Earnings Call Transcript - CGNX Q1 2024

Operator, Operator

Greetings. Welcome to the Cognex First Quarter 2024 Earnings Conference Call. 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, Shamali. Good morning, everyone, and thank you for joining us. Our results were released earlier today. The press release, earnings presentation, 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 find a reconciliation of certain items from GAAP to non-GAAP in our press release. Any forward-looking statements we made in the press release, the accompanying presentation posted to our website, 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 our Form 10-Q filed this morning for Q1 2024. On today's call, Rob Willett, Cognex's President and CEO, will discuss our first-quarter results. I will then provide additional detail on the financials, and Rob will conclude with an update on our strategic initiatives and our outlook. Laura MacDonald, our Corporate Controller and Interim Principal Financial Officer, has also joined us in the room for the Q&A portion of the call. With that, I'll turn the call over to Rob.

Robert Willett, President and CEO

Thanks, Nathan. Hello, everyone, and thank you for joining us. Our first-quarter results reflect a challenging but stable business environment. Revenue was above the high end of our guidance range as we saw order volumes slightly higher than we had expected. Revenue, excluding the contribution of Moritex, increased sequentially from the fourth quarter but remained down year-on-year across most of our factory automation end markets. While customers remain cautious with their CapEx investments, I'm encouraged by the early indications of recovery we have started to see in certain end markets. We also expect the slight improvement of macro leading indicators such as the PMI in many of our most important geographies to be a tailwind for our business. This year, we have taken important steps in executing against our strategic initiatives. We expanded the application of our Edge learning technology by launching the In-Sight L38, the world's first AI-enabled 3D industrial vision system. Our 2023 cohort of emerging customer sales representatives entered the field and began actively calling on customers. And we operated the Moritex business for a full quarter and advanced its integration. We remain on track for this acquisition to be accretive to adjusted operating margin and adjusted EPS in 2024. I would like to take a moment to welcome Dennis Fehr, who we announced this morning will become our new Chief Financial Officer, effective tomorrow, May 3. Dennis will lead the company's global finance and information technology organizations. Dennis brings over 20 years of experience, spending the last 6 years as a CFO, most recently as the CFO of 6K, Inc. Dennis joined 6K after spending 5 years as the CFO of Fluence Energy, which he led through an IPO in 2021. Prior to Fluence Energy, Dennis was Vice President of Finance at Siemens, where he spent the first 15 years of his career. Dennis brings broad international experience to Cognex; this includes time living and working in China, Mexico, Germany, and Indonesia. This knowledge will be of great value to Cognex as we continue to execute our global growth strategy. You will hear from Dennis on our Q2 earnings call. Before I go into further commentary on the business and outlook for Q2, I'd like to turn the call back over to Nathan to walk you through more of the results.

