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National Instruments Corporation (NASDAQ:NATI)

Q1 2014 Earnings Conference Call

April 29, 2014 5:00 PM ET

Executives

David Hugley – Vice President and General Counsel and Secretary

James Truchard – President, Chief Executive Officer, and Cofounder

Alex Davern – Executive Vice President, Chief Financial Officer and Chief Operating Officer

Eric Starkloff – Executive Vice President-Global Sales and Marketing

Analysts

Bryan A. Kipp – Janney Montgomery Scott LLC

Patrick Newton – Stifel, Nicolaus & Co., Inc.

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

Operator

Good day, everyone, and welcome to the National Instruments First Quarter 2014 Earnings Conference Call. Today’s call is being recorded. You may refer to your press packet for the replay dial-in number and the pass code.

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

For opening remarks, I would like to turn the call over to Mr. David Hugley, Vice President and 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 second quarter revenue, gross margin and earnings per share, as well our position on the test and measurement market. 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 annual report on Form 10-K filed on February 20, 2014. 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. I’d like to apologize in advance for my voice. In Austin, allergies are bad right now. Our key points today are record orders for the first quarter, Q1 non-GAAP operating income up 16%, and we’re got into record revenues for Q2.

Despite the challenging test and measurement industry, we received record orders for the first quarter while improving our operating margins . Given the improvements in the industrial economy in Q1 and our strong position we believe we are guiding to an improved operating performance in Q2, and I continue to be optimistic about our long-term position in the industry.

I will now turn it over to Alex Davern to review our results. Alex?

Alex Davern

Good afternoon and thank you for joining us today. Today we reported revenue of $285 million for Q1. Orders represented a new first quarter record. Backlog increased by $7.5 million and deferred revenue increased by $6 million during the quarter. For Q1, net income was $19 million, with fully diluted earnings per share of $0.15, and non-GAAP net income for Q1 was $26 million, with non-GAAP fully diluted earnings per share of $0.21 at the midpoint of our guidance range. Reconciliation of our GAAP and non-GAAP results is included in our earnings press release.

Non-GAAP gross margin in Q1 was 76%, up 30 basis points from Q4 and total non-GAAP operating expenses were $182 million, down 4% year-over-year. For Q1, our non-GAAP operating margin was 12%, up from 10% in Q1 last year and non-GAAP operating income of $34 million was up 16% year-over-year.

On a housekeeping note, you may recall that our tax rate in Q1 of last year was reduced significantly due to the retroactive impact of the renewal of the U.S. R&D tax credit in January of 2013. As a result, the year-over-year increase in our tax rate effectively offset our improved operating margin, resulting in a non-GAAP fully diluted earnings per share of $0.21, matching our EPS in Q1 last year.

Now taking look at order trends. For Q1, the value of our total orders was up 1% year-over-year. Included in that total is $12 million in orders received from our largest customer, to which delivery was requested in Q1 this year as compared to $17 million in Q1 of last year. As of today, we have received a total of $32 million in orders for 2014 from this customer, as compared to $24 million at this time last year.

Revenue from our largest customer was $7 million in Q1. We expect the remainder of this customer’s credit orders to be shipped in Q2and Q3. Excluding this customer, our orders from all other customers were up 3% year-over-year in Q1.

By taking a look at Q1 order values, excluding our biggest customer, we saw 4%year-over-year growth of our orders with a value below $20,000, while orders with a value between $20,000 and $100,000 grew 5% year-over-year. Orders with a value over $100,000 declined 2% year-over-year and it’s been up 41% year-over-year in Q1 of last year.

Now turning to cash management. Inventories were down $2 million in Q1 and accounts receivable were essentially flat from December 31. Also during the quarter we paid $19 million in dividends and our cash and cash equivalents increased by $17 million to a new record of $410 million as of March 31.

