National Instruments Business Update Call Transcript

National Instruments Corp. (NATI)

Business Update Call

December 4, 2008 5:00 pm ET

Executives

David G. Hugley - Vice President, Secretary & General Counsel

Alexander M. Davern - Chief Financial Officer, Senior Vice President, IT & Manufacturing Operations & Treasurer

John M. Graff - Vice President, Marketing, Customer Operations & Investor Relations

James J. Truchard, Ph.D. - Chairman of the Board & President

Analysts

Antonio Antezano - Macquarie Research Equities

John Harmon – Needham & Company

Ajit Pai - Thomas Weisel Partners

Mark Moskowtiz – J.P. Morgan

Richard Eastman – Robert W. Baird & Co., Inc.

Terence Whalen – Citigroup

Presentation

Operator

Welcome to the National Instruments’ Business Update Conference Call. As a reminder today’s call is being recorded. You may refer to your press packet for the replay dial in number and pass code. The replay will be available from 7:00 pm Central time today and will end at midnight Central time on December 9^th, 2008.

With us today are Mr. David Hugley, Vice President, Corporate Counsel; Dr. James Truchard, Chief Executive Officer; Mr. Alex Davern, Chief Financial Officer; and Mr. John Graff, National Instrument’s Vice President of Marketing, Customer Operations and Investor Relations. For opening remarks I would now like to turn the conference over to Mr. David Hugley, Vice President, Corporate Counsel.

David G. Hugley

In this conference call we shall make forward-looking statements regarding the future financial performance of the company including statements regarding the following, our expected revenue, expected revenue growth, expected effective tax rate, expected earnings per share, expected operating expenses gaining market share and financial performance in spite of adverse changes in the Global PMI.

We wish to caution you that such statements are just predictions and actual events or results may differ materially. We refer you to the documents the company files regularly with the Securities and Exchange Commission including the company's Annual Report on Form 10-K for the year ended December 31, 2007 and our quarterly report on Form 10-Q filed November 7, 2008.

These documents contain and identify important factors that could cause our actual results to differ materially from those contained in our forward-looking statements. With that I will now turn it over to the Chief Financial Officer of National Instruments Corporation, Alex Davern.

Alexander M. Davern

Welcome to our scheduled Business Update call. Today I’ll provide a brief update on our finances and then John Graff, our Vice President of Marketing, will provide a brief business update. Also joining us today on the phone is Dr. Truchard, President ad CEO of National Instruments who is travelling on customer business this week and he will be available to take your questions.

Today National Instruments announced that its range for fourth quarter revenues will be 2% below the company’s guidance given on October 28^th. We now expect fourth quarter revenue to be between $204 million and $218 million. As a result we currently expect that GAAP fully diluted earnings per share will be in the range of $0.29 to $0.37 per share for Q4.

For the fourth quarter the company expects non-GAAP fully diluted earnings per share to be in the range of $0.35 to $0.43 per share. When comparing our guidance with our GAAP and non-GAAP fully diluted earnings per share in Q4 of 2007 of $0.56 and $0.62 respectively please remember that in Q4 last year NI recognized an $18.3 million tax cut which had the impact of increasing our GAAP and non-GAAP earnings per share by $0.23.

Now going into a little more detail on our revenue guidance, while the company’s year-over-year order growth through the end of November was in line with the midpoint of our original expectations we are lowering our revenue guidance today by 2% in response to the dramatic fall in the Global Purchasing Manager’s Index in November.

Also as you are no doubt aware many major corporations worldwide have recently announced plans to extend our holiday shutdowns at the end of the year which will have an obvious impact on our purchasing activity. As a result we have also built into our guidance an assumption that we will see a significant pause in business towards the end of December.

We modeled a scale of this pause in business on our experience in December, 2001 the last time we saw such broad based plans by our customers to extend their normal vacation schedules. Geographically we are seeing the effects of the slowdown worldwide with year-over-year order growth in all regions being in the single digits for the quarter through the end of November.

As previously stated for Q4 2008 the company expects year-over-year growth in total operating expenses to be between 3% and 6% down from 18% year-over-year growth in the first nine months of 2008. With $276 million in cash and cash equivalents at the end of September the company's balance sheet is very strong and during this quarter through the end of November the company repurchased 1,750,000 shares of its common stock at an average price of $22.85 per share.