Nathan McCurren, Head of Investor Relations

Thank you, Rob. I will walk through our financial highlights, which you can see on Page 4 of our earnings presentation posted to the website this morning. First-quarter revenue of $211 million increased by 5% year-on-year with the contribution from Moritex of just under 8% of total revenue. Excluding Moritex and foreign exchange effects, revenue declined 3%. Turning to margins. Adjusted gross margin was 68.8% in Q1, in line with guidance and down from 71.8% a year ago. Gross margin included a 2 percentage point dilution effect from a full quarter of Moritex. There was also 1.6 percentage points of unfavorable one-time events in the quarter, primarily the strategic logistics project with future recurring revenue that we mentioned on our last call. Sequentially, adjusted gross margin stepped down due to Moritex and one-time effects. Adjusted operating expenses increased 3% year-on-year as expected, driven by a full quarter of Moritex and increased investment in our emerging customer initiatives. Excluding these strategic investments, adjusted OpEx declined 6% year-on-year. Sequentially, adjusted operating expenses increased 5% as expected. In addition to higher costs for the emerging customer initiative and the full quarter of Moritex, there was a reset in incentive compensation at the beginning of the year, as we mentioned last quarter. Adjusted EBITDA margin was 11.9% in Q1, down from 13.5% a year ago. This was driven by a lower gross margin and higher operating expenses related to emerging customers, partially offset by the positive contribution of the Moritex acquisition, which was accretive to adjusted EBITDA margin. Diluted earnings per share on a GAAP basis was $0.07, down year-on-year due to lower operating margins, acquisition and amortization costs, and unfavorable discrete tax items. Sequentially, GAAP diluted EPS increased 7%. Adjusted diluted EPS was $0.11, down $0.02 year-on-year and flat sequentially. The adjusted effective tax rate was 16% in both Q1 of 2024 and Q1 of 2023. I will now go through our end market results, which you can find on Slide 5 of the earnings presentation. I'll discuss the end market and geographic results, excluding the contribution of Moritex. Markets have been mixed to begin 2024 as we have seen both continued weakness as well as pockets of positive signals. Starting with automotive. Revenue was down year-on-year but flat sequentially. EV battery revenue continues to be lumpy, and in the first quarter, we saw customers delay some project spending as they face uncertain near-term demand. Moving on to logistics. Revenue grew year-on-year but was flat sequentially. Much of the business remains stable, and we executed a sizable strategic project in the quarter, driving year-on-year growth. Consumer electronics revenue was down year-on-year, although the rate of decline slowed compared to the back half of 2023. Rob will go into more detail regarding what we expect from Consumer Electronics for the full year. Semi had strong momentum in the quarter, with year-on-year growth turning positive after 4 quarters of significant declines. From a geographic viewpoint, revenue growth was strongest in Asia outside of China led by strength in semi and logistics. Americas also grew in the quarter, driven by its higher logistics mix. Outside of logistics, Americas experienced continued softness across our factory automation business, as is also the case for Europe. China remained challenging as revenue in the region declined year-on-year for the sixth consecutive quarter. Turning to the balance sheet. Cognex continues to have a strong cash position with $557 million in cash and investments and no debt. Free cash flow in Q1 was $10 million compared to $22 million a year ago, reflecting lower GAAP net income and increased working capital investment as we continue to scale new supply chain initiatives. We returned $22 million to shareholders in the form of stock buybacks and dividends. Now I'll turn it back over to Rob.

Robert Willett, President and CEO

Thanks, Nathan. Let me spend some time discussing the progress we're making on our strategic priorities. We are making strong progress introducing world-class AI to the field of industrial machine vision. Our latest examples of this is our In-Sight L38 3D vision system, which combines AI, 2D, and 3D vision technologies to solve a range of inspection and measurement applications. The In-Sight L38 greatly simplifies the process of configuring 3D systems, thanks to embedded AI technology that uses pretrained models with domain-specific data. Cognex has captured this data through our long history of serving customers. The In-Sight L38 example-based training replaces complex programming steps previously required in vision application development and enables our technology to address a broad array of applications. The In-Sight L38 unique AI-powered 3D tools can be set up in minutes, requiring as few as 5 to 10 labeled images to automate a task. With a few simple points and click training examples, customers can guide robotic arms to locate items on a conveyor, measure glue to ensure its consistent application, or read tire identification numbers on low-contrast black rubber material. Example-based learning solves 3D applications in a more intuitive and human-like way, enabling Cognex to expand its application where human inspectors or off-line measurements have previously been the only viable option. I'll shift now to give you an update on our emerging customer initiative. Our excitement continues to build for this initiative as it broadens our customer base and deepens our penetration into end markets such as packaging. Our initial emerging customer sales cohort fully entered the field and began to sell at the beginning of this year. These sales nodes have been demoing and selling to customers we had not previously called on. We've seen a lot of new applications with these customers. Some examples of emerging customer applications include inspecting the quality of food items like bread, pizzas, and biscuits, detecting the presence or absence of sealing caps on air fresheners, verifying bottle caps are properly filled, confirming the correct insertion of connectors for an electronics customer, and performing optical character recognition and the classification of parts for an automotive parts manufacturer. We are building a funnel of opportunities for this initiative and are encouraged by what we have seen. We expect our emerging customer sales representatives to make over 80,000 customer visits this year. We've had early success across geographies and end markets, and we continue to build this team towards delivering at least $50 million of incremental revenue in 2024. Early orders continue to reinforce our belief that this initiative will be gross margin accretive. We're excited to grow this initiative by welcoming our second cohort of emerging customer sales representatives in 2024. Let me now give you an update on our integration of Moritex. We made good progress on the integration in Q1. Our engineering teams are already collaborating on optics innovation, and our sales teams are driving successful customer engagements. The experienced leaders who joined us from Moritex are now leading Cognex Japan. While we expect Moritex products to be slightly dilutive to total company gross margin in the medium term, we continue to expect the acquisition to be accretive to adjusted operating margin and adjusted EPS in 2024 and beyond. I'll turn now to our outlook for the second quarter. In the second quarter, we expect revenue between $230 million and $245 million. This step-up from the first quarter is in line with our typical Q1 to Q2 consumer electronics seasonality. I will remind you that Q2 of last year included $15 million of consumer electronics revenue that we originally expected in the third quarter of 2023. Adjusting for that baseline effect and excluding Moritex, this range implies revenue to be slightly down year-on-year. We expect the Moritex business to contribute 6% to 8% of revenue in Q2. Gross margin continues to be below our long-term targets given the volume deleverage and approximately a 2 percentage point dilution effect from Moritex. We expect the first quarter to be the low point for the year in adjusted gross margin. For the second quarter, we expect adjusted gross margin to be slightly above 70%, a sequential step-up as we move past the gross margin diluted one-time events in Q1 and expect stronger revenues, as just mentioned. We expect adjusted operating expenses to increase low to mid-single digits on a sequential basis due to additional investment in the emerging customer initiatives and higher incentive compensation. As we disclosed last quarter, we expect an incremental $25 million of emerging customer OpEx for the full year, the timing of which should ramp throughout 2024 similar to the investment made in 2023. We also expect incentive compensation to be a $15 million to $20 million year-on-year headwind materializing mostly in the second through fourth quarters. Logistics has continued to be stable and we believe is well positioned to grow as automation penetration increases and e-commerce investment returns. For the full year, we expect logistics to grow as we start to see infrastructure investment plans materializing. So logistics growth this year will likely still be below the 30% growth we target long-term in this market. Consumer electronics has positive long-term trends, but the timing and revenue contribution can be lumpy. We do not expect 2024 to be a significant growth year for consumer electronics. For the full year, we expect revenue in 2024 to be approximately in line with 2023 with continued uncertainty of project size and timing. We are seeing more tentativeness from EV battery customers driven by concern around near-term end-user demand and political uncertainty. We started to see delayed projects result in a reduction in the pace of greenfield investments from our EV customers. We are still seeing customers invest in productivity improvements and product upgrades on existing lines, and we still expect our EV battery business to be a robust growth driver over the long term. The semi landscape is improving as leading equipment manufacturers have communicated a more optimistic 2024 outlook. We're excited that Moritex gives us additional opportunities in this market, which looks well positioned for strong growth. We are encouraged by the positive macro signals we have started to see, and we believe the progress we are making on our strategic initiatives keeps us well positioned to capitalize on exciting industry trends as the operating environment begins to improve. Now we will open the call for questions. Operator, please go ahead.

