Cognex Corporation (CGNX) Q4 2022 Earnings Call

Cognex Corporation (NASDAQ:CGNX) Q4 2022 Earnings Conference Call February 16, 2023 5:00 PM ET

Company Participants

Nathan McCurren - Head of Investor Relations

Robert Willett - President & Chief Executive Officer

Paul Todgham - Chief Financial Officer

Conference Call Participants

Josh Pokrzwinski - Morgan Stanley

Joe Ritchie - Goldman Sachs

Joe Giordano - Cowen

Guy Hardwick - Credit Suisse

Jacob Levinson - Melius Research

Jim Ricchiuti - Needham & Company

Rob Mason - Baird

Paul Chung - JPMorgan

Matt Summerville - D.A. Davidson

Jairam Nathan - Daiwa Capital Markets

Operator

Greetings, and welcome to the Cognex Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] 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.

Nathan McCurren

Thank you, Dona. Good evening, everyone, and thanks for joining us. With me on today's call are Rob Willett, Cognex's President and CEO; and Paul Todgham, our CFO.

Our results were released earlier today. The press release and annual report on Form 10-K are available on the Investor Relations section of our website. Both the press release and our call today will reference non-GAAP measures. You can see a reconciliation of certain items from GAAP to non-GAAP in Exhibit 2 of the press release. Any forward-looking statements we made in the earnings release or any that we may make during this call are based upon information that we believe to be true as of today. Our actual results may differ materially from our projections due to risks and uncertainties that are described in our SEC filings, including our most recent Form 10-K filed tonight for 2022.

With that, I'll turn the call over to Rob.

Robert Willett

Thanks, Nathan. Hello, everyone, and thank you for joining us. We continue to navigate a challenging environment. Our fourth quarter results were largely in line with our guidance, but are not representative of our long-term growth expectations.

The focus of my remarks today will be on the near-term challenges we're facing, and then on the reasons why we remain excited and confident in our long-term growth opportunities. Our largest challenge within our logistics business, we continue to see a post-pandemic slowdown with a few of our largest e-commerce customers who have temporarily reduced their investments to absorb excess capacity. Looking beyond this temporary pause, we continue to expect logistics to be our highest growth end market over the mid to long term.

We also saw lower new business activity in the quarter. Bookings were below our expectations and generated less revenue in quarter than is typical. Despite these challenges, revenue increased on a constant currency basis by 1% for the full year compared to 2021, a year where we reported strong growth of 28%. Outside of logistics, revenue from the remainder of our end markets grew in 2022 roughly in line on a constant currency basis with what we would expect over the long term.

As our history demonstrates, we can experience periods of softness in between periods of robust growth. Our revenue growth target of 15% is a multi-year annual target, with that lens revenue of over $1 billion in 2022 represented double digit annual growth compared to 2020 and 2019.

Gross margin is 71% in Q4 and 72% for the full year was in line with our latest expectations. Margins in both periods were below our long term target mid 70% level due to the elevated purchase of scarce components through brokers.

Before I go into detail on our end markets and an outlook for Q1, I'd like to turn it over to Paul to walk you through more of the results.

Paul Todgham

Thank you, Rob, and hello, everyone. Revenue was $239 million in Q4, a 2% decline year-on-year or an increase of 4% on a constant currency basis. This includes the approximately $20 million catch-up from deliveries that were delayed in Q3 following the fire. In addition to the slowness with a few large e-commerce customers throughout the quarter and slower business activity more broadly at the end of the year, foreign currency translation lowered revenue by $45 million or 4% in 2022 and by 6% in the fourth quarter.

Looking at the change in revenue for Q4 from a geographic perspective, each primary region grew year-on year on a constant-currency basis. Asia increased by 9%, excluding an 11 percentage point reduction from currency exchange rates. Revenue growth from semi and automotive more than offset softness from the challenging environment in China. Revenue from Europe increased by 4% excluding an 11 percentage point reduction from currency exchange rates. Growth was led by revenue from automotive and consumer electronics that offset a decline in logistics. In the Americas, revenue grew by 1% year-on-year. Lower investments by a few large customers and logistics were offset by growth in automotive, consumer electronics, food and beverage and medical related industries among others.

Gross margin was 71% in Q4 compared to 72% in Q4 of 2021 and 73% in Q3. The decline from Q3 is due to the significant premiums we've been paying to replenish component inventory destroyed in the fire. These purchases negatively impacted gross margin by approximately 500 basis points in the quarter and approximately 400 basis points for the year.

We are pleased our broker buy activity is winding down, now that we've replenished post-fire and the supply environment has improved. We expect it will take a couple of quarters for the higher-priced components to work their way through the P&L, resulting in a minimal impact by the second half of 2023.

Moving on to operating expenses. Our reported operating expenses included a fire loss in both Q3 and Q4 of 2022 and a modest restructuring charge in Q4. Excluding these charges, Q4 operating expenses increased by 3% from Q3. Comparing year-on-year, operating expenses decreased by mid-single digits, primarily due to the favorable impact of currency exchange rates and lower incentive compensation. These benefits were partially offset by the incremental investments we've been making in sales and engineering headcount.