While the current economic environment is very uncertain and dynamic NI continued to grow and gain market share. We believe we have been both strategic and prudent in our business planning and our reaction and execution in this downturn has once again demonstrated that our business model is solid. With that I’ll turn it over to John.

John M. Graff

Our continued growth this quarter has been driven by the success of our system level orders and by growth in the areas of modular instruments, PXI, software, CompactRIO and machine vision. We are especially pleased with very strong sales of the significant new products we introduced in August at NI Week including our 6 GHz RF Instruments, wireless data acquisition, Single-Board RIO and LabVIEW 8.6.

Given the very weak November PMI data and the over 20% year-over-year decline we saw in our instrument control business we believe that the overall test and measurement market has contracted significantly in October and November. You can see from Slide Number 3 of the presentation which accompanies this webcast that the gap between our performance and the Global PMI has been steadily widening over the last eight quarters and this continued through November.

Our ability to continue to grow our business showed that we are finding new business and taking market share. From an orders point of view through the end of November orders over $20,000 grew in the high single digits while orders under $20,000 were slightly positive. We do believe that the success of our sales force in driving large orders in new application areas has once again been the key to this growth and validates our strategy of investment in R&D and field sales.

In closing we are being very realistic about the economy but we continue to be very optimistic about NI’s future. The diversity of our business, the differentiation of our products and the innovation of our people provide great strength to National Instruments during difficult times. We will continue to focus our investments on R&D and on expanding the field sales force while carefully managing expenses in all other areas of the business.

We believe these wise and prudent investments allow us to deepen our customer relationships and expand our product portfolio to prepare for an eventual recovery. With that we will now open up for your questions.

Question-And-Answer Session

Operator

Today’s question-and-answer session will be conducted electronically. (Operator Instructions) We will proceed in the order that you signal us and we’ll take as many questions as time permits. As a courtesy please limit questions to one with one follow up question. After your follow up question you will be placed back in a listen only mode. Our first question comes from Antonio Antezano - Macquarie Research Equities.

Antonio Antezano - Macquarie Research Equities

I was wondering, looking at the guidance and now we are at the end of early December, why didn’t you narrow that guidance for the fourth quarter.

Alexander M. Davern

We looked at the range of business, Antonio, and obviously the big issue that’s causing us concern right now, at the end of November we were pretty much on the midpoint track for our guidance we gave at the end of October but the range of scale of companies we’re seeing announcing every day that they’re pretty much going to shut down from the 21^st or 22^nd of December onward is really what’s giving us pause and caution in our guidance and causing us to bring the revenue expectations down.

That’s a little bit unpredictable at the moment. We’re continuing to see more and more companies make that announcement so we wanted to maintain the range but account in the guidance for the fact that we’re now going to see pretty broad based shutdowns for the last 10 days of December that we hadn’t anticipated and had not been announced at the time we gave guidance in October.

Antonio Antezano - Macquarie Research Equities

What is your assumption for the Global PMI in December?

Alexander M. Davern

Right now we’re assuming that it’s going to stay pretty much where it is in this 35% to 36% range. Obviously it came in in November quite a bit below what we were thinking at the end of October but that really isn’t the main factor that’s driving the change in guidance. The real factor that’s driving the change in guidance is there’s going to be I think a significant pause for those companies certainly who are doing shutdowns in the last 10 days or so of the month.

That’s really the reason for us to change guidance.

Operator

We’ll take our next question from John Harmon – Needham & Company.

John Harmon – Needham & Company

To rephrase Antonio’s question before, he asked about the PMI, do you feel like the environment is still deteriorating or have you seen, even though you took down your guidance, any feeling that things might be becoming more stable?

Alexander M. Davern

I guess I’d refer back to what we just said, I think it’s a good question. When we looked at it, it was a tough decision for us. Through the end of November we were right on track to hit the midpoint of the guidance we gave in October. So I’d have to say that in October and November business trends were in line with what we expected to see six weeks ago. That would be relatively stable with where we were through early October.

