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National Instruments Corporation (NASDAQ:NATI)

Q3 2013 Earnings Call

October 31, 2013 5:00 p.m. ET

Executives

David Hugley - Vice President, General Counsel, and Secretary

James Truchard - President, CEO

Alex Davern – CFO, COO, and Executive Vice President

Pete Zogas - Senior Vice President of Sales and Marketing

Analysts

Patrick Newton - Stifel

Bryan Kipp – Janney Capital Markets

Operator

Good day everyone and welcome to the National Instruments' Third Quarter 2013 Earnings Conference Call. Today's call is being recorded. You may refer to your press packet for the 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 Pete Zogas, Senior Vice President of Sales.

For opening remarks, I would like to turn the call over to Mr. David Hugely, 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 fourth quarter revenue, operating expenses and earnings per share. We wish to caution you that such statements are just prediction 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 August 1, 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.

James Truchard

Thank you, David. Good afternoon and thank you for joining us. Our key points are: Q3 revenue of $289 million, strong revenue growth in RF and CompactRIO products and continued spending discipline in Q3. Revenue for Q3 came in at $289 million comparable with Q3 a year ago and above the mid-point of our guidance. I am pleased with our continued spending discipline during the quarter with operating expenses down sequentially for the second consecutive quarter.

This is a testament to the keen focus of our employees across the company and our collective efforts on improving our non-GAAP operating margins toward our goal of 18%. In our call today, Alex Davern, our Chief Operating Officer will review our results; Pete Zogas, our Senior Vice President of Sales 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 revenue of $289 million, $9 million above the mid-point of the guidance we gave on July 29. As you can see in the presentation accompanying n this webcast, in Q3 of 2012 we recognized $27 million in revenue from our largest customer, which was our largest sales quarter to this customer.

This compare had a significant impact on our overall revenue growth this quarter as we recognized $4 million in revenue from this customer in Q3 of this year. As a result, our total revenue was relatively flat year-over-year in Q3 while revenue, including our largest customer, grew 8% year-over-year.

For Q3, net income was $16 million with fully diluted earnings per share of $0.13 and non-GAAP net income for Q3 was $24 million, with non-GAAP fully diluted earnings per share of $0.19, $0.03 above the midpoint of our guidance range. A reconciliation of our GAAP and non-GAAP results is included in our earnings press release.

From a regional point of view, revenue was up 9% year over year in the Americas, up 7% in Europe and up 24% in the emerging markets. However revenue was down 27% year over year in East Asia, as the vast majority of revenue from our largest customer is recognized in this region. Additionally, we saw a significant negative impact from the time and value of the yen, with orders from Japan in Q3 being down 20% year over year in U.S. dollars.

Non-GAAP gross margin in Q3 was 75.1%, up 240 basis points from Q2 due primarily to a change in customer mix. Total non-GAAP operating expenses were $184 million, down approximately $1 million sequentially. The year-over-year growth in our non-GAAP operating expenses was 3% in Q3 and I am pleased with the continued budget discipline throughout the company. For Q3, our non-GAAP operating margin was 11.3%, with non-GAAP operating income of $33 million, up 8% sequentially.

Now taking a look at trends by order size. In Q3, we saw a 2% year-over-year increase in the value of our total orders. Breaking that down, we saw a 2% year-over-year growth of our orders with a value of below $20,000. Orders between $20,000 and $100,000 were approximately flat; while orders over $100,000 were up 8% year-over-year. Excluding our largest customer, our total orders would have been up by 8% year-over-year and orders over $100,000 would have been up by 48% year-over-year.

Now turning to cash management, inventories declined by $6 million as we continued to adjust our production schedules. In addition, we paid $18 million in dividends during the quarter. Cash and short-term investments increased by $21 million in Q3 to $344 million as of September 30.

In summary, Q3 was a difficult quarter for the test and measurement industry. These challenges were exacerbated by the budget process in the United States and a large year-over-year fall in the value of the Yen. But despite these challenges, we believe NI was able to continue to gain market share.