Operating margin on a GAAP basis was 23% in Q4. Non-GAAP operating margin was 24% in Q4, an improvement from 23% in Q4 of 2021 and 20% in Q3. This level of profitability is below our 30% long-term target due to lower gross margin and operating deleverage from revenue softness. The effective tax rate excluding discrete tax items was 22% in Q4 and 16% for the full year. Reported earnings were $0.32 per share in Q4. Non-GAAP earnings per share were $0.27 in Q4 compared with $0.30 in Q4 of 2021 and $0.21 in Q3, excluding the one-time charges mentioned earlier in tax adjustments.

Turning to the balance sheet. Cognex continues to have a strong cash position with $854 million in cash and investments and no debt. The strength of our balance sheet enabled us to aggressively replenish components lost in the June fire. As a result, we caught up on customer deliveries quickly during the second half of the year and ended 2022 in a healthy inventory position. During the year, we also had a substantial return of capital to shareholders with over $200 million of share repurchase activity and more than $45 million of dividends paid.

Now, I'll turn it back over to Rob for color on our end markets and on our outlook.

Robert Willett

Thanks, Paul. I would like to now give a little historical context. You may remember, we went through a restructuring in 2020. As part of that action, we reorganized our R&D and engineering teams. These teams is focused on groundbreaking edge learning technology and standard product architectures that can deploy on innovations more efficiently and at a faster rate. As a result of these improvements, we now have many new products coming to market in 2023.

Recent product launches include our new DataMan 580. This fixed-mount barcode reader is designed for five and six cited Cognex modular vision tunnels for use in the most demanding logistics applications. Pairing this product with Cognex 3D vision systems helps logistics customers to apply a label on a package in a spot that does not cover other information on that package, a surprisingly difficult task to automate. This results in optimizing processes by increasing line speeds and traceability without lowering read rates.

In another product launch, we expanded the capabilities of our Insight 2800 vision system to include deep learning enabled optical character recognition. This allows customers to deploy powerful AI-based OCR Technology regardless of their skill level. Prior industry solutions required hours of programming by highly trained engineers preventing many companies from automating this type of inspection. Now, models can be set up and deployed directly on the device in minutes, with this view as 10 sample images.

Food and beverage manufacturers will be able to easily read expiration dates, even on curved metal surfaces. Electric vehicle manufacturers can quickly locate and read the alphanumeric text edged on the bottom side of EV batteries for traceability. And logistics businesses can decipher codes and text on a variety of package types to ensure proper routing and prevent rework. We believe these products and many of that is planned for 2023 launch position us to broaden the market we serve, and capture more share.

With that, let's jump into more detail about what we're seeing in each of our end markets. Our largest end market in 2022 was automotive, which represented approximately 25% of our revenue. We reported record revenue from automotive and double digit growth year-on-year in constant currency. This is primarily driven by the increase in electronic components in vehicles and the ongoing transition to electric vehicles. The transition to electric vehicles is generated an increase in new model introductions and demand for EV batteries. We have strong relationships with the major EV battery manufacturers who are projected -- who projected continued growth within Asia and new growth in the Americas and Europe.

In the fourth quarter, we acquired Sirius Advanced Cybernetics GmbH or SAC, a German computational lighting company. Combining SAC's capabilities with Cognex's vision and AI tools, equips us with an industry leading offering for battery inspection. The SAC acquisition will support our strategy to capture a larger share of the high-growth battery inspection market.

Moving on to logistics. Logistics represented approximately 20% of our total revenue in 2022. After over 60% growth in logistics in 2021, annual revenue from logistics contracted by 25% in 2022. Aside from the few large e-commerce customers who reduced investment, revenue from the remainder of our logistics business grew both in the quarter and year. We believe logistics will continue to be an important growth driver for us over the long term. The market is still in the early stages of adopting machine vision, most companies are still highly reliant on labor and very few warehouses globally are realizing the full potential of automation. An example of the type of opportunities that exist in logistics is a recent win with a Fortune 50 retailer that was previously a relatively small customer of us.

In 2022, we deepened our relationship with this company, who had previously announced a multi-billion dollar investment to enhance its shopping experience. They are establishing regional sortation centers and converting in-store stockrooms into sortation centers to pack and ship orders direct to consumers. Cognex was chosen to provide machine vision because of our best-in-class algorithms that can reliably read barcodes of angles. Our tunnel solution enabled our customers to increase the number of products on a high-speed conveyor by reducing the gaps between them, while still reading barcodes at near perfect read rates.

After initial wins and excellent execution support, the customers asked Cognex to add value in additional areas, such as converting manual operations to automated tunnels, to offset labor shortages and costs in existing regional distribution centers.

Shifting to consumer electronics. Our third largest end market in 2022 representing approximately 20% of revenue. Consumer electronics grew in the mid-teens year-on-year on a constant currency basis. Growth was primarily driven by the premium end of the smartphone market with an additional contribution from other consumer electronics products such as tablets and accessories. We had particularly strong demand for our deep learning and 3D solutions in this market.

Turning now to our outlook. We expect revenue in the first quarter will be between $180 million and $200 million, which represents a meaningful step down year-on-year. You may recall that the first quarter of 2022 was an exceptionally strong one for us as we reported an unusual sequential increase in revenue, led by our second highest quarter ever for logistics. We had strong demand broadly across our business even from consumer electronics, which is typically quiet in Q1. We also caught up on $20 million of orders in backlog caused by supply chain delays in the fourth quarter of 2021.