Operator, Operator

Our first question comes from Damian Karas with UBS Securities.

Damian Karas, Analyst

Can you hear me?

Robert Willett, President and CEO

Yes, we can hear you.

Damian Karas, Analyst

Congratulations on completing the CFO search. To start off, I understand you put a lot of effort into that. Could you share your perspective on the logistics market? You described it as stable but expect modest growth as the year progresses. What are you observing in the logistics market? Are there any strategic projects in the pipeline that you have good visibility on and are likely to materialize later this year? Additionally, what insights do you have from your largest customer in this space?

Robert Willett, President and CEO

Thanks. So let's start with a bit of context. Our logistics business grew 65% in 2021. It was around $300 million fueled by a lot of investment in e-commerce, particularly. And then as that kind of investment really slowed down and stopped, it contracted by 25% in 2022 and by 21% in 2023. So I think we've seen a big downturn in that industry. We're now feeling much more positive that it's starting to come back. Logistics revenue grew 24% year-on-year in the first quarter of this year, although it's flat if we exclude the very large project that we talked about on the last call, but we're having positive conversations and starting to see early indications of recovery. We expect a return to growth in logistics for this year, although still below the target of 30% growth that we're expecting from that industry over the long term. Over the long term, we're expecting to see large e-commerce customers and broader warehouse automation gaining traction. We're starting to penetrate more into parcel post, where we see our technology is really starting to be very, very competitive, and we're seeing some really good trials with some of the major names in that industry. We're also seeing smaller customers growing nicely with Cognex, and the opportunities we see growing there. We're seeing more adoption of other technologies beyond barcode reading that we're marketing, such as Edge Intelligence, which is the technology I referred to in the last call that brings us recurring revenue from customers, and we're bringing more vision to allow us to inspect the packages for damage, doing dimensioning, et cetera, products like the In-Sight 28 detector that we referred to. In reference to sort of larger customers and investments, we're starting to see more positive signs that those kinds of investments will be returning back to what I would consider more normal levels. Although some of those opportunities may result in bookings this year from us but revenue next year due to the fairly long lead time on that. It would also just be worth saying that our logistics business is relatively concentrated in the United States, nicely penetrated and growing in Europe over the long term. But we see a lot of growth potential in Asia, particularly India and emerging markets. So that's kind of an overall view.