And now I would like to make some forward-looking statements. While we are pleased to see the global PMI increase to an average of 51 in Q3, we remain cautious about the industrial economy. For Q4, we currently expect revenue to be in the range of $291 million to $321 million with revenue from our largest customer expected to be below $5 million. At the mid-point, this represents a sequential revenue increase of 6% which is below our normal historical average revenue increase.

While we currently expect to see a relatively normal sequential order growth in Q4, our intention is to increase backlog of this quarter to help us better manage the mix of orders in 2014. We currently expect total non-GAAP operating expenses in Q4 to be approximately $181 million, plus or minus $2 million, with GAAP fully-diluted earnings per share to be in the range of $0.19 to $0.31 for Q4 and non-GAAP fully-diluted EPS expected to be in the range of $0.25 to $0.37.

Looking out to 2014, we will be focused on improving our operating margins and executing on the operating leverage plan we have laid out for 2014. While the industry is going through some painful quarters, we have taken the action that we believe are necessary to deliver an improved operating performance next year. These are forward-looking statements and we must caution you that actual revenues and earnings could be negatively affected by numerous factors such as any further weakness in the global economy, U.S. federal budget and debt issues, rescheduling of customer orders, expense overruns, manufacturing inefficiencies, foreign exchange fluctuations and effective tax rates.

I'd also like to mention that I would be attending the Janney Capital Markets Industrial Conference in New York on December 5 and the Needham Growth Conference in New York on January 14. With that I'll turn it over to Pete Zogas, Senior Vice President of sales.

Pete Zogas

Thank you, Alex. Despite the tough industry conditions we faced in Q3, we were pleased with the strong revenue growth in several key product areas including academic, RF, CompactRIO and CompactDAQ. Our previous investment in our sales force continues to pay off as our customer opportunity pipeline remains strong in Q3.

At this year's NIWeek, we introduced exciting new products and delivered more than 240 technical sessions to a record crowd of nearly 4,000 engineers and scientists, an 8% increase over last year. NIWeek illustrates our commitment to customer success, serving as a catalyst for high valued technical and business discussion, connecting thought leaders across the industry.

Among the new products introduced during the NIWeek were LabVIEW 2013 with more community add-on products, support for latest mobile platforms and new sample projects for customers; new software extensions for the Vector Signal Transceiver to make it easier for customers with little to no FPGA experience to access its benefits; a new CompactRIO controller that integrates state-of-the-art technologies for significantly improved performance; the NI CompactDAQ rugged chassis designed for remote measurements in extreme environments; and myRIO, a new embedded design device for students to rapidly design sophisticated engineering systems more quickly and affordably. We are excited about the expanded capabilities and new opportunities from these key new products.

Our PXI product faced a very difficult compare in Q3 due to our largest customer that Alex discussed earlier. However, we continue to see strong growth in RF, leading to a new Q3 record in RF revenue. Our strength in RF was driven by a very strong adoption of the Vector Signal Transceiver that we launched in August last year. The Vector Signal Transceiver is proving to be a highly disruptive product that realizes NI's vision by providing users with the ability to design the firmware of the instrument through LabVIEW and ultimately helps to reduce the cost of test for our customers.

Recent successes for the Vector Signal Transceiver include Hittite, a designer and manufacturer of RF chips, generated significant cost savings and increased their test throughput by 30x by replacing their previous rack-and-stack test system with the Vector Signal Transceiver for their complex MIMO test application. A mobile communication company was able to improve their test time by 25% because they switched their traditional test solution to the Vector Signal Transceiver.

Engineers in aerospace and defense selected the Vector Signal Transceiver for a military array of test application because of its flexibility and customization through LabVIEW FPGA. And leading research institutions continue to adopt the Vector Signal Transceiver for research in RF test and characterization because they can target its FPGA with LabVIEW to help them accelerate their research.