In contrast, new business activity at the end of 2022 was slower than we anticipated, and we had a slow start to 2023. Lower activity with our largest logistics customers continues, and we're also seeing a broader slowdown across many of our end markets as customers are wary of committing to significant investment. We believe gross margin in Q1 will remain in the low 70% range. The supply environment has improved and our broker buy activity has wound down by the impact of what we've already purchased will take a couple of quarters to flow through our P&L.

We expect operating expenses in Q1 will increase by approximately 10% on a sequential basis, excluding the charges related to restructuring and the fire in Q4. This increase is driven by investments we're making in our new emerging customer sales force along with merit increases and a weaker US dollar. Throughout 2023, we expect to see a ramp-down in the impact of broker buys and a ramp-up in our emerging customer sales force investment.

From an operating margin standpoint for the year, we expect these two drivers to roughly offset. We expect the emerging customer initiative to broaden our reach, increase penetration and further diversify our customer base, representing potentially hundreds of thousands of businesses. This customer segment is looking for automation solutions that are easy to implement, easy to use and provide the highest performance. Our newest edge learning and ID products position us well for this initiative.

To directly reach these customers, we're expanding our sales force. We've already hired the initial sales noise focused on this segment. We will onboard and train more in the quarters ahead. We expect costs from this initiative to ramp through the first three quarters of this year.

While our continued investments during a slower growth period will result in near term operating deleverage, we believe it's an important initiative for long term growth. We remain committed to tightly managing operating costs in this environment, and we also believe it's important to continue to invest in high ROI initiatives.

We're excited about our long-term growth prospects. Though timing is uncertain, we expect large e-commerce customers to shift back into investment mode, EV battery growth to continue, China to more meaningfully reopen and our emerging customer initiatives to start to deliver. I'm proud of how Cognoids responded in a year with many challenges. It gives me even more confidence in having the right team to deliver strong growth and new customer value together in the years to come.

Now, we will open the call for questions. Operator, please go ahead.

Question-and-Answer Session

Operator

Thank you. The floor is now open for questions. [Operator Instructions] Our first question today is coming from Josh Pokrzywinski of Morgan Stanley. Please go ahead.

Josh Pokrzywinski

Hi, good evening, all.

Robert Willett

Hi, Josh.

Josh Pokrzywinski

Just first question on sort of the 1Q guide. I know that we've gone through a decent amount of, call it, off-cycle revenue volatility with the fire and some of the supply chain stuff and the catch-up on the other side, backlog position in e-commerce. But should we think of 1Q was kind of representing normal seasonality without any kind of unusual big items as we think about the rest of the year? I know you don't give guidance, but just trying to make sure there's no other kind of noise in there?

Robert Willett

All right, yes. So, Q1 is looking slow. We've seen slow periods like this before and we've come out of them and delivered meaningful growth. I think, you know that our business in flex quickly and it's not kind of backlog driven as some of our peers. And additionally, we're comparing to what is a particularly tough Q1, given last year's unusually high revenue from logistics and other markets.

But I think it's also fair to say that, we see lower PMI data across all of the regions that we serve in our regular business, and that's certainly reflected in the activity that we're seeing, which is at a lower rate than we were expecting a few months ago.

And then, of course, as I think I've explained quite a lot, the logistics business is really at a very low level, really as a result of the large customers really pulling back on e-commerce spending. So, that's the kind of color that we're looking at. For those of you who have followed Cognex for a long-time, we know that historically Q1 was always our lowest quarter that somewhat got changed with large logistics orders coming in or sometimes high consumer electronics business in Q1, but this looks like a quarter without any of that.

Josh Pokrzywinski

Got it, that's helpful. I appreciate that color. And then just thinking about something you said in the prepared remarks that I want to make sure I’ve understand better. A reduction in broker buys through the year sounds like a good guy. And then you mentioned a ramp in some of these target investment customers like – sorry, I get the exact phrasing wrong, but both of those sound good. Are you saying it's a ramp in the expense to develop that sales force that product capability like, is it a ramp in the expense or that customer revenue?

Paul Todgham

It's a ramp in the expense. Josh, this is Paul. So, the way to think about this is, we had about 400 basis points of broker buy impact to gross margin in our 2022 results. So, think of it is around $40 million or so, $0.5 billion of revenue. We're expecting to see roughly a $25 million to $30 million reduction in that expense this year, ramping up over time. We still expect in the first quarter to have reflected in our low-70s gross margin about 300 basis point to 400 basis point impact of broker buys.

But we should see a $25 million to $30 million investment -- savings to gross margin from broker buys and that's roughly comparable to the level of investment, we expect to make in our emerging customer initiative in OpEx. So it's an increase over -- ramping-up over the first three quarters. So there are some of that reflected in our Q1 OpEx guidance, which is why we see the sequential -- one part of the sequential OpEx increase from Q4, but we'll expect to see more of that in Q2 and Q3.

Josh Pokrzywinski

Crystal clear. Thanks, Paul.