Now I’d like to make some forward-looking statements. The improvement in global PMI during Q1 gives us increased confidence in the continued recovery of the industrial economy as we move through 2014. This increased confidence coupled with our continued commitment to deliver on our leverage plan we outlined in our investor conference last year leads us to expect improved performance in Q2. As a result, we are guiding for revenue in Q2 to be in the range of $296 million to $324 million. At the midpoint this represents 5% year-over-year growth.

Gross margins are expected to be down approximately 150 basis points sequentially in Q2 due to an expected increase in revenue from our largest customer. We currently expect GAAP fully diluted earnings per share will be in the range of $0.13 to $0.25 for Q2 with non-GAAP fully diluted earnings per share expected to be in the range of $0.19 to $0.31.

But these are forward looking statements. I must caution you that actual revenues, gross margins and earnings could be negatively affected by numerous factors such as any weakness in the global economy, fluctuations in revenue for our largest customer, expense overruns, manufacturing inefficiency, foreign exchange fluctuations and the effective tax rates.

In summary, while Q1 was a challenging quarter for our industry, we continue to gain market share and make progress on improving our operating margin. Looking forward, we’re working hard to take advantage of the improving conditions in the industrial economy and continue to be committed to our operating leverage targets.

In closing I would like to mention that National Instruments will be attending the Jefferies conference in Miami on May 6, Baird conference in Chicago on May 7 and the Bank of America conference in San Francisco on June 3. We look forward to seeing you there.

With that, I’ll turn it over to Eric Starkloff, Executive Vice President of Global Sales and Marketing.

Eric Starkloff

Thank you, Alex, and good afternoon. While the PM industry remained relatively weak in Q1, we continue to gain market share versus our peers. The caution we saw from our customers at the end of last year appear to moderate and we saw improvements in customer demand as we moved through the quarter. I was encouraged by the strength of our marketing activity and customer opportunities during Q1, indicating continued strong customer interest in our approach. We’re pleased with the relative strength of our orders under $20,000, which represents the breadth of markets and applications we serve and account for roughly half of our revenue. This large volume and broad reach are key to our strength and stability and growth in these smaller orders often provides the foundation for future system sales.

Looking at software, we saw strong sales with enterprise agreements and a record number of new users in Q1. These enterprise agreements are site or company-wide licenses, which make LabVIEW and other NI software available across the account and the availability to these engineers and scientists drives increased software revenue, adoption and proficiency with our tools. Software license renewal rates continue to increase in Q1, which we view as a strong indication of the value our customers see in our software.

Our data acquisition products were another bright spot in Q1, led by CompactDAQ sales across a broad range of applications. We have several automotive deployments of CompactDAQ in Q1 for applications including infotainment testing and brake inspection. An area where the value of our software and data acquisition products can clearly be seen is in the trend towards big analog data, in which customers acquire large amounts of physical data to drive scientific, engineering and business decisions.

The IT and computing technologies that have driven the Big Data revolution in corporate and social networks are also enabling scientists and engineers to leverage these technologies to acquire and analyze vast amounts of analog data such as vibration, pressure, sound and even radio signals.

Our measurement hardware is used to acquire this analog data and convert it to digital where our software can analyze and archive it. Our software defined approach also enables customer to define how the hardware processes and reduces data locally at the source before sending it to the network, providing greater flexibility and reducing system cost. We see continued opportunities to serve our customers with software and hardware to address these applications.

In academic, our myRIO product has now been sold to over 500 universities worldwide since its release just six months ago. myRIO combines a real-time processor and FPGA into a small student-friendly package for teaching controls, robotics, mechatronics and embedded concepts with LabVIEW.

A new trend in university education is the Massively Online Open Course or MOOC in which professors lecture and make their courseware available to a global online audience at little or no cost. NI is working to incorporate hands-on learning by partnering with MOOC from several leading institutions, including Professor Johnson from Rice University, who adopted myDAQ and LabVIEW to teach analog circuits. And an upcoming MOOC from UC Berkeley that we use LabVIEW and myRIO to teach cyber-physical systems. We plan to continue to be at the forefront of this trend as the next generation of scientists and engineers learn using hands-on approach to system design.

