James Truchard - Chairman, President and CEO
Eric Starkloff - VP of Marketing for Test and Embedded
Pete Zogas - SVP, Marketing
Alex Davern - CFO, COO and EVP
National Instruments Corporation (NATI) Investor Conference Call August 2, 2011 11:30 AM ET
Good morning. Thank you for being here at our Investor Conference. Hopefully, you all saw the key note this morning where Dr. Truchard and Eric talked about graphical system design and all the various applications. We are going to continue with that momentum. Dr. Truchard is going to come up and talk some more about graphical system design and our vision as a company, followed by Eric Starkloff, who will talk about our opportunities in both Test and Industrial Embedded.
We will break few minutes for lunch and then Peter Zogas, our Senior VP of Sales and Marketing is going to come up and talk about selling and our investments in this field and how we are taking advantages of these opportunities and then we would round it up with Alex Davern talking about our financials and our commitments for the future and then we will have some time for Q&A, but we encourage you, if you have questions throughout, please ask them.
So with that, I’ll introduce Dr. Truchard to come on up and kick this off.
Thanks July. Alright. So, we saw some pretty impressive demos this morning. The 8x8 MIMO is getting us very close to our vision of what we want to do in the communications test and that is stability to demonstrate a new standard as it’s being written. That’s the end goal. Once we get there, we got it and we were very close with the 8x8 MIMO, the first time a 8x8 MIMO running that data rate for LTE that’s been demonstrated.
So, that was, in my mind, a pretty impressive demo. So I would like to share some thoughts and about what we are doing and try to once again explain this graphical system design that we talked so much about, that’s really given us the leverage to do what we are doing in the market place. First of, I want to point that there is uncertainty about the future. And you should be sure to read our documents and learn all the risks associated with our business.
So now talk a little bit, we often talk about our stakeholders. In the early 1990s I was very interested in really making certain we were getting a solid foundation the way we think about our corporation and what we do and our role in society and I think now this issue is being revisited as we had the meltdown on the Wall Street and you had folks really only looking at one vector, one direction or one stakeholder in the process and really creating some rather unfortunate results.
So we've over the years tried to create a approach that represent a balanced view. It’s really about creating a long-term view of how we are operating, where we have stakeholders, their interest and are looked after in a win-win working relationship, whether it’s the customers and obviously we have to have good and excited customers. Today you saw a lot of those, it was 3300 and some paid ones. So basically a long list of customers and then the employees, the employees are our capital really in terms of, it’s very important that we create a long-term view for them as well.
Suppliers, sustainable suppliers in the marketplace and then of course the shareholders. And if we do that we will have a win-win working relationship. So that's really been a foundation of how we’ve tried to operate over the years. Now we’ve this last year invested heavily in growing the field and in our R&D and you saw some of them outcomes of the R&D today, really substantive products, really taking, going squarely into the marketplace, this communication and telecom, where a lot of our business needs to come from, we’ve invested, we’ve seen the products, the delivering, the capabilities we need as well as in industrial embedded space and R&D.
And then the field fails to follow through and sell these products. You know if you have an opportunity it’s critical that you take advantage of it and in this timeframe we reached a critical mass of components with this RF test capability, the industrial embedded, if we didn’t take advantage of it with our field sales force, we’d leave it open for somebody to take a shot at it. Obviously, we got a big lead, but we have to make sure we follow through and get these products established in a timely manner before anybody else can jump in and take the opportunity, even though we do have a strong lead in the technology itself.
So we talked about graphical system design and this platform, in my role model it’s always been Apple as a platform and there were years when I used to say we’d like to follow example of Apple, that didn’t look so good, right? I mean the 90s, but with Steve Jobs back, they got that vision back on track and they are vision-driven company and National Instruments works to be a vision-driven company also. And a vision sets the long-term direction, in our case graphical system design this platform and our platform just like the IOS is designed it to integrate literally tens or hundreds or thousands of pieces of software and hardware into one platform, it all just works together.
So that’s a big order, but that’s what we have been working on for the last two and half decades and we’ve really, really, as you saw today with the demonstrations going all the way from toys to the smart grid, up to the most advanced demonstration of 8x8 MIMO, all with the same platform. That’s the goal and we are achieving that goal as we move forward. So on the test and measurement side, we have used FPGA technology to really, really scale what we can do and solve the harder problems in test and measurements.
But then with the same LabVIEW within to this industrial and embedded space with our CompactRIO and PXI as well. And here the really technology, really shines because we can do what it takes a custom design, may be a custom DSP design at that, we can do with off the shelf hardware. But that really is a significant breakthrough and the LabVIEW programming methodology lets us work with both processors and FPGA in the same environment, virtually only through around that really works that nimbly, as well as working with the domain experts.
So we put forward a new goal that do for embedded what the PC did for the desktop, that takes a little bit, you have to stop and think about what does that mean? That means there is a standardized hardware that you can run in a lot of different software applications on and it is reusable. So you get scale overtime and the vendors, if they want to play there is only one platform to play on. You are either in the platform or you are not.
And that creates a lot of ability to get good pricing and bring cost down just like the PC did over time where the cost to PC really left all the other approaches for computing, desktop computing behind. So that’s our goal, is to be able to create that standardized platform and this embedded side actually help us in test and measurement because there is a lot of embedded monitoring applications like in vehicle where you want to drive a car for a 100 miles or 100,000 miles and see if the software works right. For example so you have noise, either the engines gets it or whatever so in embedded monitoring you saw hardware in a loop demonstrations all the way from automobile to airplanes, so that’s done with this industrial embedded technology as well.
So it’s a win-win across these two spaces, use the same technology, getting evermore users that are using LabVIEW. We also talk about the engineering grand challenges in just a way to frame and as a recruiting tool, it certainly helps for folks to feel like there were important problems for society are, we want to do this with less effort. Obviously we talked a lot of about the shortage of engineers in the United States. One way to solve that its have better tools. So that the engineers that we do have can get more done in LabVIEW and our tools are certainly doing that. So they can meet this competitive trial.
Here we see the engineering grand challenges, we talked a little bit about them today. One of my favorite is fusion energy, back when I started physics in 1960, we were going to have so much energy that you wouldn’t even bother to meter it. Its plug like the internet and use it and it never happened. Okay. So we have to try I’d say. Of course we are doing things like fracking and that’s a little bit controversial but its the realistic answer. Natural gas half way there on the carbon footprint. A good idea I think.
So you take all these things, solar is another, I met with another customer yesterday with his strength in solar production where they’re just ramping up. So lots of things that we can relate to in society. So from the engineer’s point of view I always say that there is two perspectives, one the company and the business point of view and then the individual and the engineer making the decision about which tool they are going to use. And they too have challenges. They have to get more done in less time and they wouldn’t have a fun job and we have domain experts that don’t know all these technology about FPGAs and multi-core and all this.