Operator

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

Joe Ritchie

Thanks. Good afternoon, everybody.

Robert Willett

Hi, Joe.

Joe Ritchie

Hey. So, I wanted to touch on the logistics commentary a little bit further. So, as you kind of think about the rest of the year, clearly, there is volatility throughout the year in 2022. It sounds to me like things have kind of worsened and so, while logistics might have been down 25% for the year is probably down a lot more maybe in the fourth quarter. I'm just trying to understand going forward, where would you expect logistics, particularly the bottom just based on what you see in the conversations that you're having with your customers?

Robert Willett

So yes, so logistics represent about 20% of revenue in 2022 approximately $225 million, and it was our second largest market, right? And it contracted. And we saw that contraction kind of increases we earn through the year was relatively strong in the first half and then I think it's really a story of 2 different customer types. We've got regular logistics customers who are growing nicely, and we expect those to continue to grow. Little less than half of that overall logistics business roughly. And then we've got large customers, very few of them, some of them pretty famous businesses, and they've all really overinvested for a period through COVID and then now have really reined in investments.

Some of them are going through restructuring. And that's going on right now and we expect they'll emerge from that. And then as we get through the year, they'll start to invest again. That may not happen until late in the year or even next year, right? But we do expect to see more investment going on. But even at those customers, there's still significant work that goes on with kind of productivity improvements, regular business, regular automation projects. So that's not like that business has gone away completely. But certainly, a lot of the greenfields, really all of the greenfields for some of these bigger customers have been stopped or significantly delayed. So that's really the state of play.

Paul Todgham

And Joe, to your question about quarterly versus annual growth rates and so on, again, we don't consistently provide data on each end market by quarter. But I think we did call out in the Q3 earnings that was a -- Q3 2022 was a particularly unfavorable comparison. It was very low for logistics in 2022, and that was I think our highest ever logistics quarter in Q1 of 2023. So certainly, that quarter was difficult. In Q4, our growth rate or contraction in logistics was pretty comparable to the year-on-year and then I would say we're up against another tough compare in Q1. Q1 was the biggest logistics quarter of 2022 and then, obviously, there were some announcements about pauses in new capacity expansion and so on that muted our logistics revenue from Q2 to Q4 last year.

Joe Ritchie

Got it. That's super helpful. If I could ask just one more it is interesting. It was very helpful to get the color on the 2022 baseline, right, for the three biggest end markets. I feel bad asking for like the fourth but I'm curious, as like one of the end markets maybe just emerged and now is like a sizable percentage of your business as well? And if you maybe want to provide I don't know if it's in like food and beverage or consumer products or semis, but just provide some color around that end market and what your expectation is for 2023?

Robert Willett

Well, yes, Joe, I think we talked about our big end markets, right, consumer electronics, automotive being largest consumer electronics and logistics. And then other markets for Cognex are pretty broad, and they include medical related industries, consumer products, food and beverage, product security, so I think if I'm understanding your question correctly, you're really asking about those kind of markets in general. And there -- they provide good solid growth for us in line with our overall growth expectations. And they've been -- there's variation among those markets. But generally, they continue to grow much in the way the rest of the business does. But let me ask for clarification. Were you asking about a specific market or something?

Joe Ritchie

Yes. I was just wondering whether one of the end markets has grown to be more substantial than the others. And what's really been driving that? [Multiple Speakers]

Robert Willett

Yes. Yes. I mean we've got some nice growth drivers I could talk at length about life sciences and some of what we're seeing in those spaces and food and beverage. And -- but I don't think that's really going to -- moving the needle in terms of our results in a significant way currently.

Paul Todgham

And I think we've spoken to this before, but obviously, over the last couple of years, semiconductor has -- which is generally small for us, kind of might have been 5% of our business two or three years ago and still below 10%, but it certainly has experienced quite robust growth. So obviously, we're seeing some cyclicality there.

We are starting to grow medical-related overall is about 10% of our business, which we discussed at Analyst Day. But generally speaking, yes, the trends across that diverse range of our business with the exclusion of kind of semi, which is more volatile, I would say, have been fairly consistent.

Robert Willett

And building on that, I think the medical business is growing nicely and steadily. And the semi business has had a great run. And I think we're into a slower period as many semiconductor companies are reporting as we look.

Joe Ritchie

Okay. Thank you for the color.

Operator

Thank you. The next question is coming from Joe Giordano of Cowen. Please go ahead.

Joe Giordano

Hey, guys.

Robert Willett

Hey, Joe.

Joe Giordano

I wanted to just follow up on logistics a little bit. Obviously, it's not surprising to hear the commentary about the large players. And I think most people appreciate that the outside of those mega players kind of like ground floor logistics is much stronger. But Rob, you talked about the declining globally. When does that start to impact that group of customers? Is it likely that PMI is trending lower below 50, that logistics or even for those people who are behind, but are they still going to reflect the economic cycle and likely decline in that sort of environment?

Robert Willett

Right. So Joe, I think your question is how is sort of lower PMI affecting our base logistics business is that that's what you're getting at?

Joe Giordano

Yes.