However the experience we saw at the end of ’01 is that in the last week or so of December of ’01 we saw a very dramatic fall off in order flow way beyond the normal seasonal pattern as we experienced this phenomena of the shutdowns as companies are trying to force vacation and when we really examined that and certainly when we’ve seen the number of companies that have announced it, we anticipate that that will repeat.

That was a drop off in business for that week that was upwards of 50%. So that particular week is going to be very, very slow and that’s really the thing that’s driving us to change guidance as opposed to a change in the general tone of business or the flow of business, its been fairly steady, but we do expect that to get disrupted in the last 10 days of the month. It may just be a pause in the buying cycle and we’ll see how it plays our in January.

John Harmon – Needham & Company

That leads me to my follow up question, any feelings that subsequent decline in the PMI could exacerbate the seasonality you expect for the March quarter? Any early indications of how it could look?

Alexander M. Davern

I think it’s too early to tell at this point. We’ll obviously address that issue in January. I am somewhat pleased that certainly given what we’ve seen so far that activity through the end of November was in line with our expectations. Really the only thing that’s causing us to make any change at this time from what we said six weeks ago is this last week of December phenomena.

January, as I said on the call, the economic environment is very uncertain right now and very dynamic. We’re a year into this recession and it’s going to turn around at some point but I don’t think we’re in a position at this stage to try to call that and we’ll see where we stand at the end of January.

Operator

We’ll take our next question from Ajit Pai - Thomas Weisel Partners.

Ajit Pai - Thomas Weisel Partners

A couple of quick questions, I think the first one is just looking at what happened the last cycle relative to what’s happening in this cycle in terms of your investments in the business. I think in the last cycle you invested a lot on the R&D side right through the downturn and came out with all these new products over the past several years.

Going into this cycle, I think your efforts were focused much more on building your sales and distribution and strengthening. Given the current weakness you’re seeing in the end markets, are you changing your thinking on that? Is there going to be a reallocation of demand in which you invest in your business with the changes in dynamics that you’re seeing in the end markets? Then I’ll follow up with a couple of other questions.

Alexander M. Davern

Good question. As we look out into next year, one of the things that helps us quite a bit is that we relative to ’01 have made our variable compensation element of our business model expense model significantly more reactive to revenue than it was in the 2001 timeframe. That allows us to moderate our expenses as we have successfully done or are guiding to here in Q4, taken our expense growth rate down from 18% in the first three quarters down to 3% to 6% in Q4.

Our expectation is we will continue to increase our investment in R&D and so we do expect to continue to recruit in R&D next year. However, unlike 2001 and 2002 we’re not trying to raise R&D significantly as a percentage of revenue at this point in time. At that stage we were trying to grow it from 12% of revenue to 16%. At this stage we’re just trying to maintain it as a relative percentage of revenue.

That allows us to increase our investment in R&D without having to dramatically change the business model. On the sales side, we’ve obviously been expanding our field sales force dramatically this year and we will have some moderation of that as we look into next year based on our expectations of performance.

John could talk a little bit about the value we’re seeing from that expansion of the field.

John M. Graff

I think we’re seeing the payoff of that sales investment that was built upon the investment in R&D during the last downturn. The new product platforms, especially PXI and modular instruments on the test side of things and CompactRIO and our FPGA based devices on the industrial embedded side. Our sales force continues to see opportunity.

Obviously the diversity of our business is one of our strengths during times like this so that our direct force can easily adapt to the opportunities in the businesses where there continue to be investments and continue to be growth. We continue to feel good about that opportunity pipeline and that’s what continues to give us optimism both in the short term and obviously for the long term.

Alexander M. Davern

The other point, before you come back to your follow up question, I would make is that relative to the last cycle as we’ve changed the business to be much more growth oriented, a lot less susceptible to the downturn in instrument control, that’s allowing us at a time when the Global PMI is at 36%, to guide to revenue growth.

Also if you back out the $18 million gain last year to flat EPS year-over-year in Q4, that’s something we would not have been able to achieve given the structure of the business seven years ago on our bias towards that big increase in R&D. I think clearly we’re able to deliver a much higher operating margin level in this cycle at the same PMI numbers than we were in the last cycle.