So we like a tool that lets environmental engineer or a bio medical engineer who ever it is do the whole job. That’s much more efficient than having it pass it off to another programmer. With LabVIEW we can do that. So if you look at complexity, early phones were simpler they didn’t make phone calls and some days we wonder about smart phones and how well they do, but they were much simpler. So testing was a much simpler process. But then they starting adding complexity, we added camera as well and then you need some vision technology to work with and we add the audio and suddenly you want to listen to your music with this thing too.
Now you bring the kind of technology we are being selling to Bose for years and that we have to test to see that is really high quality music. And it goes on and on, add more features to your video, where we can do video streaming. All this needs additional testing, more complexities engineers face or even more. Then we start adding apps on top of this. So, they are adding even more interaction of things happening all at the same time for more testing and so, how can we do this.
Well, obviously we need technology to scale and match this level. So, if you look at the components of what are doing and I will point out this presentation I am just going through is what we are presenting to our editors to really talk about graphical system design to try to bring the key points out. We have been talking about graphical systems design for almost a decade now. But maybe it’s time for us to really explain in the way that we can communicate it well to the various audiences we have and that’s what we are trying to do here with this presentation. So, models for computation, we have worked with leading universities like Berkley on the technology that goes under the [herd] in LabVIEW to give us the capability to solve the kind of problems we are trying to solve.
Obviously, math and analysis, math is very important, but it’s not the only thing. So, we have to make, what we call real world map that takes in account the real world [embalm] and all the complexity that goes with that user interface. LabVIEW has always started that. So, that’s an important part of what we do, managing IO, literally tens of thousands of possibilities there.
And then the deployment targets. PXI is good for some things but if you want to rug it controller for fracing machine you need CompactRIO. We also have, you saw some introduction of single board RIO but even more embedded, deeply embedded applications all the way up to the x86 Dual Core processor, all that are very rugged, in a very rugged platform and then of course being able to leverage the A/D converters and D/A converters from TI and the other players in the marketplace.
So what if all these things could combine to make it so you can develop these systems faster which we are clearly demonstrating reduce the complexity of the design process and have tools that do not get in the way. We saw Eric talk about abstractions versus obstructions. So this is an intricate process of making sure that we are creating tools that work in that way. And of course accelerate innovation.
So graphical systems design is designed to do just that. So it’s a platform-based approach, meaning everything works in the ecosystem. Users can share their technology, they can share the example in this platform because its standardized the way it works and it’s a, you are able to visualize your solution, so there's the graphical element of the process. So we use this to show how we can bring those elements together with a combination of the software on one side and the hardware, you've sometimes seen us use the Ying-Yang to do that. And this idea is this combination of hardware and software just like a smart mobile device that brings it all together and makes these capabilities possible.
So it allows us to be more productive in what we do, we could innovate faster in how we are doing it and build in the system. Now we got many, many tens of thousands examples you saw some of them today, here we see some basically at the top, the idea behind this graphic this is taken after Professor [San Jubal Vincent Palio] of Berkeley that talked about the application space. We wouldn’t be nimble so no matter what we need for the smart grid or the wireless phone whether it’s video, audio whatever, we’re nimble enough to be able to implement the system.
So we explore up in this space, what our problem is, whether it’s wind energy whether it’s a life sciences abyss, its under ocean robot or a cyber physical robot of which we see over here. These are all possible and we have the technologies we can pick and choose from to implement in LabVIEW and then deploy on the targeted choice. So the decision process at the top map is through the LabVIEW software on to the deployment targets at the bottom of this slide.
We are also talking about model for computation, this is using Berkeley’s terminology. We’ve been working on this structured data flow which is the one on LabVIEW for the last quarter of a century, and we pointed out how we’re investing for the next quarter of a century in LabVIEW. We can integrate C-code, map, its takes map as we need it and then continue some simulation to do these applications like you saw the HIL demonstrated our control design like tracking in light and then stay towards into this platform that all works with LabVIEW onto the hardware. So this is kind of the programmers view or the person trying to implement into the system and LabVIEW is clearly demonstrated its ability to let a domain expert built a system.
So here we see that, implementation of RIO and Eric talked a lot about RIO. RIO has really, really been the key technology that let us work with FPJ’s programming let domain expert, medical doctor’s program FPJ’s like to never do that. So really, really eliminates a lot of work for the use and complexity, along with the drivers to go on the hardware. So basically RIO technology and of course LabVIEW at center stage. It is the one that started unifying view of the problem that we can work with in creating these very broad applications.
So we opened up for system design and software, we can accelerate the productivity and innovate and we see, you will see as you walked around the trade show floor, the example. It’s an incredible amount of innovation. We didn’t have wind lift with wind, flying kites to generate energy which is one of my favorite ones. Sounds cool.
Here we see how the software Ecosystem has been created with the 140,000 online users, 250 user groups over a 1000 people looking for folks work on it, LEGO with 400,000, instrument drivers. So we backward compatible with all the instruments. We work with industrial devices like PLCs and then we collaborate with literally hundreds of third parties and their hundreds of solutions and their products as well and you saw the demonstration of how we can create a product ecosystem in the way that integrates our partners’ products right into our LabVIEW product and of course training in the ecosystem for that going with it.
And then on the hardware side, the various hardware working with the suppliers like Intel and Microsoft and Prescale, Wind River to close the process via links for FPGA’s and then analog IO with analog devices the access to instruments and alike so the use in the latest technology to do that.
We often talk about what we call K2 rocket frames; and the idea here is that by creating a higher level of abstraction we are able to solve this boarder way of problems all the way from a kid’s toy, Lego, most successful ever, up to large (inaudible) which I talked about with PXI where we’re literally able to take on some of the toughest real-time control problems on the planet; all with one tool, LabVIEW.
Some additional examples, I mentioned the Virginia Tech EcoCAR, they went in there with a team that didn’t have the skill-set that some of the others did, lot of disadvantages going in, but they won. They won hands down and that was pretty incredible considering the circumstance that they have to do it in. Lawrence Livermore Lab, first version NIF was done with traditional tools.
Now they are replacing a lot of technology with our solution with LabVIEW, one of them is this repair facility for the lenses to high power laser light burns that actually literally burns the glass and they have the repair and they do it with LabVIEW system and now they are adding some advanced mirror control technology as well at LabVIEW, Space Act I guess we are going to see more on that tomorrow, is that right? And that’s some style and that was a fun visit for me, I got to walk around to rockets you know, engine and the capsule and all that and that was pretty neat.