Robert Willett

Yes. Yes. We have really strong underlying technology and growth trends in our base is business, and we still have a relatively low share and a lot of great growth drivers. So I would say that as we're looking at that business, we're expecting good strong growth from it as we look forward. But it's not immune either to PMI activities. So we do see customers more tentative about placing orders longer cycles to close business, et cetera, in that space, too. But the underlying growth prospects are very good, I think, really regardless of kind of the kind of PMI data we're seeing now, although it will slow it down a little bit.

Paul Todgham

Yes. I mean a good number of those customers delayed some investments early in COVID and are just now I can speak to my former employer for just getting back to those plans back in place. And potentially again depending on the consumer exposure they have. In many cases, the consumer data is a little more robust than the manufacturing production data we've seen.

So I think in a low PMI environment, we might see a higher percent of projects delayed, but generally, the investment cycles of building a new distribution center and so on tend to transcend a shorter-term economic cycle.

Robert Willett

And then I would say, as we look at that business, too, we really have so much opportunity to grow our business in Europe and Asia where we're still -- we have still low share and a lot of competitive advantage. So certainly, we're expecting outsized and seeing outsized growth in those areas of our business.

Joe Giordano

Okay. So just is it fair to say that, that base business and logistics in the environment that we're in right now, you'd still expect it to grow? I mean things can obviously change between now and the end of the year. But given where things are, that would be a fair statement to make.

Robert Willett

Yes.

Joe Giordano

And then my follow-up would be on the emerging customer stuff that you're doing. Where are you on the actual products? Like I know you're talking about developing like smart sensors and things that are easier to use and kind of like a different type of product than you've done historically. So I know you're ramping up this the Cognoids and getting the sales organization ready to support this, but where are you on the products themselves?

Robert Willett

Yes. Right now, we have a good range, very, very competitive products for emerging customer sales noise to sell, right? So the -- and there are more coming. But we're out in the field, and they are very well equipped to close a lot of business that they see at these small customers.

Joe Giordano

I'll pass it on. Thanks, guys.

Operator

Thank you. The next question is coming from Guy Hardwick of Credit Suisse. Please go ahead.

Guy Hardwick

Hi, good afternoon.

Robert Willett

Hello.

Guy Hardwick

Just -- I know you gave a -- in your preamble, you referred to a slow start to the year. Obviously, logistics as well known, and you also referenced the semiconductor end market. Are there any other markets which are showing weakness. Could you expand a little bit on that?

Robert Willett

Yes. I think broadness is -- I think weakness is pretty broad in general as you described and as witnessed in PMI data overall. I think if there's anything else that I would -- well, if there are some other things broad themes I'd draw. One is, obviously, at the start of the year, we're still seeing over related disruption in China, right? And then -- and I think, obviously, rising interest rates creating challenges in improving capital. And really, a lot of our business is driven by capital spend, right?

And then I think there's a couple of regulatory things I would call out. So the inflation Reduction Act it's going to drive a lot of EV battery investment in the United States. And it's going to draw some of that investment away from Asia and Europe. So we're seeing projects that we were expecting to be winning and installing in Europe or in Asia have been delayed because they're moving into America. So that's going on and a somewhat similar dynamic with the CHIPS Act restricting exports to China is causing some changes among those customers where, I think, near term, they will be spending less long term, I expect them to be equipping more facilities outside of China. And so that's causing some delays also.

Guy Hardwick

So just as a follow-up, if Tier 1 logistics CapEx comes back in 2024, I mean, what are your logistics partner integrators telling you do discussions on projects have to start really by the middle of this year have any impact in 2024, given typically 18-month lead times?

Robert Willett

Yes, you're right. Was there a question there? [Multiple Speakers]

Guy Hardwick

General what are your partner integrator is telling you in terms of potential outlook longer term. If you want to return back to the logistics growth that you referenced at the Investor Day, you've got to have kind of recovery in 2024.

Robert Willett

Yes. So I think maybe one thing to understand is for those big customers, we do directly with the company itself, right? -- and we're working often with their engineers on implementing their technology plans and their rollout. So -- and then we think of integrators really has more capacity to help execute their plans. Right? So we see we're in a dry period. It's not clear to us exactly when it comes back, certainly not in this first half.

And I think beyond that, we'll share more information when we have something more solid and meaningful this year. We think it will come back. We think we're optimistic about that. But the timing of it is it second half? Is it 2024 we're not clear ourselves on that. And I don't think our customer customers necessarily are clear on that either.

Guy Hardwick

Okay. Thank you.

Operator

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

Jacob Levinson

Hi. Good evening, everyone.

Robert Willett

Good evening.

Jacob Levinson

Just on this acquisition, SAC that you did in the quarter sounds pretty interesting. But can you help us understand a little bit about how that what the differentiation is, what the technology that they're really doing and why -- I guess, why is that so important in battery inspection process in particular?

Robert Willett

Yes. Yes. Thank you. I appreciate the question. Yes. So -- so something that goes on in machine vision is you acquire an image right? And then you use vision tools to decode and make sense of that image, right? And Cognex, I think, is undisputed in our ability to make sense of and to interpret images, and particularly with our deep learning technology, we really have phenomenal capabilities in that area. But image acquisition is something where we felt we really wanted to do better relative to our competitors.

