing sales of EVs and the relatively poor EV numbers reporting out of some of the big companies. So, I think there's a concern that they are becoming a little more cautious, the end-user consumers. And then there's another end-user vector, which is one Chinese company, BYD, is talking about developing and selling a $12,500 EV car. So - and really selling it very broadly in some of the markets that perhaps in America, we're less focused on. So there's plenty to be interested in and confused on that vector. And then the final one, in terms of long-term demand, which we see with our customers too, is there is some concern about political changes and support for EV business, right? So most - one specific large EV producer from Asia has certainly communicated that they're putting some of their investments in the U.S. on hold until they see more of a clarity in the political environment and what that means for some of the subsidies that they would be expecting to receive through the Inflation Reduction Act. Jim, it's a long answer, but I hope it's helpful.

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

Yes. We started pilot programs around 1.5 years ago and have a few sales representatives assisting us in understanding the process. We conducted numerous experiments and subsequently hired a significant number of individuals in the first class starting in April, with the last group joining around October. We've trained them and nearly all are now in the field, which is crucial to our growth expectations this year. We'll begin hiring the second class throughout the year as they become available in the regions where we're hiring. However, I don't anticipate them making a meaningful contribution to revenue growth in 2024. The trained sales representatives have a strong advantage with our learning and ID products and are currently in the field focused on metrics such as sales calls and other important sales indicators. We are tracking their performance and expect them to improve over time due to the learning curve, which we have incorporated into our forecasts. They should contribute positively in the first quarter, with increased contributions expected each quarter as the year progresses.

I would just add that we believe this is gross margin accretive based on all the tests and pilots we've conducted so far. The drivers of this are twofold. One factor is that many of these customers, though not all, are lower-volume customers, so their expectations regarding volume discounts are clearly lower and our realization of list prices is higher. The second factor is that we are selling our easiest-to-use products, which require less service, and the superior technology involved allows us to achieve high margins with these sales.

Thank you.

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

Good morning, everyone.

Good morning.

Paul, I appreciate your help over the years and wish you the best of luck in your next endeavor, and hope you get to work hard, and play hard, and move fast in whatever that next chapter is.

Thanks, Jacob.

Just on China, I know this is - it's a market I think sometimes that's just hard to know what's really happening if you're not there, and it's certainly been a challenge, for a lot of companies that we cover. And obviously, a big piece of that for you folks is consumer electronics. And maybe we have to wait another quarter to hear how that's shaping up. But Rob, maybe if you can just give us a sense of what you're hearing broadly from the field in terms of sentiment. And we've heard some companies indicate that January was actually off to a pretty good start. So just curious what you're seeing there?

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

Yes. Jacob, I’d like to add a few points regarding our financials and your earlier comment about China potentially starting off somewhat stronger in January. The seasonality in China and more broadly in Asia is a bit different compared to other regions of our business. We usually observe an increase from Q4 to Q1. Your observation may indeed be valid, and we would notice it from a seasonal standpoint. Our guidance for Q1 is essentially flat compared to last year and Q4. However, the situation changes when viewed sequentially; we are seeing a slight increase in Asia. In terms of year-over-year performance, we anticipate that China will be weaker than it was last year. Therefore, it really depends on your perspective. Moreover, in terms of our full year results, as Rob noted, we experienced a 28% decline in China for the year, which translates to a 23% decline in constant currency, with a five percentage point impact from foreign exchange due to a weaker CNY. The largest factor contributing to this was our consumer electronics business in 2023. While the overall business faced challenges, our numbers were more negatively affected due to the significant influence of consumer electronics in that decline. It is essential to distinguish between these two aspects, and as we progress through the year, I am confident the team will highlight these differences where they’re significant.