Sales of our CompactRIO products continue to see strong growth and a new Q3 revenue record, driven by energy, aerospace and defense and machine control system applications. Success for CompactRIO in Q3 include a major medical device manufacturer, who selected CompactRIO for their laser eye surgery application, and one of the nation's largest power utilities started their deployment of CompactRIO to monitor their power generation assets across multiple plants.

At the heart of both the Vector Signal Transceiver and CompactRIO is the LabVIEW RIO architecture, which combines LabVIEW and NI hardware that is programmable by LabVIEW FPGA. It provides our customers and partners with the unique ability to define and optimize the firmware of their test in embedded systems to match the specific requirements of their application.

This technology enables users to quickly iterate on their designs and implement updates to the deployed hardware if the requirements change. 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.

Sales of our data acquisition products grew year-over-year in Q3 despite continued declines in the global PC market. LabVIEW 2013 along with newly-released CompactDAQ products are enabling customers within the industry, such as automotive, transportation, infrastructure and industrial machinery to build cost-optimized, distributed and flexible monitoring systems that can be deployed in remote or harsh environments.

Revenue from our instrument control products, which accounted for about 4% of revenue in Q3, declined 12% year-over-year. Our instrument control products are primarily used to control box instruments from other vendors and are most closely connected to their business cycles. The decline in our instrument control products indicates a continued weakness in the test and measurement industry in Q3.

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. A few years ago, we introduced NI myDAQ, a portable device for students to do engineering anywhere and anytime. Today, NI myDAQ has been standardized across 600 universities worldwide. At this year's NIWeek, we released NI myRIO which lets students learn on the same graphical system design they will use in the industry.

Like CompactRIO and the Vector Signal Transceiver, myRIO leverages the LabVIEW RIO architecture so students can get hands-on experience programming FPGAs. The continued adoption of our academic products helped lead to a new Q3 record for academic revenue. During the quarter, major universities in emerging countries, including Armenia and Mexico, adopted NI tools across courses for controls, megatronics and RF communications.

In summary, we are pleased to see strong customer engagement despite continued industry and economic headwinds and are excited about new opportunities for our products released at NIWeek. With that, I will turn it back over to Dr. T.

James Truchard

Thank you, Pete. At NIWeek we've talked about how over the past decade our world has increasingly become a large programmable system, from our cars to phones to household appliances. This trend has been described as Industry 4.0, a network of things are a programmable world. And we believe it is creating an increased demand for cyber physical systems with sophisticated, intelligent systems communicate with each other across the digital and physical world.

In response, our customers must adjust to the increased challenges of the exponential growth of data as well as the growing complexity of designing and testing these systems. The result is a greater need for our customers to leverage a common platform to manage complexity, drive faster innovation and increase productivity. We have seen the role of platforms continually transform the technology industry from the standard PC platform displacing disparred computing applications to mobile operating system by Android or iOS that are creating common platforms for mobile devices.

We believe NI's role in equipping engineers and scientists with tool through a software-based will help our customers meet the emerging complexity from cyber physical existence. With innovations in the LabVIEW RIO architecture, we are now leveraging the R&D investments we made in our CompactRIO products to harness the power of the FPGA for both test and embedded applications.

This leverage gives us scale and cost benefits and increasingly differentiates NI from our peers. Our combined platform of software and hardware offers us a unique ability to benefit from the rapid advancements of FPGA technology and provide unparalleled capabilities to test and control the cyber physical world.

Over the past few quarters, I've talked about the importance of effectively managing our costs to sustainably scale our business for long term and our employees continue to better align our spending with the weaker industry. While we remain disciplined in our cost management in Q3, I keep challenging our organization to find ways to drive operational efficiency and improve non-GAAP operating margins toward our goal of 18%.

In summary, while there's still uncertainty in our industry, I believe we have made the investments needed to continue to grow our business and believe we are now positioned to realize the return on these investments. I want to thank our employees for their concerted effort to simplify processes, drive productivity and focus on innovation. I am confident that we are now redefining how our customers can use our tools to be more productive. And I believe we have the resources necessary to create sustainable differentiation for NI and our customers, partners, suppliers and shareholders.