So Space Act is really a fun one as well. There was a big article in Wired Magazine talking about how they were able to do what they did because of software they had for the testing and the developments that they had and so really Space Act has been a very successful example for us.
Now I would like to talk a little bit about trying to explain things from another point of view, a way to look at this problem and I use this to explain our way of offering; if you look at the traditional approach to design, it takes a big design team. There is the main expert at the top, he knows or she knows what she is trying to do and then you have to get this big team. And there is a tremendous amount of inefficiency in the process to do that. To do the first prototype that demonstrate this idea, it is going to work and if you are venture finance guys, you loose a lot of equity, because you are going to pay all these guys for a two year time period or may be more to do all this work.
What if you had an alternative that you can demonstrate your idea very quickly as you heard today; actually it was two months calendar time, sixth to nine months of effort on an 8x8 MIMO; what if you could demonstrate it very quickly with our off the shelf technology and get to the first prototype out in the field showing that this thing really did work how much better off you would be? And do it with a lot of less labor, lot of less cost; with a combination of domain expert and those were strong too. And then the system designer who is going to talk about the IO sensors and may be mechanical design, usually it’s mechanical designer to build a system, so substantial savings.
And then if you do have a very high volume like a cell phone or smart mobile device, you can always go back to the traditional high-end tools, mentor, cadence, synopsis type tools to create you know high-volume solution, after you fully demonstrate your operating prototype and all the capabilities that’s needed. So we play a long sign, the traditional EDI companies, not in places; we are working in space where we are moving what would have been a custom design, to off the shelf. But as you want to go to high volume, maybe to custom chips or like, you can go back to traditional tools in the process.
So now summarizing, we do have a long-term plan. Today, I talked about instrumentation, traditional instrumentation and we use this as a timeline for decision making. Obviously, every quarter we probably show results. But we also plan on a yearly basis, like works to a budget, works with offices to create a budget. We make decisions about what we are going to do on a yearly basis, projects we are going to do.
And then at the longer timeline, we look at the areas, what’s hot, clean energy is hot. So we are doing a lot of this. Smart Grid is hot, smart mobile devices is hot. So these are the areas we are going to put special emphasis in. And then at a 10-year level, the vision that we’ve created for the company is expanding over to decades from self-financing with GPI beam moving to virtual instrumentation, moving to systems with cRIO and PXI, now graphical system design is center stages of our vision. There is an expanding vision building on the decades before. So it gives us continuity overtime. Then its hundred years about the values and those came into play as we went through the downturn, that hundred year plan played a big role in our steadiness as we went through this last downturn.
So now I would like to summarize by showing the slides I showed this morning. I mentioned general radio with vacuum tube instrumentation really was the major player in the instrumentation market for some 45 years. And then Hewlett Packard through the 60s it was rapidly expanding. Going into 60s they were still not the player you would recognize as the major one, but exiting the 60s that come up with all these RF instruments, integrated circuit transistors to build these things, greatly expanded their role in it.
So some 45 years later, we see software center stage, where software is going to make all the difference. So our goal is for next 45 years to carry software the major way instrumentation gets done. So this really is pointing out the role of software in instrumentation. So summarizing, we work on the grand challenges. So we are relevant to society, we are solving some hard engineering problems associated with energy and grid and communications, all of the things we care about in our daily lives. And here is some of the examples that we can talk about.
So I would like to thank you and we’ll take a few questions then, a question or two if you have a question.
Do we have a microphone?
Thanks and thanks for that; a very interesting presentation. I am hoping if you could talk a little bit how you think you can align management’s compensation with along the timeline that investors are accustomed to thinking about I think and I tends to think in very long-term perhaps the only company I’ve ever heard of talk about 100-year plan. My understanding is management’s options best over 10 years which is a period by generally at least twice as long as what most public equity investors think about. How does management think about formulating these plans and aligning them with investments?
Right, okay. So do we want to talk first about 30 days or do we want talk about 90 days or year and a half which one you want to talk about first?
Wait, I mean I think a year and half to Q3…
You know one of the challenges we faced, if you got an investor that’s thinking 90 days and there are some of those and they’re telling you to take actions that are on a 90-day – there isn’t a whole lot you can really do in 90 days; that’s other than things that are very detrimental to the long-term success for the company. So 90 days is really, really challenging to try to and a lot of the investors are on that timeline.
So then we go out a year and a half and may be I would personally think you’re going to have some time myself I must confess when I am looking at investments. There we got some possibilities of what we can do and we have annual, we have plans that, the goals that we published the top guys and in our annual report, it is on a annual basis. So we do have goals to officers, specific goals are set up on that timeline and so the most concrete goals that are actually set are on the annual basis.
And then in the longer term, we actually, the officers are on plans that will accelerate vastly. So they start out ten years, but if we meet these aggressive, I must admit goals, they become five-year plans. So it’s actually in there that we are incenting to accelerate growth through accelerating options and I think we are unique in this. So I would say I don’t know anybody else who uses that scheme, but I think it’s a very good one. It gives you long term, but it also gives benefit on the shorter term if you meet the more aggressive goal and get that achievement. Alright, are there questions, if not we will.
You had mentioned that the hundred year plan that was (inaudible)?
Can you elaborate on your thoughts on why that kind of?
Well and I think if look at some of our competitors, where they literally were saying, we are going to slash and burn until we show a profit. But they didn’t know how bad things were going to get when they said that. And they ended up with commitments that, in some cases try to keep and it was a disaster. So by taking a view that we are going to work through this.
We ask for things from each of our stakeholder. We’ve [trained] in terms of stakeholders. The customers, we had to make sure that certain things that, suppliers we ask for discounts and employees, we ask pay cut at one point and vacation. So we did things where everybody shared in the challenge and that’s a long term view. Okay, yes?
Can you talk about the long-term strategy of the company in the shift and kind of back into semiconductors or hardware and other products? But looking at these opportunities, show there is a whole wake of opportunities out there. In term in the short run how do you drive these opportunities? What is the process in terms of you are saying, what is it going to work on now. You are a very broad platform, you have got thousands of applications. So how do you think about that or where does the resources, both from an R&D perspective and the sales perspective?.
Okay. So one of the harder areas, it’s been this RF, the design you saw today is a very challenging one and it’s one of those kinds that you have to get this very high end experts and they have to come up the curve of what we are doing and that’s set the timeline. So some of those are really determined by our execution. Our will was there, we wanted to do it, but we needed the time to execute on it, to get the right expertise in place and do it. So I would say that was less about priority and more about our ability to execute against what is a very challenging problem.
There is a only few places in the world at that level of expertise exist. So building that took some time. So that gave us time wise, we love to and done it much faster. Other areas are more immediate. We see opportunity with smart mobile LTE, things like that. So again we press hard to close on those and try to get the right expertise.