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

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

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

Revenue declined by 21% in logistics last year and was down 25% in 2022 after a significant growth of 65% in 2021. We've experienced a shift, influenced by pandemic-related investments in e-commerce during 2021 and the subsequent overcapacity that is being addressed. This trend is continuing as anticipated. Our logistics business is seeing solid growth among newer, smaller customers, although not at the pace we desire, yet we recognize the underlying growth potential. We observed positive quarter-on-quarter growth in logistics in Q4, indicating a promising shift back toward growth primarily from smaller clients who are starting to adopt vision technology and edge intelligence, along with expansion in parcel and postal services. We've secured some significant contracts that suggest an upward trajectory for larger business in the future. There's considerable opportunity across various global markets, particularly in e-commerce in India. We believe our larger customers will eventually resume their previous scale of engagement with Cognex, although predicting the timing is still uncertain. Overall, our business momentum, market reach, and technology acceptance are showing encouraging signs of growth. Notably, companies like Walmart are planning to automate many of their U.S. warehouses, while UPS has expressed its commitment to enhance warehouse automation and throughput, exemplifying the strong demand for advanced automation and vision technology. It is also worth mentioning that we did not have a customer contributing 10% of our revenue last year, which is a significant observation. However, we are optimistic about the prospects for our logistics business as we move forward into the year.

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

The quick answer is that we made the decision to assist a significant customer in implementing our edge intelligence technology during this quarter. This product has been in development for quite some time and enables us to manage all of our vision systems, which is particularly useful for large clients with extensive deployments. It allows us to coordinate support and upgrades, while also providing crucial manufacturing data to our customers. We believe that customers should subscribe on a monthly basis for this service, and this represents our largest achievement with the product to date. We've signed a contract that will facilitate monthly billing and we hope to enhance its functionality over time. Additionally, when we install our applications, we provide this technology to customers and encourage them to use it after a free trial. This initiative is part of our strategy to transition our business to a subscription model, which should be highly profitable as it expands. We have been diligently working on this for a significant period, and while it is still early for commercial rollout, this is a promising first example. We anticipate many more successes as the technology matures and customers recognize its value.

Thank you.

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

Thanks. Good morning. Paul, wish you the best of luck. And then love the slides, so thank you for the additional detail this morning. My first question, maybe just starting on Slide 6. I know it's really early in the year, Rob, and kind of hard to have a perfect crystal ball on exact growth rates for 2024. But I'm curious, you already mentioned that logistics you expect to grow. If you had to force rank your different end markets or businesses in '24 and where you would expect to see the most growth versus potentially the least growth, I'd love to hear any color you would have at this point?

Yes, Joe. I'm doing well. We don't provide full guidance for the year or by industry. However, I can share some insights. From my 25 years of experience running industrial companies, January is often a confusing time as many businesses are still getting into gear, especially with Chinese New Year around the corner. So, it's too early to make definitive statements. Overall, I believe our industries align with our long-term growth plans for the year. We anticipate growth in logistics and are confident about returning to strong performance there. It’s worth noting that logistics can have longer cycles, so bookings might not translate into revenue immediately, possibly up to 25%. However, we expect to report good results. Consumer electronics has the potential for a strong rebound, though it’s too early to confirm that. The automotive sector is generally a long-term grower at around 10%, but it currently faces some challenges. We are optimistic about electric vehicles contributing to growth and potentially offsetting declines in the internal combustion engine business, but I would rank the automotive industry lower in expectations among our major sectors. That said, the situation can change quickly. Those are my thoughts for you, Joe.

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

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

Okay. Good to hear. Thank you, guys.

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

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

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

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

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

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

Appreciate all the color. Best wishes, Paul, and good luck this year.

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

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

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

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

Most of the new sales representatives are recent college graduates who have received the necessary training. While many possess engineering backgrounds, they are generally more comfortable with technology and its applications. As the industry evolves from analog to digital, there is a shift away from specialized programming, resulting in a different pace and cycle in sales. Cognex provides these new sales representatives with a promising career path, investing in their training and development. They appreciate our company culture, and we value the energy they contribute. We aim to help many of them advance into larger roles, with more complex sales opportunities and management positions. This is our perspective on the situation.

I think we have time for one more question, I think.

Yes, please go ahead.

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

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

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

Okay. Helpful. Thank you.

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

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

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