National Instruments' CEO Discusses Q2 2013 Results - Earnings Call Transcript

Jul.29.13 | About: National Instruments (NATI)

National Instruments Corporation (NASDAQ:NATI)

Q2 2013 Earnings Conference Call

July 29, 2013 17:00 ET

Executives

David Hugley - Vice President, General Counsel and Secretary

Alex Davern - Chief Operating Officer

Dr. James Truchard - President, Chief Executive Officer, and Co-Founder

Eric Starkloff - Senior Vice President, Marketing

Analysts

Mark Douglass - Longbow Research

Patrick Newton - Stifel

Rob Mason - Robert W. Baird

Operator

Good day, everyone, and welcome to the National Instruments’ Second Quarter 2013 Earnings Conference Call. Today’s call is being recorded. You may refer to your press packet for replay dial-in number and pass code.

With us today are David Hugley, Vice President, General Counsel and Secretary; Alex Davern, Chief Operating Officer; Dr. James Truchard, President, CEO and Co-Founder and Eric Starkloff, Senior Vice President of Marketing.

For opening remarks, I would like to turn the call over to Mr. David Hugley, Vice President, General Counsel and Secretary. Please go ahead, sir.

David Hugley

Good afternoon. During the course of this conference call, we shall make forward-looking statements, including our guidance for our Q3 revenue, gross margins, operating expenses and earnings per share and statements regarding our expense control plans and future financial performance. We wish to caution you that such statements are just predictions and that 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 most recent quarterly report on Form 10-Q filed May 2, 2013. 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 Executive Officer of National Instruments Corporation, Dr. James Truchard.

Dr. James Truchard

Thank you, David. Good afternoon and thank you for joining us. Our key points are second quarter revenue of $296 million, all-time record revenue for RF products, and good spending discipline in Q2. Our revenue in Q2 was weaker than anticipated as we continued to see challenges in our industry. However, I was very pleased with our disciplined cost management during the quarter, and we plan to continue further actions to optimize our spending going forward.

In our call today Alex Davern, our Chief Operating Officer will review our results; Eric Starkloff, our Senior Vice President, Marketing will discuss our business, and I will close with a few comments before we open up for your questions. Alex?

Alex Davern

Good afternoon and thank you for joining us today. Today, we reported second quarter revenue of $296 million, 3% below the midpoint of our guidance range. Although our year-over-year growth in Q2 was weak, we were pleased to see growth given the current weakness in the test and measurement industry and believe that we are continuing to gain market share.

For Q2, net income was $14 million with fully diluted earnings per share of $0.12 and non-GAAP net income was $22 million with non-GAAP fully diluted earnings per share of $0.18, $0.04 below the midpoint of our guidance range. During Q2, we incurred a $0.01 per share loss on foreign exchange, which we had not anticipated when we gave guidance. A reconciliation of our GAAP and non-GAAP results is included in our earnings press release.

During Q2, we saw a broad weakening of revenue growth across geographic regions. Year-over-year revenue was down 15% in the emerging markets, down 1% in the Americas, up 2% in Europe, and up 10% in East Asia. Growth in East Asia came despite the significant negative impact from the decline in the value of the yen with orders from Japan in Q2 being down 20% year-over-year in U.S. dollars.

Non-GAAP gross margin in Q2 was 73%, down 390 basis points from Q1. As we anticipated in our April’s earnings call, our gross margin was negatively impacted by lower factory utilization and a significantly lower margin on orders for our first RF test application with our largest customer. I will give additional detail on this application in a moment. Total non-GAAP operating expenses were $185 million, down $5 million sequentially. The year-over-year growth in our non-GAAP operating expenses dropped from 12% year-over-year growth in Q1 to 3% year-over-year growth in Q2. And our non-GAAP operating expenses in Q2 were $8 million lower than our guidance. Given the recent broad weakness in the industry, we have identified additional actions, which we are taking to further reduce our spending for the second half of the year. For Q2, our non-GAAP operating margin was 10% with non-GAAP operating income of $30 million. Our operating income was flat sequentially. Our tax rate increased significantly from Q1 mainly due to the impact of the reinstatement of the R&D tax credit in Q1.