For National instruments, coming up the curve as it would be for any body new in the area, getting the right expertise is often the challenge that gates us time wise, so other than that we are always working to see that we are getting the broadest phase of LabVIEW can keep its popularity, it’s ability to compete in the market place over the longer term as a priority as well. Academic for example, good example that where we invest heavily.
We are actually going to have time for more questions at the end, so we are going to go ahead and bring up Eric Starkloff
All right thank you.
Thank you Dr. T. Okay welcome every body. Let me just get a quick idea how many people got a chance to see the key note this morning. I am going to reference, okay just about for everybody. Okay I am going to reference it a few times during the presentation. It will be actually available by tomorrow on our website for those of you that weren’t able to join us earlier.
So what I am going to talk about is, let’s see there I am. What I am going to talk about is a little bit use that same flow that I did this morning at the key note (inaudible) for applications and demonstrations but put a little bit more color on it, obviously for the information that you are looking for and the insight that you are looking for. Feel free to interrupt me during the presentation. I can take questions through out and then we will also have some time at the end for questions as well. So this is the image as I showed this morning and Dr. T just talked about on the top of all these applications and then our products and platforms. I am going to start with the applications and talk about our opportunity areas, some of the places where we are focused on in this applications space
So fundamentally we have a platform that cuts across these two major opportunities, custom measurement and industrial embedded. I will spend a little bit of time actually drilling down to each one of these, but I think as hopefully you saw this morning at the key note, it doesn’t divide very simply among our products. Our kind of platform goes across these different spaces. What makes them distinct is really the way that our customers use our products, whether they are using them for the purposes of testing and measuring something or whether they are using them for the purposes of actually building an embedded system or a control system.
Let’s start with the test and measurement opportunity here. This has obviously been core for us for a long time. And it’s an area where our opportunity has been expanding over the last number of years with the some of the technology investments that we have made. So last year when I spoke to this group I talked to you about these areas of real time test and semiconductor tests and those of you that saw the keynote this morning saw some tedious demonstrations of some of the things we are doing, real time tests.
That’s the area where we showed the transmission, hardware and the loop system and the big test system at Embraer where they are using it to test this ironberg, basically it is a prototype of a jet. And semiconductor test, we showed you new products there, a couple of years we had a major customer on stage with analog devices showing you just dramatic improvement that they are seeing in their test time and test costs using our platform.
So those are couple of areas that have been emerging opportunities for us. Another one that I added kind of to our list formally this year is in strucutural and physical tests. So this is sort of an extension of our long term position that we have had in our PC based desk business which is mainly measuring sensor phenomena physical things. But really this is an opportunity and much larger types of systems in large structural test systems. These are test systems that are used to test full airframes, wings of aircraft, bridges, things of that nature and that’s an area that we are putting a little bit more focus on as we move forward as a market opportunity.
Now I want to take a little bit of a deeper dive probably not surprisingly I have done this for last few years as in RF, the big focus area for us. It’s a major opportunity, talked to a lot about this morning and I want to talk about our strategy in that space. So showed this morning at the keynote ST-Erickson came up as one you know kind of user application. It is pretty indicative of the benefit that we are bringing into this market space. So essentially this is a validation lab. It is kind of a little bit earlier up into the design process and in general and in the design process requires higher fidelity of measurements. So, we’ve been investing in that area, the product that we announced this morning. This 14 GHz Analyzer probably more than just a frequency as this being very, very high fidelity. So, obviously we demonstrated that by comparing it us best-in-class instrument.
That capability is what enables us to service a customer like ST-Ericsson who need the combination of high fidelity, but also fast measurement time. So, put into context, I mean what he showed is literally, you know we cut that one kind of test system, cut two days of their time to market and that’s directly. They get to market two days earlier just because of the measurement performance that he showed this morning in the key note space, that’s pretty impactful.
And that’s the kind of pretty typical application that we have in the space in RF. Now, it’s obviously been an area, we are investing in a lot. So, I showed you again, the product that we did this morning. We’ve done a couple of strategic acquisitions over the last few months. We did a call on that earlier in May, but I want to review a little bit of that and go in a little bit deeper on these two companies.
So, the first is Phase Matrix and it’s the company that really focuses on components and hardware that is used at very high frequency and there are about 50 people, almost all of those are in manufacturing and R&D. So very R&D focused organization with world class capability. Dr. T mentioned this morning, they have capability that's used in some of the highest performance instruments in the world to the OEM into that space. They are used in military and aerospace applications and increasingly there's other things going on at these higher frequencies.
So it’s important that we have a position, there are some standards work going on for example at 60 GHz. One of the ideas or one of the uses of that is to get wireless HD connection to your laptop, to your TV or your laptop to a projector. So that's a 60 GHz and so this is the type of technology that's needed to make those measurements to that kind of frequency.
We show it on this chart, we've probably shown you this chart a bunch of times. We kind of think of the world as if you digitize it, you can apply software and make any type of measurement, so we plot it on this curve and essentially Phase Matrix adds this high frequency capability on this curve in a highly complimentary way. So they do have one product already in PXI, our primary hardware platform for the space and that's already now available on NI's channel and we see existing demand and know about existing demand already on that product.
We actually worked with them on that product for the last several years. So that ones in the market now. We will be working with them to bring more of that kind of high frequency hardware capability into our product lines.
The second company was AWR, showed a demo this morning, and I talked about this measurements in the design flow and that was the demonstration where we actually were combining real world measurements into the design tool and showed the kind of comparison of simulation to measurement. You have a question, yeah?
How much does Phase Matrix expand your addressable market?
The question was how much the Phase Matrix expand your addressable market, also I figured the question about the same thing with the 14 gigahertz that we just released today and really the way I think of it is RF test the measure of market is $3.8 billion and this is really about giving us more capabilities to serve more of that market. I don’t have to breakdown to give the exact number but this is about giving us more capability to extend into that market. Right now most of the measurement capability from pure frequency point of view is 26 gig and below and now with Phase Matrix we have up to 26 gigahertz product today.
But as I mentioned with the 60 gigahertz, that’s always changing, right. You have to have the technology capability to makes sure if wireless HD takes off, it will be a lot of opportunity for the 60 gigahertz.
Another one is if you have a radar basically that’s a cruise control system you use as radar to make sure you don’t run into car in front of you that’s a 60-70 gigahertz. So that’s an emerging area. So it’s also about having the technology to make sure we can continue to serve the $3.8 billion RF market.
Okay. On AWR I’m going to show that them of combining design and test, that’s a pretty big deal to be able to get that level of integration into these RF systems. It’s really as I mentioned, in the keynote Dr. [Tee] mentioned as well, it’s really mainly pertinent in this RF space where things are a little bit more difficult to predict and simulate. So you need real world I/O. A lower frequency things can be simulated with very good accuracy into that but integration has led critical than it is in this RF space.