Damian Karas, Analyst

Very helpful color. And then I wanted to ask you about semi. It sounds like the business is improving more than you had expected. Could you just maybe give us a sense of how much of a recovery, how much of a snapback you think you could see in semi this year? And your initial guide for Moritex was up 6% to 8%. Was that factoring in already a better semi outlook for this year? Or just based on what you're seeing, could that possibly be tracking better?

Robert Willett, President and CEO

We're observing a positive shift in our semiconductor business after a couple of challenging years, particularly in 2023, with Q1 revenue increasing by 6% year-on-year, excluding Moritex. It's still early to see the full ramp-up, but this market offers us long-term opportunities and established relationships with OEMs. Factors like investments in high bandwidth memory, fueled by the growth in AI, are showing promising signs for us. Moritex is a highly respected brand, and our strong connections with machine builders are invaluable. I recently visited several of them in Japan, and as those companies grow, it will be advantageous for us in the long run. We've been navigating a period of adjustment due to changes in the market, particularly concerning China and the scaling of significant AI investments, along with initiatives like the CHIPS Act. We're optimistic that as these investments materialize in the automation sector, we will see a considerable rebound in growth. When we take Moritex into account, semiconductor sales represent about 10% of our overall business, with strong growth potential in the coming years.

Nathan McCurren, Head of Investor Relations

And Damian, I'd just point out I know you mentioned Moritex. There are some puts and takes in terms of end market growth and timing. We originally guided to 6% to 8% of our total revenue coming from Moritex for the year, and that's still our guidance for that end market, just given how some of the other pieces of the businesses are expected to move throughout the year.

Operator, Operator

Our next question comes from the line of Rob Mason with Robert W. Baird.

Rob Mason, Analyst

So Rob, you said consumer electronics probably tracks flat year-over-year with last year. I'm just curious how the makeup of that business would compare on a flat basis and really maybe the composition coming from what your historically larger customer versus other customers? Have there been any efforts to change the customer mix diversification efforts on that front that you would comment on?

Robert Willett, President and CEO

Rob, I think you're right in interpreting what I said is sort of broadly flat. There isn't a broad change in our overall exposure to different customers. We do business with a lot of major names in that industry, although historically, we've had one very large customer. I would say my sort of outlook for the industry is broad across a range of customers not being overly swung one way or another by a particular customer overall. But as I did mention that the industry can be lumpy, and we can see features coming into products that perhaps might have been expected next year coming in or this year moving out. So that can move around quite a lot in our experience.

Rob Mason, Analyst

Sure. And just as a follow-up, on your emerging customer initiative. Curious if you could just comment. I know it's early with all the forces just being in the field to start the year, but early reads on maybe productivity levels. And if you've had any feedback from the field just in terms of things that Cognex can do to help them be more successful and understanding it's kind of a tougher market you're selling into as well. But whether that's lead generation, product tweaks, product portfolio enhancements. I'm just curious what the early feedback is.

Robert Willett, President and CEO

Yes. I think the central thesis around emerging customers was that traditionally we've been very strong at the most sophisticated accounts in the world where they really like to work engineer on engineer. A couple of years ago, we developed this technology called Edge Learning, which makes difficult machine vision applications pretty easy to demo and sell. The 2800 is the best example of the product in that area. And then we also have a nice ID portfolio, which is broadly considered the best in the world at reading industrial barcodes such as laser-printed 2D matrix codes or metal applications, those types of things. With that kind of strength, we realized we needed to get this technology to more customers. And if we serve about 30,000 or so customers today, there are perhaps 200,000 customers or more that we could be reaching with this technology as it becomes easier. So we brought in very strong young salespeople, most of them engineers, and we've trained them, and they're going into the field now. At the same time, we've implemented Salesforce.com over the last few years, and we have a lot of intelligence now in terms of what activity goes on, where we're demoing, how to generate leads, and get those to those salespeople. So that process is kind of, I think, getting implemented. And I think we're pretty pleased with what we're seeing. I mentioned we expect that team that's gone in the field to make about 80,000 customer visits this year. They're certainly on target to do that. We're going to be able to help them get in front of more customers over time as our lead generation engine ramps up, as they learn how to be effective in front of customers. So we expect their productivity to improve. I would say in the data that I see on average, they're selling more and more each month currently. And they're getting in front of new customers, and I gave you examples of applications that we certainly a few years ago would have probably walked away from because there was just too much engineering to make some of those things work. But now our emerging customer salespeople can demo and sell those products and create impacts to new business. It's generally what I would observe. So we're going to see the metrics keep moving up. We're pretty pleased with what we're seeing. We will see more products coming to market and more tools, enabling them to address more applications, and it builds from here. So based on that confidence, we're bringing in another full class, and we're training them up and we're getting better all the time. It does feel like turning a flywheel; it's getting faster and faster.