Now, taking a look at the trends by order size. We saw 4% year-over-year growth of our orders between $20,000 and $100,000, while orders over $100,000 fell 30% year-over-year. We had a particularly difficult compare in Q2 as the value of orders over $100,000 was up 130% year-over-year in Q2 of last year. So, for perspective, when you compare with Q2 of 2011, our orders over $100,000 were up over 60%. With respect to our largest customer, we are currently serving three different applications for them, each involving the use of LabVIEW and the NI PXI platform to rapidly develop production test solutions, which offer the customer outstanding performance and accuracy at a very low cost of test per unit. Two of the applications we serve for this customer ramped up significantly for initial production in 2012, and as a result, the customers ordering far less units this year. The majority of orders from this customer in 2013 relate to a new PXI application in RF test, which is a highly competitive space in an area which we have not served for this customer before. As a result of the highly competitive nature of this application, the margins were significantly below our corporate average.

In the first half of 2013, we received $30 million in orders from this customer, and in Q2, 2013 we recognized $23 million in revenue. Included in presentation materials accompanying the webcast are the details of the revenue we have recognized from this customer over the last 10 quarters.

Turning now to revenue from orders under $20,000, these orders have historically been directly affected by the economic conditions in the global industrial economy, and we have continued to see a weak performance in this area in Q2 with these orders down 4% year-over-year. In summary, Q2 was the difficult quarter for the industrial economy and for National Instruments. These challenges were exacerbated by the sequestration process in the U.S. and a large fall in the yen, but despite these challenges, we believe NI was able to gain market share in Q2. On the expense side, we successfully reduced our spending and will continue to adjust our spending plans to align with the industry’s current weakness.

Now, I would like to make some forward-looking statements. The continued weakness in the PMI with the three largest economies, the U.S., the Eurozone and China, all falling below 50% at some point during Q2 makes us conservative in planning for the rest of 2013 and 2014. As a result, we currently expect revenue for Q3 to be in the range of $265 million and $295 million. As a midpoint, this represents 3% year-over-year decline. For perspective we’ve recognized $27 million in revenue form our largest customer in Q3 of last year and we are currently anticipating less than $5 million in revenue from this customer in Q3 this year.

Factory utilization will continue to be a challenge in Q3, but we expect gross margins to be up approximately 250 basis points to 300 basis points from Q2 on the change in customer mix. Total non-GAAP operating expenses are expected to be $186 million plus or minus $3 million. We currently expect GAAP fully diluted earnings per share will be in the range of $0.04 to $0.16 for Q3 with non-GAAP diluted – fully diluted earnings per share expected to be in the range of $0.10 to $0.22.

Looking at the Q4 and beyond, we are adjusting our spending plans to reflect the more difficult industry conditions and to help ensure we keep a strong focus on our operating margins. As a result we currently expect that our total non-GAAP operating expenses will decline sequentially in Q4 and that there will approximately $181 million plus of minus $3 million in Q4.

Looking at the 2014 our priority will be to improve our operating margins and as a result we are currently planning to keep our overall headcount flat in 2014. While the industry is going through some painful quarters, we are taking the corrective actions necessary to adjust our expenses. We expect this to result in a significantly improved operating margin in Q4.

As these are forward-looking statements I must caution you that actual revenues, expenses and earnings could be negatively affected by numerous factors such as any further weakness in the global economy, rescheduling of customer orders, expensive overruns, manufacturing inefficiencies, foreign exchange fluctuations and effective tax rates. We will be hosting our investor conference next week as part of our NIWeek User and Developer Conference, and we look forward to seeing you there.

With that, I will turn it over to Eric Starkloff Senior Vice President of Marketing.