We will now take your questions.

Question-and-Answer Session

Operator

(Operations Instructions) Our first question comes from Patrick Newton from Stifel.

Patrick Newton - Stifel

Starting with Alex, in your prepared remarks, you stated that you intend to increase backlog in 4Q to better manage large orders. I make three assumptions from the statement. One is that your December quarter revenue guidance could have easily been higher. Two, that whatever backlog is built should help dampen 1Q seasonality. Three, that perhaps you've secured some material volume design wins in 2014, likely from your largest customer. I guess my question is this, are these assumptions correct? And could you help us quantify how much you intend to increase backlog?

Alex Davern

So let me start off, Patrick, I am not going to confirm any of your conclusion. But let me tell you what the message I am trying to send with that statement. Number one obviously we are guiding to a revenue number that’s below our historical seasonal average. Number two, right now we don’t see any reason why our order volume won’t match the normal seasonal pattern. And as a result, we intend to be biased towards meeting the kind of expectations from a process point of view but also building backlog in this quarter. The extent of the scale of that will remain to be seen. I will be able to answer that one when I get to December 31, but the purpose of that is to allow us more flexibility in managing revenues as the overall mix of large orders as part of our business profile is evolving.

In terms of revenue expectations with our largest customer, really we’re only guiding to Q4 at this point in time, and we will be in a better position perhaps to talk about that at the earnings call in January.

Patrick Newton - Stifel

I guess that dovetails nicely into the second question, which is if I run the mid-point of your guidance, I calculate an implied gross margin of 76% or higher. Is that fair ballpark for the gross margin? And as these large orders start to evolve and I would assume contribute more to revenue in 2014, how should we think about your gross margin profile in the coming quarters?

Alex Davern

Sure. I think your math is definitely in the right direction. We do expect a modest improvement in gross margin sequentially in Q4, driven by an improvement in obviously overall utilization of revenue. And then a geographic mix, because we tend to see stronger mix of revenue from Europe in the fourth quarter, which always helps our gross margins.

In terms of looking forward, if we do a compare with 2012 and 2013 as an example, our overall margin will be down a little lower 100 basis points this year. The bulk of that will come from the gross margin on the lower margin RF business we talked about our largest customer in Q2, and then about 40 to 50 basis points from introduction of our new Penang manufacturing facility that we opened in Q4 – late Q4 of last year. As we are looking into 2014, if we are able to drive single digit type revenue growth we will see what happens. We will drive leverage on that Penang operation. So we should see a reduction in 40 to 50 basis point impact that we saw this year, that should be less next year. And then we intend to continue to work on driving good margins out of our larger order business.

In general, outside of our large number we have seen our gross margins be benefitted from the evolution of orders over 100K. So that in general has allowed us to bring up our gross margin by leveraging that volume. And we saw that through ’09, ‘010, ‘011, ‘012 and really outside of Penang and our one large customer we would have seen very stable slightly improved gross margins in 2013.

Patrick Newton - Stifel

And then just one last one on the competitive landscape. I am curious as you’ve had success in your RF portfolio, have you seen any noticeable shift reaction from competitors and also given the announced spin-out to form a very T&M focused competitor, I am curious how you view this announcement and whether you’ve already seen any changes in the competitive landscape or if you anticipate it will result in some competitive changes?

Alex Davern

Thank you, Patrick. I will answer that one, we really want to focus our efforts and energy on running our business to the best of our abilities and really I try to avoid commenting on changes that are happening at competitors. What I will say is as a disrupter and as a serial disrupter in multiple markets over multiple decades, we generally always see a reaction at some point some competitors and that’s something we are very used to over multiple decades.

Operator

(Operator Instructions) And our next question comes from Paul Knight from Janney Capital Markets.

Bryan Kipp – Janney Capital Markets

This is actually Bryan Kipp on behalf of Paul. Can you guys hear me?

Alex Davern

We can hear you, Bryan.