Ajit Pai - Thomas Weisel Partners

In your earlier commentary, I think you indicated that part of your guidance being reduced another 2%, your growth rate expectation, is to do with a lot of large corporations that are revising down their guidance, some of your pretty large customers.

Could you give us some color from a geographic perspective if there’s any market trend that you observed, whether it’s primarily more in the developed countries, whether it’s in emerging economies, where you’re seeing the slowdown the most?

Alexander M. Davern

The best way I can probably address that is historically because this is an expectation we have and it’s tough to put exact numbers around it. Right now all regions of the world are showing growth through the end of November in the single digits. We’re continuing to see growth in all regions so far through the end of November.

When we went back and looked at ’01, it really became obvious as we started to go through early November here in 2008 and certainly into December that the number of companies planning these shutdowns is just growing every single day.

We went back and looked at it in ’01 and while our revenue growth rate for the first three weeks of December was in line with October and November of ’01, the last week of December it dropped over 50%. That drop was over 50% in all three regions. It was down over 50% in Asia, Europe and the Americas. It was very much a global phenomena, not isolated to any particular geography.

That’s pretty much what we’re expecting to see again. It may ultimately turn out to be more geographically biased but we’re assuming that it’s a global phenomena because it appears to us that we have a very synchronized global recession under way, so I think it’s going to be global.

Operator

We’ll take our next question from Mark Moskowtiz – J.P. Morgan.

Mark Moskowtiz – J.P. Morgan

A couple of questions on my end, first on your cost cutting plans, you mentioned earlier that you’re going to moderate your sales expansion going into next year. Can we expect you following your customers’ lead on the shutdown at the end of December or should the hiring trend or your focus be more back end loaded in ’09 or are we shutting down that in the near term as well?

Alexander M. Davern

No, we do not have any plans to do any kind of shutdown at NI in December. As we’ve talked here the company is continuing to grow. We see a lot of long term opportunity for the business and we have many customers who require us to make delivery by the end of the year to satisfy their budget requirements for committed dollars. We will be open for business as normal through the end of the year.

As we look out into ’09 while we’ll be moderating our plans for investment, we do intend to continue to hire through ’09 and we will be investing through this downturn. We will not be making the kind of investments relative to what we did in 2001 in R&D because we’ve already largely addressed that issue.

But we will be continuing to hire as we go through ’09. It’s amazing, and John can probably add some anecdotal evidence, in this timeframe as in ’01, we are seeing a lot of talent come available from many different companies. Just in the last four to six weeks, the number of very talented individuals that have become available to potentially be hired at NI that can add a lot of value to the company is quite surprisingly high.

We want to take advantage of this downturn, our financial strength, and we’re going to acquire talent during this downturn and put that work at NI to drive our business forward as we go on. We will, of course, be moderating our expense growth. We’re not going to be growing expenses at the 18% rate we saw trough the first nine months of this year.

It’ll be very much like what you’re seeing here in Q4 but we are going to opportunistically continue to expand the field and we will be certainly in a talent acquisition mode for talented engineering talent. John, do you want to comment on that?

John M. Graff

I’ll just briefly add on and mention that like Alex said, if you looked back in the last downturn, specifically in R&D we were able to add some key experienced hires that played a pretty instrumental role in a lot of the successful products that we’ve had over the last five to seven years.

Now we continue to see that similar type opportunity, but also the opportunity to bring in talent and experience into the system engineering roles that we’ve talked about I think in the last couple calls. The system engineers play a critical role in this large system selling process.

Alexander M. Davern

Dr. Truchard may want to comment on his philosophy on investment in these downturns.

James J. Truchard, Ph.D.

The good news is we’ve got a really solid product portfolio going into this downturn that just gives us a lot of opportunity. As we’ve spoken in the past, looking at the opportunities we have and we know of, some of them basically may be a little harder to get. Our first step is to look at opportunities that we may have not been able to get to in the past because of the limited resources.

That will gate how we view the investment in sales because we feel that we do have really solid opportunities, just like I this week have been visiting fusion energy conference and clearly that’s a long term deal, but there is opportunities that we can take advantage of that may take a little bit more work, but longer term they will pay off for us. Because of the diversity of our business we can always at this point find these opportunities.