Eric Starkloff

Thank you, Alex. Despite headwinds from the global economy, sequestration and the decline in the PC market in Q2, we are pleased with continued order growth in academic, RF, CompactRIO and CompactDAQ products. All product platforms oriented around LabVIEW. Additionally, I was pleased to see continued growth in our customers’ interest in our platform as evidenced by strong growth in our leads and opportunities in Q2.

Our PXI products faced a very difficult compare in Q2 with the large orders Alex discussed earlier. However, we continued to see strong growth in our RF orders leading to an all-time record revenue this quarter. Our strength in RF was driven by very strong adoption of the vector signal transceiver that we launched last August. The vector signal transceiver is proving to be a highly differentiated and disruptive product that realizes NI’s vision by providing users with the ability to design the firmware of the instrument through software.

Following the success of other FPGA based products such as CompactRIO and FlexRIO, the vector signal transceiver has generated more revenue in its first nine months than any other single new product in the history of the company. Recent successes for the vector signal transceiver include a supplier of leading edge wireless technology selected the vector signal transceiver because of it’s flexibility to test multiple wireless standards in a single instrument which ultimately reduced their overall test hardware investment. The vector signal transceiver displaced incumbent technology for a multimedia test application because NI solution increased test throughput by 80% while decreasing equipment cost by 30% compared with traditional instruments.

And leading partners in non-linear network analysis leveraged the vector signal transceiver and LabVIEW to develop solutions to overcome the increasingly difficult characterization requirements for RF power amplifiers used in applications such as wireless base station testing. Growth in our embedded control and monitoring systems in Q2 was tempered by weakness in product areas including vision and motion control. However, sales of our CompactRIO products continued to outpace company growth resulting in record Q2 revenue. This growth was driven by applications in aerospace and defense, machine control and power generation systems. For example in Q2 CompactRIO and LabVIEW displaced what would have been a custom design for controlling machines that manufacture and test consumer electronics devices because it was better able to meet this customer’s complex measurement and control requirements.

CompactRIO is also being deployed by one of the nation’s largest power utilities to monitor their generation assets across multiple plants. We plan to showcase this as a very significant application at NIWeek. Enabling the success of both the vector signal transceiver and CompactRIO is the LabVIEW RIO architecture based on a user-programmable FPGA. The LabVIEW RIO architecture provides our customers and partners with a unique ability to define and optimize the firmware of their test and embedded systems to match these specific requirements of their application. This technology enables users to quickly iterate on their design and implement updates to the deployed hardware if their requirements change. And because data is processed locally on the hardware, test and control loop execution can see dramatic speed increases resulting in faster test times and more efficient control.

We will be showcasing the LabVIEW RIO architecture and its impact in multiple application domains during NIWeek. Despite relative weakness in our broad-based data acquisition business, NI CompactDAQ continued to be a bright spot with record orders in Q2. Since releasing the standalone version of CompactDAQ at NIWeek last year, customers have utilized it successfully in a wide array of applications, including data logging for transportation systems, power grid monitoring, and component testing. Over the past decade, we have had an intense focus on working with academic institutions to provide students with tools that enable hands-on learning. The continued adoption of our academic products and universities help lead to a new Q2 record for our academic orders.

During the quarter, EPFL in Switzerland, a leading university in Europe adopted our NI ELVIS and MIDAS teaching platforms and the NI USRP for communication system prototyping across areas in teaching and research, such as software-defined radio circuits, controls, and mechatronics. Leading research institutions around the world are also adopting NI product platforms, such as PXI and the vector signal transceiver for research projects and leading-edge communication standards like 5G wireless and new medical imaging technology, such as optical coherence tomography.

Finally, I want to mention our NIWeek User Conference coming up next week in Austin, which brings together several thousand engineers, scientists, and thought leaders from a breadth of industries. What all of these attendees have in common is that they are using NI’s platform to accelerate their innovation, lower their cost, and increase their competitiveness. Attending our Annual Investor Conference held in conjunction with NIWeek provides investors with access to executive management, customers, and partners, so that you can talk to them directly about their use of NI technology. We are currently on track to achieve record attendance this year, and we hope that you will be able to join us on August 6.