Operator, Operator

Our next question comes from the line of Joe Giordano with Cowen & Company.

Michael Anastasiou, Analyst

This is Michael on for Joe. Great. So on the end market front, I think we're surprised on like the semi strength in the quarter based on some of the industry commentary there. What was driving that outperformance in the quarter? And I have a follow-up.

Robert Willett, President and CEO

Well, in semi, we're very strong in the wafer process, particularly where we're reading IDs, barcodes, letters, and numbers reflective surfaces of wafers. So it has been a very strong area for Cognex for a very long time and with many of the leading OEMs in those types of spaces and the fans we rely on our equipment. So that business is strengthening nicely. We have a good team in ASEAN markets such as Malaysia, certainly where we're seeing strong investments going on in that area. But as we are also reading more and more semi coming to other markets like Europe and America. But I would say more of the growth that we're seeing is around some of the areas that I described, reading wafers and also kind of inspection and alignment in applications such as high bandwidth memory.

Nathan McCurren, Head of Investor Relations

And Michael, I want to remind you that our business operates on a much shorter cycle compared to many of our peers in this industry. As you assess our customer base, they have expressed very positive expectations for 2024. You can expect Cognex to respond more quickly than some other suppliers in the industry due to the short-cycle nature of our operations. Regarding geography, much of the activity in Asia, excluding China, has been where we've experienced significant business growth.

Michael Anastasiou, Analyst

Great. That's super helpful. And just one more, if I may. You had mentioned that you thought logistics was up for the year. CE likely flat. But can you discuss the puts and takes on the auto side, the growth expectations there, maybe cadence throughout the year as well?

Nathan McCurren, Head of Investor Relations

Yes, sure. You asked about automotive. I think context, automotive was our largest and best-performing market last year, representing 25% of our revenue. It looks to be entering a more difficult period at the moment. I think we see that particularly around some of the EV battery investments, which over the long term look very good, over the short term have really been scaled back and pushed out. So that can give our revenues some big bumps, and we saw a pretty nice EV battery order in the first quarter of last year in China that did not repeat this year. Certainly, there's some tentativeness there, much as you're probably reading about automotive. We are seeing customers, some of them move more quickly into hybrid. We've seen some success with customers there. But the broad view is that automotive is slowing down and looks challenging for this year, and EV investments are being pushed out.

Operator, Operator

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

Jacob Levinson, Analyst

I know AI and deep learning is certainly something you folks have been doing for quite a while now. But can you help us understand how the proliferation of high-density compute, if you want to call it that, really changes or doesn't change for that matter, the capabilities? And I would imagine it would be pretty expensive to put GPUs in the computer next to a lot of your cameras. But I guess, how does this computing power that hasn't been available before change the product roadmap for you folks?

Robert Willett, President and CEO

Thank you, Jacob, for your question. Looking at the long-term perspective, deep learning technology has been around for quite some time, but it really gained traction around 2013 and 2014 thanks to the work of Jeffrey Hinton. This technology became applicable in machine vision and factory automation later in the decade, and we expanded our capabilities by acquiring ViDi in 2017 and Sualab in 2019. Cognex recognized this trend early on and has taken the lead in applying deep learning technology, and as we now transition into generative AI, we aim to be at the forefront in factory automation. I encourage you to visit our website to explore our In-Sight L38 3D vision system, which leverages this powerful technology, simplifies its use, and integrates it into a point cloud environment for 3D vision. Traditionally, vision systems were 2D, but incorporating 3D allows for managing exponentially more data, making it significantly more computationally intensive. Your question relates to how chips influence this area. Previously, AI models were complex, requiring lots of computing power and time to manage. However, with advancements in cloud computing and GPUs, we can now utilize, train, and manage extensive datasets efficiently. The reality of factory automation is that it primarily operates at the edge, meaning we need to condense all this powerful technology into a compact form that can be implemented right where manufacturing occurs. Cognex excels at designing efficient processors, and we have developed something called Edge Learning, which pre-trains models and efficiently applies them to edge devices. As chip technology advances, we can enhance performance right at the edge. While powerful chips are still utilized in the cloud, I wouldn't expect them to significantly transition to the edge in the near future. Nevertheless, following Moore's Law, we anticipate that chips will continue to get more powerful and smaller, presenting numerous opportunities for impressive machine vision performance in the years ahead. Rest assured, we plan to remain at the cutting edge of these advancements.