That’s what we’ll be working hands on to see that we get the right kind of opportunities to find for whatever resources we bring on board.

Alexander M. Davern

Anthony, did you have a follow up question?

Mark Moskowtiz – J.P. Morgan

I did actually. My follow up is basically you talked about regional sales growth being in the low single digits. I was wondering if you could give us some color on the end market themselves? Your order growth was in line in November but you’re expecting a fall off in December. Can you talk about what’s underperforming in November and then ultimately in December?

Alexander M. Davern

I’d like to emphasize again, the fall off we’re expecting to see is really is in this last week or so. John can share with you on the industry side.

John M. Graff

In terms of industry color we don’t have the specific data at this point, we’ll share that obviously in January. Qualitatively though, you can imagine we are seeing weakness in areas like semiconductor, automotive as well as our sales to traditional ATE vendors. Areas where we continue to see some pretty strong growth and momentum include communications especially with our RF instruments. We’re seeing very strong growth in that area.

We continue to be very pleased with the new opportunities and business we’re securing in industrial and embedded applications. Again, a key point for National Instruments has always been this diversity of our business where no end vertical is more than 10%. We think that’s again what gives us this continuing opportunity that our products and our sales investments can play into.

Operator

We’ll take our next question from Richard Eastman – Robert W. Baird & Co., Inc.

Richard Eastman – Robert W. Baird & Co., Inc.

John, I was just curious, or Alex, when you had mentioned that orders over $20,000 were up high single digit and under $20,000 were slightly positive do you attribute that to your increased field sales force? I guess it correlates to the end markets that you said were strong, but I’m just curious what’s your read through on that divergence in growth rates between the price points?

John M. Graff

We think the continued success with the large orders is very attributable to the investment in the field sales. Again, it’s layered on top of the investment in R&D but really driven by platform products like PXI, the modular instruments and specifically the RF instruments on the test side. In the industrial embedded space, continued momentum with CompactRIO, the Single-Board RIO platform that we introduced just this past August.

Those type of products coupled with the sales force’s ability to go and identify these larger opportunities is really what’s driving that success with the larger orders.

Alexander M. Davern

One other thing if I may add on to John’s comment is that talking to the sales management and Pete Zogas, Senior VP in Sales and Marketing, a lot of our sales guys are continuing to work large longer term opportunities and while some of those budgets have clearly been perhaps delayed, we’re going to create I think some pent up demand among our customer base as we continue to execute on design wins that perhaps the budget may be delayed for some period of time.

I think that that work of our sales force in this timeframe is going to be very, very valuable for sowing the seeds to allow us not only to outperform as we have done I think very well here in this downturn but to ensure that we continue to outperform very successfully to market when we move into recovery.

Richard Eastman – Robert W. Baird & Co., Inc.

That’s probably the answer to my second question, that being that we’ve already been inundated with companies commenting that their capital investment budgets were being tuned lower for ’09 and given the order size greater than $20,000 now, are you again sensing that that’s going to create some problems early in the year next year?

Alexander M. Davern

I think we’ll be in a better position to address that obviously in January, Rick, but again I would emphasize that for us over $20,000 is still a fairly small capital item in the budgets of the vast majority of companies. For NI cost is a pretty massive differentiator so I think this pressure in cost will help us in terms of market share gain significantly but certainly there’s no question the overall market as we said in the call, we believe the TNM market contracted pretty significantly in October and November.

That restriction on capital budgets has obviously already happened to a fairly large degree in the last two months. Our ability to continue to grow in that timeframe and to have an adjusted EPS that’s flat in Q4 if we hit the midpoints I think is going to be a stellar performance relative to the norm.

Operator

We’ll take our next question from Antonio Antezano - Macquarie Research Equities.

Antonio Antezano - Macquarie Research Equities

Just a follow up on the last question, regarding your statement of market share gains, if you could expand on that and maybe share some examples on how you’re gaining market share especially in the communication test platform.

Alexander M. Davern

Antonio, as you know we’re fairly new to the RF test business. That business has continued to grow quite successfully through November and all throughout the year. Our new products have been very well received. This is a space where clearly we had no measurement capability in the past and so all our revenue growth there is very, very clearly coming market share gain. I think that’s a classic example of what we’re talking about.