With that, I will turn it back over to Dr. T.

Dr. James Truchard

Thank you, Eric. Last quarter, I talked about the importance of effectively managing our cost to sustainably scale our business for long-term. I am pleased with our employees’ efforts to better align our spending with the weaker industry. While we were disciplined in our cost management during Q2, I continued to challenge our organization to find ways to drive operational efficiency. An important factor in scaling our business is building on their vision of graphical system design, which integrates our software and hardware for measurement and control systems.

When we started NI, we envisioned the central role software would play in instrumentation. Decades later, we see LabVIEW continue to revolutionize the way engineers approach a diversity of applications, most recently an RF design and test, where the vector signal transceiver delivered the next step in our long-term vision. In this new age of software-based instrumentation, I believe we are well-positioned to continue to increase sales in the industries served by empowering our customers to design, test, and deploy their products more efficiently. At the same time, we plan to continue to extend our technology and vision into new application areas for NI as we have an embedded control in monitoring systems, where we believe we can fundamentally change the paradigm by which scientists and engineers approach their research and design.

One emerging trend we are excited to explore is big data, specifically when scientists and engineers are gathering physical analog data such as light, sound, and temperature. This area of big analog data brings new challenges to test and measurement applications that must keep pace with the exponential growth of data. Big analog data solutions require higher channel counts to capture the volume of data produced and our long-term leadership position in data acquisition will help us enable customers to meet this growing data demand. Our customers find value in using the techniques of big analog data and we will be showcasing our solutions at NIWeek that can help customers to reduce risk and achieve value from their data quicker.

I am looking forward to NIWeek, which will showcase many of the technologies and new products that our R&D team has developed. Thousands of engineers will join us in Austin to see these new products and explore how these applications can benefit from NI technology. We will be hosting the graphical system design achievement awards which showcase how our customers tackle some of the world’s most significant, scientific and engineering challenges like cancer research, space exploration and next generation wireless. I look forward to seeing you next week.

In summary, while there is still uncertainty in our industry I am pleased to see how our employees exercise disciplined cost management. We have invested in our R&D and field sales teams significantly over the past two years and believe we are now positioned to gain leverage and return from these investments. We are concentrated on prioritizing projects, simplifying processes, driving productivity and focusing on innovation. I am confident that we are redefining how scientists and engineers can be more productive in their tools for research and discovery. And I believe that we have the resources necessary to create sustainable differentiation for NI, our customers, partners, suppliers and shareholders.

We will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Mark Douglass with Longbow Research.

Alex Davern

Hey Mark, how are you.

Mark Douglass - Longbow Research

Good afternoon, can you hear me?

Alex Davern

Good afternoon, yes, we can hear you.

Mark Douglass - Longbow Research

Alright, great. Alex, you talked about the reduction in spending, so we have already seen it in 2Q and then it’s going to continue in 3Q and 4Q, can you talk about how you are reducing the spending, where it’s coming from?

Alex Davern

Mark, we are as you would in a situation like this where you see weakness across the industry we are moving to align our investments with the opportunities. So, we are looking at areas that would normally be affected in this timeframe, areas like variable pay, some discretionary spending, etcetera, but the primary vehicle will be to use attrition that we would normally see as we go through the year to balance our headcount with our revenue growth as we move towards the end of the year. So, as you – we can talk to you here that we had our headcount was actually flat from March to June. Time period when it would normally go up we will see a modest increase in Q3 as there are new hires come on board from college recruiting and then we are expecting to see our headcount fall sequentially in Q4. We are planning currently to end the year with several hundred less people than we originally planned.

Mark Douglass - Longbow Research

And then that’s all just from attrition?

Alex Davern

Correct.