But the other thing I want to talk about if you think about this curve, I have a lines of influence that happened between these users. Okay for sure the technical demonstrations of what the integration looks like but there’s this influence. So in some organizations, the R&D folks really have some flavor of what equipment is purchased downstream in to validation and production, they specify the type of equipment. And sometimes it’s the other way. Sometimes companies has very high volume production and really focused on how producible this thing is the production folks will be able to dictate sort of downstream what the R&D people use for their test and measurement equipment. So these lines of influence are very important part of understanding the strategic value of AWR, which has a very good position kind of upstream and the users that are doing research modeling, design and simulation and what that means for an opportunity for NI in terms of test and measuring. So just quickly, the AWR, the really the best tool in the market for doing the high frequency EDA. They have about a hundred employees in the company. They serve a fairly broad set of industries but all of it is very at a high frequency gigahertz and above.
Here is another way to look at it. From kind of a market view, so there, if you look at the overall EDA software space, it’s like a $4 million market. This is the mentors that came to this world and RF EDA is a very small niche within that market, depending on exactly who you are at, this is representing a, Gary Smith report, $170 million, a very small focused part of that industry and it’s really a two player market, Agilent’s ADS tools and AWR. And of course, the test and measurement industry as I mentioned is a pretty large market. A classic T&M is about half of the market as in the RF equipment because of high cost of that equipment. And so this line of influence that I mentioned sort of goes between this designers that are using RF EDA tools as their primary tool chain and the purchase of a test equipment too those designers. So the point is these designers represent a very small part of EDA, actually specify a large amount of equipment in test and measurement.
And so building the integration like I showed this morning is important on delivering value to those designers to use the combination of AWR tools in NI's test and measurement platform. So that’s the goal.
So now I want to transition and talk about the other side of that opportunity or what we call industrial embedded. As we told you before its made up of kind of three areas on the lab this PLC that’s kind of one of the classic industrial automation kind market for basically controller acquisition, on the far right, a single board computer is basically like PC but than more industrial form factor and in the middle is custom design and actually this is the really sweet spot for our platform. Most often the customers that choose to used to our platform designer embedded system there are alternatives, if they build it themselves, put the chips on a board and write the software and design the things from scratch. So that’s kind of a sweet spot and then we see opportunities that kind of extend into this other areas as well.
Now, with this one I think illustrating with an example probably makes it a little bit clear. So I would like to think a bit in terms of this you know long tail of applications. So you basically have kind of all embedded applications you can put on a curve from things in the far left are the really high volume application. So like this morning I mentioned the smart grid and Bill Kramer from NREL talked about putting a single board RIO system in the smart grid application. That’s pretty high volume, as for example that component is going into every switch on the whole grid and its pretty high volume application and then as you go down you get into a incredible diversity of applications and you get far down on the right side and this is where research and prototyping is happening, where someone’s building a new machine for the first time. Its really one of then in the world. So in general kind of everything start on the right hand side right, everything start as a new thing, a new prototyping, a new idea for machine. So here is an example this is the company we are actually going to showcase them in the key note tomorrow for those of you who are still around you will be able to see this on the Wednesday key note and we are going to show you this system at lunch as well. So it is actually over there to your right on that arm, I will get to that in a second.
But this is what it started as. This is the company in Japan doing medical imaging and the new and disruptive techniques for medical imaging it is called optical coherence tomography. It is optical technique that do sub surface imaging and they were prototyping this idea, trying to figure out if they had a novel way of bringing this thing into the market and they started with PXI systems and one of our FPGA card, this flex RIO system and started prototyping this with the optics and putting the algorithms down on the FPGA to build this new idea for a machine. So that starts off as sort of a one off opportunity now and I and people come and talk about the channel later and I will hit on a few points but we have a lot of breadth in our channel and our tools are used very broadly as I showed this morning. And so it likely when people are doing these types of things and they are trying to do something for the first time they are using LabVIEW, they are using I/O and they are talking to our field. We can very efficiently serve these kind of one-off opportunities.
Now, [Fairtech] also has systems that are sort of medium volume that are used in kind of packing stuff and used in labs for doing further research on OCT and they have a fairly high one that is targeted at fairly high volumes, which is a portable OCT system. So that thing will show up in [Then/if] software in a doctors office and that’s what actually our prototype version of that is the Themis over there on the desk on the right and we are going to talk about that at lunch. Now that system actually has a digitizer and with an FPGA inside of it.
So, its basically a similar component as a prototype and it’s running effectively the same software LabVIEW that they use in a prototype. So, you allow them to give them this technology to prototype but then we have the tool chain that they can go in to higher volume deployment with lower cost and more embeddable components that can go into a machine like that. I think this one’s a really good illustration. We talk about this industrial embedded applications. We wanted to show you one so you can have a vision of really what this kind of machines look like. Obviously, as Dr. [Tee] mentioned earlier, it’s not a cell phone. You know, we can do early prototyping on a cell phone but we are not embedding components in to that. It things that look like the OCT system over there or larger industrial machines as well. Yes? Let me give you a mike there. Go ahead.
On that chart, when you look out next five years, where do you think, which part is going to be your sweet spot?
Well, here is the thing. If you got the sweet spot, there are couple of ways to address that. You know, one is when we look out five years, I think Pete is going to talk about this one. But one of the great things about a broad platform is that we don’t necessarily have to predict what the big industry or technology is going to be five years from now. We can sort of have this broad platform, watch for these things and then you know it naturally gets pulled into energy applications and then we can put some specialized resources as n expertise. So, not necessarily have the make best on a very specific application. Now for the point of this chart, I mean certainly, we are, we are focused on having a balance across this but certainly we are deliberately building capability, so that we can go into higher volume deployment. So, this morning actually let me show you this. I will come to it later. So, this morning I showed this two CompactRIO Systems that we launched today. So, one was the multi-corer, its kind of the big one, got a Intel Core i7 processor, it’s pretty high-end. That’s going to be more on the proto-typing end. The other one was the single-board RIO, small, half the price, half the size of our previous small embedded target and that’s really, deliberately targeted for the higher volume deployments.
So certainly that's an area where we are investing to make sure that our customers as they get more and more successful and as their system reaches higher volume that we can stay in there and stay designed in with the right capability and the right price point and then our value-add is one helping them get that system out faster, that’s our fundamental value proposition. And then overtime that they get to retain their investment in software. So we can go to these smaller form factors, the software is the same, they don't have to change their software, and as these systems get more software centric that's where all their investment is, its in all the software that's inside of these things. So that's the kind of value proposition in this embedded space.