Bryan Kipp – Janney Capital Markets

Perfect, thanks for taking the question again. Leaving second quarter guidance, coming into the third quarter you guys seemed a little tepid and you came into probably one of the strongest – I guess it was the strongest PMI quarter in the last two years. Can you just give me a sense of how kind of things played out for you guys? You guys closed the quarter stronger than you started, or was it kind of pretty even flow, just trying to get an understanding of how I should expect to look at modeling something like 4Q strong start and maybe with macro indicators?

Alex Davern

Bryan, first, I guess it’s an indictment of the times that 51 on the PMI is the strongest we’ve seen in two years. (Multiple Speakers) Yes, that is definitely true but it’s a little sad, hopefully we will see that improve as we go into 2014 but that remains to be seen.

Certainly I would say that the tone of business improved somewhat in August and September. And I am reluctant to carry any kind of tab of that straightforward because we’ve got the events we saw in DC. Excuse me, this month and we have an expectation that, that’s likely to happen again in the spring. So for now, we certainly got a bit of PMI over 50. I think it’s likely to pull back a little bit here in October based on the preliminary flash numbers that I have seen and we hope to see it gain some sustainable momentum at some point. There is real stagnant period for the industrial economy, going to have to change eventually. It’s not just flair that it will be Q4.

Bryan Kipp – Janney Capital Markets

And I guess just a quick follow up. Just kind of get an understanding of where you guys are. You mentioned last time that you would expect to see a significant reduction in headcount in 4Q. Was that any of that pulled through in the 3Q and is that still on track for 4Q?

Alex Davern

So a very good question, Bryan. Originally when we kind of set that expectation, we kind of set a commitment to keep our overall headcount flat from the March quarter to the December quarter. We had an anticipation based on recruiting that we would see headcount go up in Q3 and then come down in Q4. And the way it’s played through as we’ve managed our recruiting start dates et cetera, overall headcount is flat really from March through September and we anticipate that we will now be flat from September through December, which gives us an ending December number, which was in line with what we set out when we released the results at the end of April. So year-to-date our headcount is up 3% from December and we expect to finish the year very close to that.

Operator

(Operator Instructions) We do have a question from Patrick Newton from Stifel.

Patrick Newton - Stifel

Alex, I guess one is, did your embedded business outgrow your T&M business in the quarter?

Alex Davern

Well, as you know, Patrick, it is difficult for us to measure the embedded business specifically. But when we look at the product lines that are connected to that business, we did see good growth in Q3. And given that we had no growth at the aggregate as a company, I have to answer your question but yes.

Patrick Newton - Stifel

And then one last one I guess would be on your framework for a spinning intention. Last quarter you gave us very straightforward OpEx goals that – it looks like you are right on pace to achieve. I am curious if you can help us as we look into 2014, to help us walk through how to think about the framework of your OpEx – do we just take revenue growth and hedge it as you kind of alluded to 30% incremental margins on any revenue growth or any framework for 2014 would be helpful?

Alex Davern

So yes, just as a reminder, for those of you who may have seen, and it is available I believe in our IRS slides that are on the web accompanying the conference call. At the investor conference in August at NIWeek we laid out a real specific set of guidelines on potential revenue scenarios with the related spending intention by National Instruments for 2014 and had a series of scenarios from 0% revenue growth next year to 5 to 10 et cetera, with the leverage factor that was planned at each level, so I would encourage you to take a look at that our spending plan for 2014 and our intention of leverage relative to different revenue scenarios is very much in line with what we laid at the investor conference in August. So we intend to execute against that plan.

Operator

Thank you. And I am showing no further questions at this time.

Alex Davern

Thank you very much. I just like to remind you that I will be at the Janney Capital Markets Industrial Conference in New York at December 5 and Needham Growth Conference in New York in January 14. Thank you and have a good sector [ph] treating.

Operator

Ladies and gentlemen thank you for your participation in today’s conference. This concludes our program for today. You may all disconnect and have a wonderful day.

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