Mark Douglass - Longbow Research

Okay.

Alex Davern

It’s a bit more patient process, but one we believe will help preserve the culture and drive the value that we believe we can get through productivity.

Mark Douglass - Longbow Research

Okay. And then looking – you mentioned 4Q and OpEx down sequentially from 3Q is that assuming you get a normal seasonal up-tick in 4Q or are you employing a sequential down-tick from 3Q to 4Q?

Alex Davern

Well, on the spending side we are definitely implying a sequential down-tick from Q3 and Q4.

Mark Douglass - Longbow Research

Right.

Alex Davern

And that’s only on spending. On the expense side at this point obviously we can’t give guidance on Q4 but I don’t see any reason to believe that we won’t see our normal historical pattern in the fourth quarter.

Mark Douglass - Longbow Research

Okay, so…

Alex Davern

On revenue from a sequential point of view.

Mark Douglass - Longbow Research

Okay. Okay, thank you.

Operator

Our next question comes from the line of Patrick Newton with Stifel. Your line is open.

Patrick Newton - Stifel

Yes. Thanks for taking my questions. Good afternoon. Alex, first question, I wanted to dig a little bit in the gross margin side and with the 400 basis points roughly sequential decline, I think the original guidance was for 200 basis points, so I assume that lower than expected revenue and utilization was the key driver of results relative to guidance, but I am hoping you can help us bucket the relative impact between the inventory overhang you had heading into the June quarter, the underutilization, and then also the impact from the RF test application?

Alex Davern

Sure, Patrick. So, when we talked last time I was estimating I think I have answered somewhere between 200 and 250 basis points. We came in at about 390 basis points. So, it was little lower than we had anticipated. Really, three or four factors there, one being as we discussed the large order, which has significantly lowered on our normal margins as we are ramping that product up into production, our cost for servicing that application now, obviously that it’s in volume production. Going forward, factory utilization was clearly an issue. We did reduce our contractor employment by about 140 people over the course of the quarter. That perhaps took a little bit longer than we originally anticipated. The weakness in the yen as you know also had an impact and then from a revenue point of view coming in below revenue, the other element that contributed to gross margin has been a little bit lower than we anticipated. As we gave guidance, we expect to substantially recover that in Q3. We expect to be back on model in Q4.

Patrick Newton - Stifel

Okay, back on model meaning back into a normalized range of 77% plus on a pro forma basis?

Alex Davern

I don’t want to get that specific at this timeframe, but certainly we would expect if we see our normal sequential revenue growth in Q4 that we should be able to leverage that into improved margins in Q4.

Patrick Newton - Stifel

Okay. And then I guess on the inventory side, I think you had previously talked about out of the 200, 250 basis points you talked about that being a decent chunk of that impact. Did the inventory burn through aid results at all in the quarter or is it as it’s going to I guess originally you talked about it perhaps being cleaned up by the September timeframe? Is that likely to push into December now?

Alex Davern

Yes. Well, I think we will largely be complete with that by the end of Q3. The biggest factor that caused margins to fall sequentially and would cause to grow sequentially into Q3 was only that one large application for that one particular customer.

Patrick Newton - Stifel

Okay. And with that large customer and large application with the expectation of less than $5 million of revenue in 3Q, can you discuss visibility or opportunities with this customer beyond 3Q?

Alex Davern

Well, inherently large orders like that are difficult to predict. Certainly, we are continuing to engage with this customer looking at mutually beneficial opportunities as we move forward. I think if you look at the slides on the webcast, you will see the correlation as we put out there large orders over 100K. Obviously, we had a very, very difficult compare in the second quarter, comparing against the 130% year-over-year growth rate in Q2 of last year. So, that certainly posed a challenge as it turned into revenue in Q2 and also then into Q3 of 2012. So, it’s difficult to predict at this point. The only visibility I would be willing to share would be a guidance of less than $5 million in Q3.