I think the broader based data we’re seeing from all of our competitors clearly shows significantly negative revenues for the last few months and I think it’s pretty clear that we’re gaining market share in the broader space as well as in the narrower slices that we look at internally.

John M. Graff

I might just add on that we talked a lot about RF because we’re extremely pleased with the very strong growth, but if you look a little broader, our overall modular instruments and PXI platform which is ideally suited for a lot of ATE production test type applications where again our cost benefit, the performance advantage of our software based platform really shines through.

When you have a lot of companies that are squeezing on their capital budgets, it actually makes our value proposition look a little better. The success in RF, the success in modular instruments, the success in PXI is what we believe is continuing to drive our growth and success.

Antonio Antezano - Macquarie Research Equities

Just one clarification, you said that instrument control revenues were down 20% for the first two months of the quarter.

Alexander M. Davern

Over 20%, Antonio.

Antonio Antezano - Macquarie Research Equities

Over 20% for October and November?

Alexander M. Davern

For October and November and that’s a pretty dramatic drop off obviously from, don’t quote m on this because I may be wrong, I’m going to double check it, but I believe we were minus 4% or minus 5% in Q3. A very, very clear drop off and I believe that’ll be reflected in the overall TNM world in general.

For us to have double digit order growth through November in modular instruments and PXI clearly shows the type of market share difference that we’re talking about.

Operator

We’ll take our next question from Terence Whalen – Citigroup.

Terence Whalen – Citigroup

I tuned a little bit late so I apologize if we have gone over this, your initial expectation I think for 4Q for PMI was about 42% to 44%. It looks like we’re going to come in closer to 38% yet we only have a 200 basis point reduction in revenue expectation. Was that a little bit of a positive surprise to you guys relative to where PMI has come in?

Alexander M. Davern

Definitely, we were quite surprised by the 36% number we saw. By the time it came out, we weren’t but relative to what we thought we would see at the end of October and we’re now looking probably at a Global PMI that’s going to average somewhere around 37% for the fourth quarter which is a lot lower than we had anticipated.

The resilience of our broad based business, especially in the areas of modular instruments and PXI and embedded has been impressive to us internally. If you’d asked me about a PMI of 36% six months ago or two years ago and would we be able to continue to grow and maintain our profitability, I would have been somewhat skeptical.

This is definitely at the high end of my expectations relative to this economy. I do think our decision to grow the field at the time we decided to do it is probably a significant contributing factor to that and I think that plays heavily to our benefit. Dr. Truchard may also care to comment on that.

James J. Truchard, Ph.D.

I think that’s correct and as I mentioned earlier the fact that we have the resources to go after what may be a little tougher business is a real advantage at this point. To date, the decision to grow our field sales force definitely is helping us.

Terence Whalen – Citigroup

If I could follow up, now that we have the updated information for November, what’s your expectation for 1Q ’09 PMI level? I think other questions had alluded to this but I wanted to get your internal planning, what you’re gearing up for 1Q ’09 PMI.

Alexander M. Davern

I think that’s the $64,000 question and a very good question and obviously a tough one to answer. November proved to be a lot worse than I had expected so my recent track record’s not that great. It’s tough to predict, but my feeling is that there is going to be a recovery. It’ll probably be fairly strong and the question is when is it going to start?

I personally believe that it’s not unlikely that the PMI in the end of Q1 is going to be higher than it is today based on the longer term history. If you go back and look at what happened with the US PMI when it fell to these levels back in 1980, it didn’t stay down there for very long. I’m not sure if 1980 is the model but if you use 1980 as the model, then that would imply a significantly less bad PMI, probably still below 50%, but significantly less bad by the time we get to March.

What historical pattern we’re actually going to follow remains to be determined. As John said we are being very, very realistic about the economy while still planning to invest in the crucial areas of the business to prepare for the upturn.

Operator

This is all the time we have for questions today. With that I‘d like to turn the call back over to our presenters.

Alexander M. Davern

Thank you very much for joining us today. We will be presenting at the Needham Investor Conference in New York on Tuesday, January 6^th. We hope to see you there and thank you very much for your time.

Operator

This does conclude today’s call. We thank you for your participation and ask that you have a wonderful day.

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