And we saw a big need in this market to do that. The company, SAC that we've acquired is really a leader in this area of computational lighting or computational optics. And what that technology does is it it's think of it like a dome of light that sits on top of an image that's being analyzed. And there are LEDs that are lit up in a very controlled and specific way using very sophisticated software to create almost like a 3D image of what's underneath them. And in this case, it very often is illuminating dense and scratches on the surface that's being analyzed. They can do it very quickly and almost with 3D type capability.

And this technology is better at doing that than any other that we've seen in the market so far. And what is that going to allow us to do, it's going to help us serve some really important needs in battery production, in EV battery production. And looking at material like even just take the outside of a cylindrical battery that is pretty widely used and widely out there in the world of EV. Dense and scratches can cause fire and other problems and have done, right? So it's a very hot topic for sure. As companies are rolling out new EV battery technology and they're building billions of dollars of manufacturing capability. This is a technology we think will be highly prized and will help us drive growth in years to come in that space. So that's a little bit of an overview.

Jacob Levinson

Super interesting. And just one for Paul quickly. I know you guys prior to the fire in Indonesia that we're embarking on a supply chain diversification plan for lack of a better description, but maybe you can just update us on what you've been able to qualify some other contract suppliers or manufacturers rather?

Paul Todgham

Yes, sure. Thanks, Jacob. I think we've reflected in our previous Qs and in this K. Really, since 2021, we've been bringing online a second contract manufacturer as well as a couple of sites for our primary contract manufacturer. And we're making good progress there. The second manufacturer is producing at this point in Q1. So we're happy with that and has the capacity to do quite a bit more, and we'll continue to ramp that up over this year.

So we're -- this will be a journey. It is a progress, but I think we are headed in the right direction as well as there are broader efforts to diversify some of our supply chain risk, including distribution centers, we move to a much larger distribution center in the Americas, for instance, earlier in 2022 and looking at potential opportunities globally for distribution and warehousing.

Jacob Levinson

Perfect. Still welcome 2023 guys. Thank you.

Operator

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

Jim Ricchiuti

All right. Thank you. You've given some commentary, some color around many of the end markets. And Rob, I'm wondering if you would maybe talk a little bit more about your expectations for automotive. You've got some puts and takes. Obviously, the EV market still seems like it's fairly healthy. What's your sense as you look at the automotive part of your business this year?

Robert Willett

Yes. I think we're pretty optimistic about the automotive market overall. I mean, revenue from automotive 2022 grew 13% in constant currency, which is above what we expect for that market over the long term. And we do see a lot of multiyear investment in new capacity particularly EV battery manufacturing capacity getting teed up, right? And we also see more of that investment going into the United States.

I mean we're a very, very strong share and a very, very strong team able to execute on the needs of those companies. And then we have the SEC acquisition that I mentioned, which brings a really powerful tool to bear into what is a very difficult manufacturing problem. So and our deep learning capabilities in general and our edge learning tools really, I think, are going to be very valuable in those applications. So -- it's -- yes, I think we remain pretty optimistic about the outlook for automotive over the coming quarters and years.

Jim Ricchiuti

And I know that you don't normally have a lot of color on the consumer electronics market. The question I had more in that area is around the reports that we've all been seeing about more production, consumer electronics shifting to places like India including for applications around smartphones. First of all, are you seeing any signs of that? And how soon -- how far out if that were actually occurring and is it going, would you see orders as that capacity gets built out in places like that?

Robert Willett

I think some major smartphone manufacturers are on a multiyear journey to diversify their manufacturing footprint. And I think various recent -- various things that have been going on in the world are certainly continuing to drive that kind of sentiment for sure, production is being moved to other markets such as India and Vietnam, and we've been seeing that over a number of years, and it's definitely continuing and gathering pace.

And yes, we are certainly receiving orders and doing business for a business that historically might have been done in China and is now being done in India.

Jim Ricchiuti

Okay. Thank you.

Operator

Thank you. The next question is coming from Rob Mason of Baird. Please go ahead.

Rob Mason

Yes, good evening. I have a question about --

Robert Willett

Hi, Rob.

Rob Mason

Good evening. I had a question about the build-out of the emerging customer sales force. What -- if you think about at the end of this year or maybe even over the course of the next two years, what percent of your sales head count would you expect that sales force to comprise?

Robert Willett

Yes, I do think we're going to get that information just for competitive reasons. We have competitors in this space that are very tight lipped about their own investments, et cetera. But certainly, if you do the math on kind of what Paul told us about investment, it's going to be a significant number of heads we would expect to add this year and train and put into the field. And then I could see this as being an initiative that's going to build, really deliver for us over many, many years as our products get better for that market and our sales force becomes more established.

Maybe there's another kind of trend or data point I'd point to is like certainly plus years ago when we were talking, and about 50% of our business was going through distribution, right? But as our products have got more powerful and easier to implement and our business has got bigger, it's really 70% of our business now is direct and only 30% through distribution. So certainly, we recognize that continued growth is going to mean continued end-user direct sales head count. And that's a path we're on and we'll continue to be on.