Patrick Newton - Stifel

Okay. And just one last one for you, Alex, I think your software maintenance revenue dropped below 7% of total sales, and this is the first time that’s occurred in my modeling horizon. So, I was wondering is there anything specifically that impacted this, was it this large application sale? And then are we likely to see a snapback as a percentage of revenue and then a resulting gross margin tailwind in the coming quarters?

Alex Davern

We would expect, you know, certainly this large order is $23 million in revenue in Q2 affected the percentages for all the product lines, and we expect that to revert in Q3.

Patrick Newton - Stifel

Alright, thank you. Good luck.

Alex Davern

Thank you.

Operator

(Operator Instructions) Our next question comes from the line of Rob Mason with Robert W. Baird. Your line is open.

Rob Mason - Robert W. Baird

Yes, good afternoon. Alex, could you….

Alex Davern

Hi, Rob. How are you doing?

Rob Mason - Robert W. Baird

Very good, very good. Could you comment on the month-to-month trends that you saw in the transactional business, how that trended?

Alex Davern

I don’t think I’d want to get as specific as that. We certainly saw quite a bit of weakness in the middle of the quarter with some improvement as we moved into June. I wouldn’t want anybody to extrapolate that out into a trend, but May was a difficult month.

Rob Mason - Robert W. Baird

Is it fair to characterize that part of the business, the transactional piece where most of the variance to plan or at least to the midpoint of your guidance occurred?

Alex Davern

No, I wouldn’t jump to that conclusion. We had seen it to be somewhat weaker earlier in the year, and I think we saw everything kind of slow down from all categories, but certainly that is an area that has traditionally been highly connected to the broader economy and the broader industry.

Rob Mason - Robert W. Baird

Right. Well, relative to the larger orders, you mentioned obviously the comparisons maybe obscure some of the trends year-over-year comparisons in the large orders, large customers you gave the comparisons versus 2011 but if you strip out the large customer impact both this year and last, and maybe it’s more helpful to do it on a year-to-date basis, are you seeing growth in the orders over $20,000 within that business excluding the large customer year-to-date?

Alex Davern

We broke it down into three buckets I think, Pat you can see if I answer your question, below, sorry Rob, below $20,000 was down 4% I believe.

Rob Mason - Robert W. Baird

Right.

Alex Davern

Over $20,000 was up 4% and then if you get above 100K you see it minus 30%. And I think your specific question is excluding the large customer what was our order growth in the above 100K bucket, is that correct?

Rob Mason - Robert W. Baird

Well, really if you just want to combine anything over $20,000, I am just thinking larger orders in general?

Alex Davern

It will be down. The size of the over 100K being down 30% year-over-year because of that very difficult compare. That would make the overall over 20K bucket be negative.

Rob Mason - Robert W. Baird

Okay.

Alex Davern

If you want to take it offline we could have map and we just don’t have it right in front of me.

Rob Mason - Robert W. Baird

Sure, sure. Was there any acquisition revenue contribution in the quarter?

Alex Davern

The new acquisitions from last year were roughly about 1% of revenue.

Rob Mason - Robert W. Baird

Okay. And then maybe just a follow-up on the large customer visibility, is there anything I understand that the lack thereof that you have, but is there anything inherent in those applications either be it with this large customer or future customers for those particular applications, anything inherent in the – around seasonality for those type of orders, are they more likely to occur in the first half versus the second half given the application?

Alex Davern

I think that’s very much depends on the customer’s business cycle, product release cycle, ramp up etcetera. We’ve talked before that this is a high volume consumer electronics device, so that cycle of new products introduction is certainly a factor. I can’t really comment beyond that.

Rob Mason - Robert W. Baird

Okay, okay, fair enough. Thank you.

Operator

And I am not showing any further questions at this time. I would like to turn the call back over the management for closing remarks.

Alex Davern

Thank you very much for joining us today. We will be having our investor conference at NIWeek next week on Tuesday. We look forward to seeing you there.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.

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