Now, turning to our system products. We saw continued adoption and successful system deployment for RF in Q1 across a broad range of customers, industries and geographies. Those wins also span a wide range of applications throughout the design cycle from initial prototyping to component validation in R&D to end-of-line production tests, all using the same software and hardware platform. For example, our customers in the semiconductor industry are using our vector signal transceiver products to characterize and pass RF power amplifiers because the firmware of these instruments is user-programmable through LabVIEW. Our customers are able to keep pace with rapidly evolving power amplifier test applications such as envelope tracking and digital pre-distortion.

We are also seeing success in leading research institutions around the world on prototyping next-generation wireless standards, including Fifth-Generation wireless or 5G. One example is that Lund University in Sweden where they are using think LabVIEW and RF hardware to stimulate mobile devices and base stations in application called Massive MIMO. With more than 100 antennas, this prototype is the largest and most comprehensive of its kind and research could significantly impact the definition of 5G networks for the future.

Our unique position in development of early 5G prototypes, also positions NI as well to provide software and instrumentation for commercial 5G applications as technology evolves. Our opportunity pipeline for PXI remains strong across a broad range of industries and end-user application. Since pioneering the PXI platform in 1997, NI has a led the ship from rack and stack instrumentation to PXI modular instrumentation for applications ranging from basic research to R&D to automated production test.

We see this trend continuing as more customers and vendors recognize value that this modular software defined platform brings to test applications. And believe it presents opportunity for NI to gain additional market share in 85% of test and measurement industry that's still served by the traditional instrument approach. With over 17 years of investment by far the largest portfolio of modules available and highly differentiated technologies like our LabVIEW real architecture, NI is at the forefront of delivering the benefits of PXI to engineers and scientists worldwide.

Turning to our embedded monitoring and control products, we saw order growth in application areas including industrial, life sciences and semiconductor automation. Strength in those areas was offset by difficult year-over-year comparison condition monitoring and machine control application where customers made several large deployments in Q1 last year. We were especially pleased with a strong adoption of the new CompactRIO controller, we released at NIWeek last August, which leverages which leverages latest FPGA technology and NI Linux Real-Time.

In summary, I’m pleased with the growth we saw in Q1 for our orders under $20,000 which represent the broad diversity of markets and application. And I’m encouraged by the strength of our opportunity pipeline for PXI and CompactRIO base system opportunities. As the leader in PXI and software defined instrumentation, I believe we’re very well positioned to benefit from the improved conditions in near-term and for long-term sustainable growth.

With that, I will turn it back over to Dr. T for some closing statements.

James Truchard

Thank you, Eric. Q1 remain challenging for our industry, we delivered record earnings for our first quarter. While improving in our operating margin, I’m optimistic about our opportunity and long-term position in our industry. I’m particularly excited about the growing trends towards big analog data, this trend touches every part of our business, because its so board in nature, I believe we are just at the front end of big analog data trend and there is a growing appetite for real world data to drive science, engineering and business decisions and serve as a long-term driver of our business.

In closing I want to thank our employees for their concerted effort to deliver innovative new products, value and improve productivity to our customers. I’m confident in the operational improvement that we’re making to drive margins back and our long-term model will allow us to efficiently and profitably continue to innovate and drive long-term sustainable growth.

Thank you. we will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) our first question comes from Paul Knight with Janney Capital Markets.

Bryan A. Kipp – Janney Montgomery Scott LLC

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

Dr. James Truchard

Yes, Bryan, go ahead.

Bryan A. Kipp – Janney Montgomery Scott LLC

Just a quick question. You cited strength in the second half, partially here in the second quarter – sorry, my apologies – partially because of the strength in the first quarter from PMI numbers. We saw the same kind of dynamic and maybe even stronger dynamic U.S. and China in the back half of last year. It doesn't seem to be pulled through. Is that something that you – it's what is giving you conviction for 2Q and beyond? Is it a six to nine month lag of bookings through order recognition kind of what’s the dynamic going on there, just so we can kind of look at how 1Q should track the remainder of the year?