Okay, let me touch on kind of where we are in the lower side of that picture, the platforms and products. So as we've told you before, we have a pretty intense focus on our investment in new product development and R&D. This is an updated version of this chart we've shown before, National Instruments is in the blue line and this is our absolute R&D investment compared to some of our peers in the market.
And the point about this is that there has been a drastic change in the industry’s capacity for R&D among these different organizations over the last decade. You know 10 or 11 years ago, Agilent, EMG Group had about 15 times our investment in R&D. And you could see companies like Teradyne, is like seven times our investment in R&D. Well, now you can see that we are up with the biggest investments in the industry right now, that’s Agilent, that’s [RODI], that’s Teradyne, we obviously don't have the 2011 numbers.
But this has been a big change in the market and obviously being, having the focused, you heard from Dr. T and our focus on technology in the long-term, this is basically the investment we make in our capability for the long-term and we have a very large capacity for investment and you saw some of that this morning, unprecedented number of new product that we’re releasing here this week, at NIWeek, the total number this week is about 50 products, by the way 50 new product introductions.
Now fundamentally, we do hardware and software combined systems. It’s always about the combination of hardware and software neither two images of basically two of our major hardware product lines is CompactRIO, this is PXI, I want to just give you a kind of status report on both of them.
So CompactRIO has been extremely successful, we’re seven years in and we launched it seven years ago at this NIWeek; seven years in to the lifetime of that product and it’s been extremely successful. This year, it’s growing over 50% still seven years in. This thing has a lot of momentum and you look at that chart, look at ‘08 or ‘09, 2010 it’s hard to see the great recession in that chart. You know this product line continued to grow strongly through these difficult economic periods.
We’ve also had the investment in the ecosystem and the products and obviously I showed a couple of new products in that today, like I just mentioned basically going up in performance and going down in size and cost to be able to deploy these systems and increasingly high volume applications. So a lot of success around this RIO platform and a lot of excitement you know we just had a Global Sales Conference preceding this event, a lot of excitement about this new capability.
The other major hardware product is PXI and that’s also doing quite well. This is actually industry data from Frost & Sullivan, one of the analysts in our industry and this is a report that they just released a new version back in June that is on modular platform; it’s a prediction of growth of these different modular standards. And they actually revised the PXI numbers in this latest report upwards and are showing increasing momentum. So their prediction is an 18% CAGR for PXI overall market and going to over $1 billion PXI systems in 2017.
Via this blue bar by the way of VXI; we’ve served VXI markets since their beginning, we continue to. We sell most of the embedded controllers that go into VXI, a fairly small business for us and we will continue to maintain that so that our customers continue to buy them. But that’s declining market and has been for a number of years.
And then this other one that is kind of hard to see is AXI, that’s another standard that’s been put out there in the market; it’s a larger form factor, in fact the team may have referenced that when they talked about Moore’s Law, and we think things should get smaller and the standard is bigger and that’s obviously got pretty modest forecast going forward.
So clearly the message on this is that PXI is a preferred modular standard in the market and lots of people agree, and of course from Agilent about PXI being the dominant standard for modular instrumentation. This is the type of thing that actually we use quite a bit in our marketing and sales Agilent’s endorsement of PXI is very important for our market. It was sort of a main impediment or barrier to many of our customers as they are looking for wide industry support and certainly they want to see the largest company in the industry supporting it and they jumped in last September with a major announcement and quotes like these are, we use in our marketing and in our sales to show the industry acceptance of the PXI platform.
Of course we’re also focused on keeping our leadership position, growing our leadership position and this is again a quote from Frost & Sullivan about National Instruments, a leadership position in these PXI based systems.
So how do we do that? You know I want to focus a little bit then how do we differentiate and I know I get a lot of questions when I talked to many of you about Agilent or other company’s entries into PXI and how NI differentiates our offering in this growing opportunity. And so I want to touch on a couple of things that I think are important to understand.
First is software; obviously we are all about software and fundamentally these modular systems sort of by definition are software centric systems. You have the right software to make then do anything, right; you have to have for the software defined is inherent in this modular systems and the software to do is pretty complex; we talk a lot about LabVIEW and I think know our position with LabVIEW, you see the excitement this week with our LabVIEW users. There is another part we don’t talk as much about but its really important and this is basically all the infrastructure and driver software that enabled all of these modular components to work within this LabVIEW environment. We’ve put a pretty substantial investment in that, the significant part of our software investment as a company and it’s what enables our hardware to work really well inside of LabVIEW.
Now another thing that we’ve talked about is this investment we made on the FPGA, so increasingly our instruments and IO devices have a programmable FPGA where LabVIEW can actually program the embedded code down on that FPGA or inside of that instrument. And that is highly differentiated capability; since we know no one else can do, we do on this being able to program at this level of abstraction in LabVIEW and that’s a huge amount of value to our users and that’s you know one of the reasons that this kind our margins have been maintained or growing as we’re delivering incredible value to people that are able to use this technology, and you saw some of them in the keynote stage; I mean its amazing what some of these users are able to do and they don’t know how to program these low level tools, so they didn’t have this high level of abstraction they would not be able to accomplish the same thing.
So that’s one differentiator, the software especially at the driver level that is able to pull these systems together. No one else in our opinion really has that level of software. Another element of that software is the ecosystem, so all of the users and the third-party components and the add-on tools are all built around this LabVIEW environment, we have been nurturing that ecosystem for many years and I think nowhere is that ecosystem more evident than being here at NIWeek. I mean this is kind of a living embodiment of the ecosystem of LabVIEW. The companies around it add-ons that they delivering and you see the excitement that’s kind of in the air and it’s really about this ecosystem of developers around our core software piece so that’s also a pretty tough thing to produce and we’ve got a really incredible ecosystem around LabVIEW.
And the other thing that I want to point out is we talk a lot about the products and the software and the capability and FPGA and everything else, but another element, a really differentiator for us is the supporting organization in the channel that makes our customers successful. So this is our investment that’s mainly that Pete is going to talk about after I am done, in our field sales organization, our increasing investment in system engineering, our large partner networks, 600 companies doing value-added systems on top of our platform we just had our alliance day yesterday with those folks and our support and services. And all of these things besides just having that capability, this capability is tuned to modular software based systems. And that’s critical in our ability to make our customers successful in these very complex applications.
You have heard us talk about and some of these areas really complex applications are system engineers help our customers architect these systems and have the expertise of how to put these components together, program it the software environment so that it works, has the performance they need etcetera. So that’s a big investment; just to put some numbers on it, this is kind of what the numbers around that channel, fifty countries 1,200 engineers deployed in sales and support, as all our people in sales, these are engineers though. So, 500 application engineers. As I said, a 100 system engineers. That’s been a growing footprint for us and a very deliberate investment we’ve made and 600 field engineers.