Jacob Levinson, Analyst

That's very interesting, Rob. Shifting focus to China, a market that's often difficult to understand if you're not present. While we're interested in your insights on other markets, we're trying to gauge what feedback you're receiving from your team in terms of your customers' investment strategies for this year.

Robert Willett, President and CEO

Yes. The China market is certainly the most difficult market geographically for us at the moment. We've seen revenue decline year-on-year for 6 straight quarters. In China, it was down 17% year-on-year in Q1, excluding Moritex. We have a pretty large team in China, and we're very successful with larger customers, particularly in that space. I think we see this as a broad-based phenomenon. I can't think of a company in the automation space that's putting up good results in China at the moment. This is pretty typical of what we're seeing. It's certainly intense competition, as one would expect in that market. We've seen quite a lot of private equity and venture capital funded companies kind of in that market over recently. I think some of them are obviously struggling with the market conditions that we're seeing there. Our decline in automotive in the quarter was most pronounced in China also. So that's certainly a tough situation. We do see the phenomenon of customers moving production or diversifying production away from China. I think we're often familiar with that phenomenon, so into markets, particularly India and Vietnam. That is another dynamic that's going on there. In terms of Cognex and the team, I think we're enthusiastic about adding Moritex to our business, and Moritex has a good business in China and is able to be very competitive now selling more alongside Cognex products, so that's a positive development. The kind of technology that we talked about, our 3D AI technology certainly is something that our team there are very enthusiastic about demoing and selling, and I'm very pleased with the progress that I see them starting to make with our edge learning technology broadly in that market. Plenty to work on but difficult conditions.

Operator, Operator

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

Thomas Moll, Analyst

I wanted to start on logistics, where in the quarter, it looks like revenue was flat year-over-year, excluding the large project that you've referenced a number of times. You've given us some reason to be optimistic about the recovery in that end market. And so my follow-up question is, are you seeing those positive signs fairly concentrated among a smaller list of customers? And the reason I asked that is just because it looks like the base business there was still flat year-over-year. Maybe I'm missing something, though.

Robert Willett, President and CEO

Yes. So my optimism about logistics really comes from our funnel. We see a nice build in our business overall. The logistics win we had was with a big customer, but not necessarily our biggest customer in that space. We do see some nice progress in penetrating parcel and post where we're seeing, and obviously, that's an industry dominated by some very large names that we're all aware of, and we're making now a lot of progress with our new modular vision tunnel that we've launched this year, which brings a lot of functionalities, demoing really well with those customers. Now in terms of smaller customers, we see that as a growth part of our business, and it continues to feel that way. I don't know if Nathan you can give us any color on Q1 and base logistics?

Nathan McCurren, Head of Investor Relations

Yes. I mean I think you're probably referencing it; we said stable year-on-year. The thing to point out is we are seeing kind of broader-based funnel optimism. Typically, this business has been higher penetration in the Americas. We saw some strength in other parts of Asia in the quarter and expect to see going forward growth from both the large e-commerce customers that we've referenced as well as our base logistics. I think you should probably expect a little bit less of a bifurcation there than what we've talked about over the past 18 months or so, just given really the hyper growth that happened and with the large e-commerce customers followed by really a pause in their greenfield investment. We would expect those to converge a little bit more going forward and see more similar trends across the full spectrum.

Thomas Moll, Analyst

And then following up on emerging customer initiatives, which quarter this year do you hit the full run rate for the expense investments there? Is it Q4? Or is it really the first quarter of next year before we'll see that full run rate? And a related question, Rob, is there any chance that you roll out a third cohort here as well? It sounds like things have gone well. But the first, you're ramping a second. Just wonder what else might be on the marker board.

Nathan McCurren, Head of Investor Relations

I'll start with the cost aspect. As we discussed last year, the initiative will increase throughout the year. In 2024, there are two main parts to consider. The first part relates to the ongoing costs stemming from the investments we made in 2023, which should remain stable throughout the year. The second part, which Rob will elaborate on shortly, involves the new class we are bringing in for 2024, and this cost will increase gradually throughout the year. Last year, it's important to remember that this investment mainly involves hiring recent college graduates, leading to a lot of summer start dates. Therefore, the costs will rise steadily up to Q3, with Q3 and Q4 expected to be quite similar. We anticipate Q3 will be the peak, with Q4 mirroring Q3 regarding operating expenses.