James Truchard

Sure, Bryan, we’ve obviously pioneered the use of the PMI, is a way to look it is whole industry because as Eric said, we serve a broad base, a very broad base of customers in many industries across many geographies, and now I’ve been watching this for a very long time and generally, you tend to see the PMI lag with varying of one to two to three quarters depending on the broad based level of confidence in the economy in general.

So we started to see that obviously improve a lot in October. we certainly saw that continue in the second – in the first quarter. and certainly, the initial data we see here for flash PMIs in April indicative, Q2 is turning off with reasonable strength as well. We expect to see those positive trends pass through into orders and revenue as we move through the year. Certainly that’s included in our guidance for the second quarter. but when I look at the overall positive trends that are emerging, I see an improved PMI.

internally, we see an improved opportunity pipeline with our customers engaging with the sales people. As Eric said, we’ve seen an increase in the volume of our broad-based orders that tends to be a leading indicator. Also we have easier compares. Q1 last year was our toughest compare for the year, we grew about 10%. and so we have much easier compares for large orders as we go into the rest of the year.

And then another element I would say is that our instrument control products, which tend to be a bellwether of the overall industry for the traditional test players and ourselves has seen an improved performance in terms of relative growth is very weak towards the back half of last year and also has easier compares, but it’s trending toward the positive number and that’s another element that gives us confidence and we’ll see strength build as we head towards the second half.

Bryan A. Kipp – Janney Montgomery Scott LLC

Appreciate it. I guess I have a follow-up on the wireless side. I know you guys kind of alluded to some demand there in the semiconductor and wireless side for the 5G conversion. There has also been a lot of investment – or at least for Vodafone, their Project Spring. And I know China Mobile has come out and mentioned some stuff that they want to, I think, spend upwards of $8 billion to roll out full 4G in China this year. Are you seeing any incrementals from that? And if not, do you expect it going forward? Just additional color on that and maybe broader China as well. I'd appreciate it.

Eric Starkloff

So this is Eric, I can comment on that. First just to calibrate, our RF business is quite a broad place for us. It’s about a $6 billion market opportunity that we serve that stands from RF used in aerospace applications and radar applications to signal intelligence inspector monitoring, all the way through wireless R&D as well as production tests.

And so, when we talk about that RF opportunity, we really see opportunities for our platform across that whole space and again we are used in the early development of standard. So I mentioned 5G, that’s obviously an early lab kind of application today and then we are also used through the design cycle into the production test of the current generation of wireless standards.

Bryan A. Kipp – Janney Montgomery Scott LLC

Thank you. Again, I guess my final one too, as we saw a – not only I guess a year-over-year decline in R&D as a percentage of sale. Is that how we should look at it tracking for the rest of the year is that significant or I think you guys have 10% decline on non-GAAP basis. Is that something that you continue to expect going forward to claims or do you think it will all start to ramp as revenue starts to reaccelerate if they hit your guidance numbers?

James Truchard

Overall, Brian our model for R&D has been to give out 16% of revenue on a non-GAAP basis, we’ve been a little bit headed of that for the last several years, we are working to bring that line, having said that as we’re looking at guidance going into the second quarter we’re looking for a modest year-over-year increase in total expenses in Q2 and obviously it’s very much in line with the leverage target we laid out our investor conference last year in August.

Bryan A. Kipp – Janney Montgomery Scott LLC

I appreciate it.

James Truchard

Thank you. Brian.

Operator

Our next question comes from Patrick Newton with Stifel.

Patrick Newton – Stifel, Nicolaus & Co., Inc.

Yes, good afternoon. Thank you taking my question. I guess first Alex; I was going to ask you how many employees did you have actually in the quarter? And what was your average order size?

Alex Davern

At the end of the quarter, we had 7,129 employees it was relatively flat with this time last year. If you have second question Patrick, you are going to ask while I get the average order size. Go ahead and ask your second quarter question.

Patrick Newton – Stifel, Nicolaus & Co., Inc.