We believe this is one of the largest channels in our industry. And also as I pointed out earlier, certainly you know the largest channel focused on module and software based systems you know by far. So, that capability of making our customers successful and reaching our customers all around the world. That’s a big differentiator for us as well.
So, let me just summarize and I can take some more questions. So, kind of talked about, you saw a lot at the keynote about this sort of one platform view, scaling across these different application areas with a common approach, common software and hardware. We are seeing a lot of success in our core hardware capability in PXI, in CompactRIO we see a lot of momentum in those two platforms. And as I covered at the end, our long-term differentiators continue to be our software capability which we invest substantially in and our channel. They really understand how to build these systems and work with customers to define them.
So with that, let me take a few question. Hold on, they want to get a microphone to you so.
So, just looking at these two modular platforms, PXI and then CompactRIO. So, you’ve talked about you know the fact that you have third parties also developing on this platform and have their own modules.
So, I think the broad numbers I’ve heard is about 1500 modules to PXI available and National Instruments has about 400 modules over there. And then on CompactRIO, you just provided a number that you have 100 modules and you have 50 external vendors that are providing modules.
So, looking at those numbers that you broadly, could you give us some color as to off those other vendors that are producing those 1100 modules of PXI. How many of them are competing with your products directly are similar products and how many of those are actually complementary and on the platform that don’t compete with National Instruments and a similar number for the CompactRIO platform.
Yeah, so let me take the CompactRIO on first, [Ajith]. The CompactRIO on a really, in that case is more complementary, working pretty directly with vendors that add complementary capabilities specifically, yes that's not a, while it is a platform that has an ecosystem, it’s not an open published specification where other people build controllers and everything, that’s really a fully and a complementary space. PXI is an industry standard, so companies can build complementary and they can build competitive. And
I guess the real answer to that is certainly we have 400 to 500, we are releasing a lot of PXI products this year. So that number is getting up there close to 500 now. So we have, while we don't have the majority of the modules, we do have a majority of the revenue that Frost and Sullivan reported – pegged the number we do have most of the revenue with that market place.
So I think that having a bunch of modules is very important to the health of the market. I think we are pretty pleased with our position in terms of our ability to compete and win and in general another way of saying it is when we have the module we are typically winning the business and it’s because of a lot of the reasons I mentioned with the software and everything else.
I mean we are able to deliver a lot of value if the module is ours than if there's a third party. It also has to do with having a complete set of capability. It’s a little bit more difficult if you only have one module and the other guy has everything at the end of that one module and we tend to be that other guy right so. In the back, yeah [Eric].
I had a question regarding your ST-Ericsson profile. What was the previous solution that they were using and also regarding kind of the cost of your solution, is that for the complete system or just the modules?
Yeah, good question, so the previous solution was a box solution, looked a lot like the one we did in the demo right before. The demo when ST-Ericsson came up and as [Sullivan] said it was three times the cost was a number he put with kind of the whole system. He gave two different numbers actually, said the specific RF box was about twice the cost and the whole system when they put all that digital, had some other capabilities that it was about three times about the cost, the previous solution versus the NI based solution. But one interesting dynamic just to put you know, it’s interesting note is that he spent the same, don’t know if you caught that, but he bought more instruments because it was cheaper. So he still spent the same amount of money. He bought two times as much of our stuff as he had with the previous vendor. So I think that’s an interesting note as well.
With Agilent having endorsed PXI and joining that alliance, it’s clear that then it uses that as a marketing tool. But when you look out among your customers, certainly they don’t need Agilent to tell them that any standard will work for them, they can figure that out on their own. Have you seen a response change among either your customers or your channel partners accelerating adoption of this technology or driving more opportunities or has it come in the way?
Yeah, it’s a good questions. It’s a little early to put a definitive answer but I will say this. One is the upticking growth expectation from the Frost & Sullivan study to reference a third-party. They referenced Agilent’s endorsement as one factor and why they think it’s going to grow faster. And you know certainly and I can say this personally customers yeah, they don’t need Agilent’s endorsement to know that the system will work for them and we’ve obviously been very successful in PXI. But you get to more and more pragmatic kind of users, the more industry support there is for a standard, the more comfortable they feel about the long term longevity and everything else. I do think that, I have seen that some customers where that is a positive thing and I see that as a positive thing but in terms of how many opportunities that creates for us, I think it’s little bit early to say. Yeah. Okay, turn the microphone here. sure
Do you have any statistics on TXI either by customer or by particular instance where your modules and someone else’s modules are being used sort of together, I mean, is it 90% of the time only or is it half of the time a mix.
Yeah, Joe. That’s a good question. I don’t have a definitive data. I can tell you that we have looked at that in the past. It’s a relatively large percentage that has at least one-third party component. Like I can say that, you know, fairly large percentage as a one-third party component, from a value of the system point of view, I think a substantial majority of the value of the system intensity in our components. Yes. Over there.
I saw you have a new product co-developed with type of products, can you tell me a little bit more story behind this why and I want to do that. I want to try and want to do that. And then I hear about Tektronix about [inaudible] and they are doing all their data [rehearsing]. So how, how is NI going to compete with data here with more and more high quality name under their control?
Yeah. Good, good question. So, yeah. Yeah, I have a lot of personal experience of that digitizers one of my space I worked on personally. So that is a very high performance to give this, it’s a high performance 12.5 k sample digitizers, the highest performance digitizer available in PXI and you ask kind of why I guess a little bit, why do we work together. Well one of the Dr [Tee] showed in his beginning of his key notes this morning is the different instrumentation kind of uses cases and that’s kind of hardware talk about a one side you have sort of box instrument that are used total interactively that have sort of fix function capability that deliver lot of value to an RD engineer and then you have sort of custom measurement and PC base measurement, then automotive test and frankly Tektronix who we have partner with on the digitizer is a leader on those boxes in R&D and the interactive used case is very, very strong. When you get into the automated and software defined and the more custom obviously we have a lot of value and the recognition of that partnership was that we could deliver more value to customers if we combine some of our capability on modular and software base and the technology that Tektronix has and this specific technology that they have is they have basically some components from A6 and some design expertise at these very, very high frequencies that are unique and require a substantial investment to have the kind of design expertise. Now, the other side of it is, they have a very strong brand in that space. So you may have noticed that actually says on the digitizer Tektronix’s enabling technology that was a deliberate decision based on our testing with users and users assigned more value to that specific class of instrument when they knew it had this basically what’s recognized as the best technology inside of it. Now that product will be exclusively sold in NI‘s channel as a National Instrument product, as its ingredient brand but it’s a Natural Instrument products and when we actually released a several months ago and its been successful so far in market. Yes. Right up here, yes.