Robert Willett, President and CEO

Yes. Your question about 2025 is obviously too soon to make a call on that. But we view emerging customers as a long-term initiative with significant potential, aiming to grow our customer base from 30,000 to hundreds of thousands. This is a multi-year initiative overall. In terms of 2025, we will begin to develop concrete plans probably in the fall as we start recruiting for next year and planning our budget for that period.

Operator, Operator

Our next question comes from the line of Andrew Buscaglia with BNP Paribas Asset Management.

Andrew Buscaglia, Analyst

So you made the comment that you think gross margin marks the low point in Q1 and guided obviously a step up into Q2. A couple of questions on that I guess what gives you the confidence that, that is the low point? Presumably, you have logistics improving and you got a large order that was somewhat dilutive to that gross margin. So I guess you're not assuming any larger orders in the rest of the year. Can you just comment on some of the things that you see in the back half that would give some confidence in that comment?

Robert Willett, President and CEO

Yes. Q1 gross margin was dragged down by that larger order we described, right, and a low revenue quarter. Those are the kind of factors that impacted us. Overall, through the year, Moritex is about a 2% headwind. With that as sort of context, what should lift gross margin for Cognex going forward is obviously revenue, particularly in markets like electronics, but particularly factory automation, which for us is a high margin business in a broad-based way. As we begin to see that market recover, that has strong gross margins overall. As we've discussed, it's been under pressure for quite a few quarters now; our industry has, and as that returns, it would lift gross margin. Our emerging customer initiative is selling high gross margin, very competitive products. That will also be gross margin accretive for us, selling to smaller customers who perhaps do not get the same kind of discounts that large customers do. Many reasons to feel positive about gross margin and our return back in the long run to that 75% target. In the near term, those one-time factors being behind us in Q1 to build a business, particularly consumer electronics, which tends to be a high gross margin business, and semi, also and scale going back and return on our factory automation business.

Andrew Buscaglia, Analyst

Yes. Okay. Okay. And then my next question, I wanted to go back to consumer electronics, a flattish this year. You commented on uncertainty around project size and timing. I'm wondering, there's not much innovation in phones and handsets these days, but the latest is the implementation of AI features. And I'm wondering, that's not a physical form factor change, but I'm wondering what you're referencing there in terms of these projects, whether the timing is tough, but does AI have an influence on machine vision as it relates to consumer electronics?

Robert Willett, President and CEO

If we discuss the market and our enthusiasm for its long-term potential, we note that it experiences waves of innovation. Currently, we are in a phase where that innovation hasn't translated into products, but I am confident it will. The emerging AI technologies and chips being released will lead to a new generation of products, which could include smartphones as well as augmented and virtual reality. The investments in semiconductors that we all recognize will fuel growth in this sector. Another reason I anticipate growth for Cognex is the increasing replacement of human labor in electronics manufacturing, especially in the smartphone sector. The possibilities in this area are substantial; for example, one of our clients spends over $1 billion annually on human visual inspectors, which highlights the potential to substitute some of those roles with machine vision. Our latest machine vision technologies are becoming remarkably human-like in their capabilities. The long-term outlook for this industry and its technologies is very promising. While I do not expect to see significant developments this year, I am aware of the plans many companies in this space have. We may be fortunate to witness some of these innovations in products launched before the holiday season, but for now, we are considering that significant advancements may still be a few years away.

Operator, Operator

Our next question comes from the line of Piyush Avasthy with Citi Research.

Piyush Avasthy, Analyst

Following up on your auto commentary, Rob, you have been very constructive on the EV battery space. Can you help us better understand on what surprised you? I understand some bigger projects being pushed out, but for EV battery investments in China, is that softening for you guys as well?