Rob Mason

I see. Okay. And then just as a follow-up, maybe going a little bit the last questioner, but just around consumer electronics. And again, I know you don't have great visibility at this point in the year. But just sizing up the year that you just had, which I think played out better overall than maybe you were thinking at the outset of the year. Is the -- are you seeing anything, any indications that would support, I guess, growth this year, just given the typical cadence that, that business often is on? Or is there -- is there anything that you would call out that we should think about as we try to model out 2023?

Robert Willett

Rob, I think you're right in the characterization of last year. We as normal last year, as I'll tell you now, we really don't have a clear picture of how it's going to play out and we'll have a much better picture when we talk next in May, and we'll give you, I think, a clearer read at that point. And then last year, yes, we bought high single digits and our growth rate was substantially north of that, right? So as the year played out. But there are things that drive our growth in electronics. And I think there are factors that are coming together quite nicely as we look out over longer periods, right?

Certainly, continued waves of investment in consumer electronics. There's a lot of new innovation coming, and we see it particularly in areas like virtual reality and augmented reality. We see electronics manufacturers beginning to diversify their supply chains outside of China, particularly. And generally, that's new equipment that we're helping them install in those markets. And then I think a really major trend really links to deep learning and edge learning, which is the desire to replace there are millions of visual inspectors that are working in these markets today where I think COVID has made customers particularly sensitive to their vulnerability to large numbers of human inspectors.

And as a result, I think we're seeing a lot more interest in applying our technology to help address that vulnerability that they have. So I don't really know how this year is going to shape up I have a lot of optimism about our future in electronics, and we'll have a clearer view on this year's kind of CapEx and timing and spending. We certainly expect to at least maintain, if not gain share with some of those large consumer electronics customers that we have where we've built such great relationships over time.

And you can see one of them referenced as one of our largest customers last year as they have in a number of years.

Rob Mason

Fair enough. Thank you.

Operator

Thank you. The next question is coming from Paul Chung of J.P. Morgan. Please go ahead.

Paul Chung

Hi, thanks for taking my question. So just on -- you have a large kind of sequential increase here in the first quarter. But does that OpEx level kind of stay at that north of $110 million kind of quarterly run rate for the rest of the year? Or I think you mentioned some offsets, but how do we think about overall OpEx levels as we exit 2023.

Paul Todgham

Yes. Paul, this is Paul. We -- again, we don't have full year guidance on that. But I think our increase of about what we said about 10% sequentially, that's driven by a few factors. It's driven by our investment in our emerging customer sales force. It's driven a little bit by just a weaker dollar, which helps us from a revenue perspective, but hurts us a bit from an OpEx perspective, some investments in product launches and so on. I think this is a decent starting point to sort of model the year. I think if I were to compare versus a year ago, with this guide, if we're up 10% on average sort of sequentially or approximately 10%.

We're up a little less versus Q1 2022. But we are expecting to see some of our emerging customer expenses to ramp up a little bit over time. So I could see us being up a little more than like in the sort of 5% to 10% range overall for the year. Again, that's a combination of being very, very disciplined about discretionary expenses and investing in a couple of really important long-term growth initiatives.

Paul Chung

Great. That's very helpful. And then just a follow-up on product mix by vertical. So consumer electronics is -- continues to kind of shrink relative to logistics and auto given the growth rates there. But how do we think about longer-term gross margin impact? I think you mentioned in the past that kind of logistics comes in at slightly relatively lower gross margin. So how do we think about those moving pieces as we kind of model out gross margins longer term? Thank you.

Paul Todgham

Yes. I mean I think on a long-term basis, our mid-70s gross margin target is really the right way to think about that. And I expect and hope that you will be able to see that in the second half of this year. By far, the biggest contribution to getting back to that will be the wind down of the broker buys. And again, from a new purchase activity, that wind down has already occurred, absent some new crisis emerging, and now it's just a function of how it flows to our P&L in the current quarter we're in and next quarter and ideally by then, we're mostly through it.

The mix between industries, certainly, as Logistics remains slightly dilutive to our margins overall. We have some good initiatives including the modular vision tunnel and session, some of the standardized solutions that we've spoken about before, and Rob spoke about in the prepared remarks. That I think will help on that front. But overall, the product mix factors and the industry mix factors, I feel like we're quite manageable within our mid-70s target.

Obviously, as we continue to grow, we get some leverage on our fixed costs that may offset if a disproportionate out of that might be coming from a slightly lower gross margin area.

Paul Chung

Great, thank you.

Operator

Thank you. The next question is coming from Matt Summerville of D.A. Davidson. Please go ahead.

Matt Summerville

Thanks. So really just have one at this point, Rob. Just curious about that emerging customer initiative. I guess why now? Why not a year ago? Why not a year from now what sort of end markets and applications are you targeting? Is this broad from a geographic standpoint? And maybe more importantly, how much does this widen your TAM? Thank you.

Robert Willett

Great. Yes. Thanks for the question. Well, why now is because we got the products, right? We've been launching. We've been developing this edge learning technology, which is really -- and it's -- you can see it in our Insight 2000, and you can see it in the OCR version we just launched, which it really takes Cognex has kind of been famous in our life for serving the most challenging applications. The most sophisticated companies in the world want to work with us and their engineers on the most difficult machine vision problems and we've shined in that segment.