Sure. So I just want to make sure I heard you right, that you said your largest customer accounted for $34 million and orders for the year-to-date is that correct? And then pertaining to what the orders are for, is that for the third application of you’re shipping last year, was that something new?

Alex Davern

So, let me just be sure, I could be really clear about this. When we look at orders and we talk about orders for the quarter. We are really focusing on orders for the customer, the timeframe is based on when they customer wants delivery. So, when we looked at in Q1 we had $12 million of orders from our largest customers where they wanted delivery in Q1 that was compared to $17 million at Q1 of last year. When we look at it for the total orders received from the customer that we had booked for delivery in 2014 for the full-year that was $32 million through yesterday, and this time last year that was $24 million.

So, it’s up about a third year-over-year in terms of our business volume with our largest customer. We also believe obviously this customers has a strong interest in reducing their overall test spend by leveraging the innovative and disruptive technologies that we bring to market by reusing our software based measurements and multiple generations of their devices. And also driving productivity, so we feel like we’ve definitely been successful in gaining market share in terms of the spend of that particular customer. In terms of the applications we’re serving a variety of applications, obviously wireless based applications are a significant portion of that total. Is that fare enough for you?

Patrick Newton – Stifel, Nicolaus & Co., Inc.

Yes, that’s very helpful. And I guess if we think about the opportunity at this customer in 2014, given that you have about $32 million in delivers for the full-year and fair to say that revenues probably likely going to be higher than the $35 million that you achieved in 2013, but lower than the $70 million in 2012.

Alex Davern

I’m sure I want to given exact number at this point, I would say that a certainly we’re optimistic about our relationship and value we bring to this customer. And I would say its unlikely that’s its going to cause our negative on our growth this year than it did last year. Your question, Patrick, on average order size was $4,840 in Q1.

Patrick Newton – Stifel, Nicolaus & Co., Inc.

All right, that’s helpful. And then I guess dovetailing off the large customer question and based on the OpEx, you said OpEx should be up on an absolute basis slightly from a year-ago quarter. So, there should be a little bit of margin pressure, if I just look at the mid point of revenue guidance, but it looks like nothing like kind of the trough level that you saw back in 2Q of last year. Is that a fair characterization?

Alex Davern

On the OpEx I think yes, if you are looking low-single digit increase year-over-year, obviously gross margin follow be down sequentially will be up pretty dramatically from year-over-year basis.

James Truchard

Also there will be up also 200 basis points. So, our guidance assumes operating margin and operating income were up reasonably significantly in Q2.

Patrick Newton – Stifel, Nicolaus & Co., Inc.

And what’s allowing you to shift a greater number of to this larger or greater amount of revenues this larger customer and yet not see the same gross margin type of pressures this is the cost also you talk about kind of the second generation of products and benefitting from the manufacturing facility in Malaysia.

James Truchard

It’s all of those things we’ve talked about last year that when we were ramping in the first wireless application of this customer last year; a brand new technology just release to market and obviously we work hard to be as efficient as we can overtime. And so, that’s the key way to look at that pressure.

Patrick Newton – Stifel, Nicolaus & Co., Inc.

Okay. And just, one more if I may, and I don’t if this is best suited for Eric or Alex, but or Dr. T. But I am curious on the academic business. Are you starting to see an acceleration there, I believe through this malaise over the last several quarters, it had held up well, even without a PMI tailwind, and even with budget constraints. But I'm curious, with the PMI recovering and with the funding from the Ryan-Murray budget, have you seen any material change or inflection in that business? And then also, if you could tell us what percentage of revenue academic represents?

James Truchard

Okay. Yes. I will take it. And I’d say that it continue to hold up well. Our academic business we in particular I highlighted in the call of success and some of our academic product lines, products that we have built really directed that areas, those have done quite well, especially those that are now student-owned. And so, that’s a really important part of our strategy because it really broadens the base of students that are proficient with our tools.