Robert Willett, President and CEO

Yes, I think for maybe on the order of 6 months now, we've started seeing concern around EV battery investment that it may be getting a little ahead of demand in general in the world. We're working closely with really all the large EV battery manufacturers, the tenants that I think really constitute most of the investment going on. It's a huge investment, with the idea that this is a multiyear phenomenon. Two ways in which Cognex really benefits can really help those customers, where we do very well. One is just helping them build out their capacity. We've been working with customers in that area, and I would say I can think of quite a few instances where those plans have been slowed down over the last 6 months and pushed out. Partly, that is just to do with demand; customers are not buying as many EVs as the industry had perhaps expected. Secondly, just uncertainty about the political environment and whether the subsidies that are being discussed for consumers who buy cars and for companies that invest in building out battery plants and EV plants, whether those are still going to be there. I think that kind of concern, I think over the long term, EVs, no doubt, will have a larger and larger market share of automotive overall. There will be waves of technology coming, whether that's the current cylindrical, prismatic, and pouch technologies that we see moving more toward solid state. There are going to be waves of investment there. Those are challenging technical problems to deal with. We're certainly working closely with customers, and I think they recognize the value of our technology. We're building out greenfields, which is the challenge. The second area is just increasing the productivity of manufacturing batteries. This is an area where Cognex excels, particularly applying our computational optics technology, partly that we acquired with SAC, with which we have more strength alongside Moritex to create fantastic almost 3D images of battery surfaces and to inspect them, and then applying our deep learning and Edge Learning tools to those applications. What that allows a customer to do is take an inspect to surface and tell whether dents, scratches, or the position of a defect on a battery is a problem and should need it to be rejected or whether it's not a problem and the battery can pass through. There's a very high scrap rate going on today. A very high rate of human inspection going on those surfaces. One customer I visited over the last six months told me that they scrap $200,000 to $300,000 of good batteries per day, good batteries they're throwing away because they're concerned about quality. Our technology can help reduce that significantly. That's one example of where Cognex technology can help that industry. One of the reasons based on all the investment plans and all the challenges that we see, we're expecting long-term growth in that industry.

Piyush Avasthy, Analyst

Got it. Helpful. For my follow-up, I have a two-part question. First, we've been hearing a lot about India and its growth potential. Can you provide some insight on the opportunity in India and Vietnam that you've mentioned? Secondly, regarding Japan, the yen has been under pressure, but you reiterated your revenue contribution from Moritex. Could you share your observations on the presence you're seeing in the end market and any concerns related to foreign exchange? That would be helpful.

Robert Willett, President and CEO

Yes, I'm aware of the time and will respond to your question quickly. India presents a significant opportunity. I regularly visit and was there early in the first quarter. We see huge potential and are building our business there. It remains a relatively small part of Cognex overall, but it is likely one of our fastest-growing markets. Regarding the weak yen, it creates interesting dynamics. It certainly benefits the cost of goods for some competitors and aids their gross margins. The strong dollar makes the business environment more challenging for us. However, we have excellent technology and a strong team in Japan, which allows us to remain competitive. I believe we have time for one more question.

Operator, Operator

Last question comes from the line are Jairam Nathan with Daiwa Capital Markets.

Jairam Nathan, Analyst

Just two of them. Just wanted to clarification first on the recurring revenue and the large project that you had on logistics. Are those the same things, and has the recurring revenue started flowing in? Or is that a future business?

Robert Willett, President and CEO

Yes. Yes, so that large project came with a nice piece of regular recurring revenue, which we do with our edge intelligence, allowing to extract huge value out of vision data and manage our business systems more effectively and build on a kind of a regular basis and tied to that large installation, where we took a lower price to get this technology embedded, and we're excited about that.

Jairam Nathan, Analyst

Okay. Great. And then finally, your biggest competitor seems to equate revenue growth with increases in employee headcount. I understand that if I look at sales per employee or marketing employee for you, the figures for emerging customers may not be as high as they currently are due to the nature of your existing large customer mix. However, I realize it's still early, but how is the sales per employee for emerging customers progressing? How do you foresee it comparing to the current average, or is that one avenue to reach the $50 million target? I'm trying to grasp the potential here.

Robert Willett, President and CEO

Yes, for competitive reasons, there's not necessarily data that we share at this point. But certainly, yes, emerging customers, we have much more modest expectations for them out of the gate. We expect to see good improvement. Our emerging customer initiative is designed to create salespeople who will go on and manage larger accounts in the future; it provides a nice feeding ground for that. But certainly, it's going to dilute sales per salesperson in the initial years.

Nathan McCurren, Head of Investor Relations

Yes, Jairam, this initiative will actually ramp over time, so we'll expect to see more revenue go on. But I think we're not going to give an actual number on what we expect for each of those heads versus a more tenured sales employee.

Operator, Operator

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

Robert Willett, President and CEO

Well, thank you for joining us this morning. Thank you for your interesting questions. We've enjoyed talking with you, and we look forward to speaking with you again on next quarter's call.

Operator, Operator

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.