But now Edge learning technology takes a lot of the power of our technology and makes it really available for people who aren't trained automation engineers or vision experts. So -- and that, together with our ID products, which are also becoming increasingly easy to use and powerful means we have a vascular products finally that we can put into the hands of relatively inexperienced and sales noids that we train and send out to do that. So that's what this initiative looks like. That's why we're doing it now.

Certainly, our competitors have some very strong share in those segments of the market, and we're looking forward to sharing our products with those types of customers. They're going to be very broad ranges of customers. They're going to be customers who work in a lot of -- who manufacture in a lot of different industries who may not have a lot of automation already, may not use machine vision already and that's -- but are keen to adopt the technology and what it can do for them. So that's kind of how to think about it. Geographically, yes, very the potential is to deploy very diverse globally around these types of initiatives.

Matt Summerville

Thanks. And then Rob, if you've mentioned this already, I apologize. But can you maybe talk about it sounded like 2022 auto had a record year for you guys, up double-digits constant currency. What's your kind of big picture expectation for auto and EV battery this year particularly with the ongoing cutover to EV. Just maybe your overall thoughts on how auto plays out this year versus 2022.

Robert Willett

Yes. Automotive grew in 2022, about 13% in constant currency. And we've seen some good momentum and strong growth potential there. It is EV and EV batteries and the use of more and more electronics in automotive design sensors and entertainment, et cetera, which is really, I think, driving the use of machine vision that's somewhat offset, but certainly not completely offset by a reduction in internal combustion engine type business, powertrain, which is where most machine vision used to be sold in that segment. We're feeling optimistic about the long-term growth drivers for that. There will be some pun intended bumps in the road around the timing of deployment of some of the EV spend, I think, which will lead to some volatility in that. But I think over -- I think we think we're in a pretty good three year period with what's going on in the industry with our capabilities, the SEC acquisition we discussed a lot of drivers, I think, really, again, no pun intended, helping us grow that business over the years to come.

Paul Todgham

Yes, if you want a little bit of color kind of by quarter, Rob gave some feedback about the slow start to the year more broadly. I will say automotive is a piece of that, right? References to some legislation that are potentially along with PMI, leading to some delays in investment and reshuffling the plans and so on auto would be a piece of that. Historically, automotive is one of our less volatile industries quarter on quarter and so on. But -- so I think we think we're off to a slower start this year. And then if we looked against last year, obviously, Q3 was a particularly low quarter for automotive, just given the fire and other factors. So those would be the sort of relevant call it, Q1 being low, Q3 ideally would be up. So a little more back half optimism.

Matt Summerville

Thank you, guys.

Operator

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

Jairam Nathan

Hi, thanks for taking my question. I just wanted to kind of dig a little deeper on this auto opportunity, especially on the battery side because it's it seems to be kind of incremental to what you -- what Cognex had before, and especially with IRA and the shift to U.S. if you kind of compare what you saw in China over the last two years in terms batteries. Can you size the opportunity in some way or in a different way, I think in last year, you gave us an addressable market of $1.5 billion in automotive, I believe. Is that has -- can that number grow given what we are seeing in IRA or what that included the battery opportunity?

Robert Willett

Yes. I think we talked generally about the size of our automotive market and the long-term growth potential. Yes, we sized it at $1.5 billion. And we see estimated long-term market growth of 10%. I think over -- that's going to cycle up and down over time periods, but I definitely think EV battery investment and the timing about when it comes, is going to and it helped drive higher growth rates for us last year and could -- and I hope to see that again in the years to come.

We obviously see great need for our technology in that space. So I think what some of what we've been doing recently, such as the SEC acquisition means that we would hope to gain more share in that space and have better and more deployable solutions for customers. So we'll see how that plays out. We'll see what our competitors come with also. But we're optimistic about that. And then I think you mentioned, and it's another thing that potentially lifts our business here is the IRA investment plans from the U.S. government will mean much more investment in the United States, where we just have big share and a great reputation and a lot of experience with U.S. automotive companies who are obviously putting up the money to do this. So yes, we're optimistic about the space.

Jairam Nathan

And just finally, related to that, I think, historically, you guys have talked about how you are more focused on the auto supply base rather than the OEMs. Is that still the case? Or do you see some of that changing, especially given the move away from ICE?

Robert Willett

Yes, it's a really interesting question. So yes, I think historically, we've seen the majority of our automotive business being with Tier 1 automotive suppliers. And that dynamic may change over time. You're seeing a lot of kind of joint ventures and relationships between brand names and then big Asian technology suppliers.

We see that playing out in partnerships. And then you see also pure-play companies that are really going to business to manufacture batteries. So certainly, there's plenty of change going on in that space. But quite where that ends up, I wouldn't claim to know. We tend to look at applications and needs and often those are driven by the end users themselves and how they're executed can be through third parties. Like Tier 1s or in partnership between end user brands and Tier 1s. So yes, it's an evolving space. One, I look forward to talking with you about in future.

Jairam Nathan

Okay, thank you. Thanks a lot.

Operator

Thank you. Unfortunately we are out of time for questions today. I would like to turn the floor back over to Mr. Willett for any additional or closing comments.

Robert Willett

Yes, well, thank you for joining us tonight. We look-forward to speaking with you again on next quarter's call. Good night.

Operator

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time.