It’s not only a business and revenue opportunity, but it’s really an adoption opportunity for us as well and we look at it those contacts. As a percentage of our business it’s very stable, about 12%. It can go up and down a little bit from quarter-to-quarter depending on the seasonal buying pattern of the academic institutions but it’s very stable.

Alex Davern

We managed to create set of products that serve mechanical engineering and bio-medical or electrical engineering and play to really add value and the hands on learning process. Now, it looks for an opportunity hands on learning even in remote class.

James Truchard

Robert, thank you.

Patrick Newton – Stifel, Nicolaus & Co., Inc.

Thank you.

Operator

(Operator Instructions) Our next question comes from Richard Eastman of Robert W. Baird.

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

Just a quick question on the large orders. If I recall, the way the orders flow into that marketplace meeting the wireless and also with this large customer, the majority of orders for a year, are they generally in house by mid year.

James Truchard

If you look at that specific customer Rick, generally that has been the case not always.

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

Okay.

James Truchard

But, that’s not a bad way to think about it.

Alex Davern

Yes, okay, all right. So we've got good visibility on the $32 million, and maybe we can step that up. And then again, we've got $32 million of orders year to date. We shipped $7 million in the first quarter, so we've got -- the other $25 million mostly gets recognized in Q2 and Q3. That’s what you’re suggesting?

Alex Davern

Right.

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

Yes, okay. And then, can I also just ask, Alex, North America was down about 4%. And sequentially, was down about 7%. Normal seasonality, at least in the North American market, would suggest that would be flat sequentially to maybe up a little bit. Was there a particular market and I may be thinking aerospace defense that stayed pretty soft?

Alex Davern

When we look at it last year we had a pretty strong quarter in the Americas in Q1 Rick. And it got a much easier compare as we going to Q2. Certainly there was possibly some pull in of business in aerospace defense last year in Q1 pre the whole budget shutdown. We’ll see how that place up and certainly we have an easier compared to then in the second quarter.

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

But the seasonality from Q4 to Q1 in North America, it looks softer than it normally would. And I'm curious is there anything that you can attribute to that or is it just…

Alex Davern

Nothing in particular.

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

Okay. And was the defense market military aero-defense market, how did that do in the quarter? Are you seeing any signs of life there or?

Eric Starkloff

Actually this is Eric, globally aerospace and defense business was up double-digits in the quarter, and this by well it was one of the sort of stand out successes along semiconductor which has done well and automotive would continue to be quite strong as well.

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

Okay, excellent. And then just a quick question on – in the first quarter, the capitalized software was a pretty high number, $7.6 million. Anything unusual there or how does that – how do you expect to capitalize software number to track for the quarter – for the full calendar year?

Eric Starkloff

Might be slightly higher for the full calendar year than last year, the way I would think about it is obviously we have pretty major software product that’s getting close to release.

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

Yes, okay, all right. And then just last question. For the second quarter, when I look at kind of the revenue guide, and I look at it, again I'm thinking sequentially like trying to just pick up any seasonal trends, but what pegs the low-end, which would be about a 4% increase sequentially versus the high-end, which would be mid-teens?

Eric Starkloff

Obviously, we are looking at a overall forecast by based on pipeline and entering team or trends and then bracketing around that to give a reasonable aero bars of studying the overall guidance. The other point I would make Rick is that we did see our backlog grow up by about $7.5 million in Q1. Normally you might see backlog comedown in Q1, so that’s about 3% of revenue that did in flow through in the P&L in the first quarter.

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

Okay, all right. And then, seasonally, again, you're going to pick up maybe a $5 million to $8 million delta on this large order?

Eric Starkloff

Do you mean on the larger customer? We would at this point expect revenue from our largest customer to be bigger Q2 that it was in Q1.

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

Right, right. Okay. okay thank you.

Eric Starkloff

All right Rick thanks very much. See you next week.

Operator

And I’m not showing any further question at this time. I would like to turn the conference back over to your host.

David Hugley

Thank you, very much for joining us today. Have a good day.

Operator

Ladies and gentlemen, this concludes today’s presentation. You may now disconnect, and have a wonderful day.

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