So in your last investment presentation you mentioned addressable market for TMN as about 2 billion so I see your revised of the total market. So what is addressable now and I guess second question how do you define addressable market? And then I would like to add a question like how long the typical sale cycle for your product?
So, addressable market first I may have to come back and just remind me the second one. So, addressable market first and I didn’t revise that for this year to be frank and in general of course the addressable market is growing as we expand into I added a whole new market area that we would just started addressing in physical tests this year. So I believe there will be substantial growth in our addressable market in test and measurement. So the point is it is a large market that we have focused on and really broad part of that market as I showed you in that slide.
Average sales cycle is one with two sides so we talk to you and people talk more about the sort of a large order small order dynamic of our business which we talk a lot about the larger orders we classify over 20K are really a growth engine for the company of course as expected to have a longer sale cycle and that sales cycle is sort of range across that spectrum from a very short sales cycle on the LabVIEW DAQ kind of core part of business. And honestly we see sometimes our customers buy these on faith and they buy and expect it to work, its that kind of sales and sometimes it is on the web or with the field engineer.
And you get into PXI systems and it could be a few months sale cycle and you get into the large systems like the fair and large Hadron collider, large production applications where they are deploying tens and hundreds of systems and those are closer to 12 months sale cycle as they are long and when you are specifying very complex system and applying a system engineering.
Okay, one more question. Yes. Over here.
Can you explain a little bit more about your opportunities right there. Is it mostly in R&D and development at this point and eventually it gets to manufacturing side or is it a mix of both. And also what portion of RF right now is providing a lot of the driver for you -- 4G…
Sure. Yeah I can touch on that. So, on RF, you know I would say, over the last few years our market has actually been – our opportunity has actually been more on the highly automated tests which is sort of validation and production test and it’s across lots of different types of wireless standards. So of course all the big growth in wireless is driving some of that and they need to lower test cost, faster test time in production, but also in validation.
All of those same needs are in the validation whether you need the speed and so then kind of showed that in ST-Ericsson. I would you do, that’s not the only kind of market we serve. Those same products are used in kind of military, aerospace, defense applications, quite a bit. There is quite a few tests of RF applications there. There is areas like RFID where we have sort of a unique position and our FPGA-based systems are uniquely positioned in RFID and then that’s kind of evolving to a similar standard around near field communication there has been lot of buzz around NFC. So we’re going to pay for things in the future with their cell phones.
So it’s fairly dropping a lot of this automated side and validation and production and then some of these other military applications. So then the new products that we released today really are getting us a little bit upstream. There is best-in-class capability. The instrument that we compared to from Agilent that’s classically thought of as more of a lab instrument; you know most people aren’t using $100,000 RF instrument in production test. This is not that common; some people, but not most. And so that’s kind of more of this fidelity coming and getting up, a little bit more upstream into the application so. And you asked about, did I get all that, I hit all your questions I think so.
Okay, so, I think that's time to, I can keep taking, okay. I didn't know which signal that was. Yes go ahead.
What’s different about it now than before, because it seems you've always been monitoring temperature, strains and things like that?
And you are focused with the sales force or in…
Yeah a good question, its both products and focus. So one is, on the one hand, yes, it’s the same type of physical measurements that we've talked about before. Its strain, its stress, temperature sometimes, but its thousands of synchronized channels, so if you are testing an airframe you outfit the entire thing with strain gauges and you put it under different loads and you measure all of those channels together.
So that is a little bit different from our PC based that business which is usually a few channels in the desktop and its more multiple racks of PXI systems with high channel count synchronized. And we have products over the last year we've introduced new products particularly there's a line called SC Express which are designed specifically to these high channel count applications.
The other element is that, there is an element of real-time control, so I showed for example hardware and the loop demo this morning, that's kind of real-time control combined with measurement and some of that same dynamic is in the structural and physical test. So for example that airframe example, you are basically actuating the wing you know to see what happens under different stress conditions and you are measuring it and there is a need for this close loop control combined with the measurement.
And so some of the same tools, software tools like VeriStand and the INERTIA tool we showed today that are used in kind of HIL actually have benefit in the structural and physical tests. And we are putting some focus on the kind of marketing and sales into that area. We are pretty early in that, but we definitely see an opportunity and we have again like a lot of these are customers are sort of pulling us in into this new area.
Okay. I see the food is arriving and Pete just came in to so there is -- okay, so no other questions. Well thanks and enjoy the rest of the day at NIWeek.
So for those of you listening on the webcast, we’re actually going to take a break for the next about 30-40 minutes. So we’ll jump back on here about 12:30.
To give the example of the Semtech opportunity and so we actually have that Semtech system, so if sometimes during lunch you want to come, just take a break and check it out I’ll be answering questions to help you better understand that. So feel free to stop by whenever it’s convenient.
Okay. We will start this afternoon session. My name is Pete Zogas, I am the Senior Vice President of sales and marketing, also a shareholder of National Instruments. So I would like to spend the next hour or so talking to you about this aggressive investment in the field that we have been communicating to you and where we are coming with from that investment, what we are looking for as far as a cause and effect from this investment and really to also put it in perspective with our entire strategy for selling and marketing at National Instruments.
So, basically a brief summary, the main points are we are looking for areas of investment to go after the strategic opportunities in this high profile accounts and growing industries. We want to increase our business through this system level selling and I want educate you a little bit about the various pieces of business that we have from the high velocity, low-touch systems to these lower volume, but very complex system level business.
We want to go after the influential customers in their various ecosystems and industries that we serve. So we have good reference accounts, that can translate our value propositions into their actual business impact and we want to also maintain flexibility so that we can move within the tested measurement space as well as the industrial embedded space.
And then lastly I’ll put up there that these investments will also continue to optimize the feedback that we have between the customer and R&D. You can see every, those of you that have come back for your second or third or fourth NI week, you can see the proliferation of our platform elements every year. We get more new products to go out there and position in the market place and sell. And so we are very reliant on making sure we have good feedback from the customers into the R&D operation.
So under the covers of our business, we see two styles of business and this is a graphic from a very popular article that we read around at National Instruments called Strategy And Your Stronger Hand. It was published by Geoffrey Moore and he talks about two different business models and you can see some of the elements above and below the [Chevron]. So below it talks about volume operation. So there it is all about velocity, a lot of quantitative type analysis that you do to analyze your business.
In this mode you are bounding your support with very discreet transactions that you can keep efficiency on a large number of customers. In this mode, the customers are not really the scarcity because you are trying to get to everybody and then you look at the top end of this [Chevron] and you enter in the domain of large complex systems. So there every customer is very valuable. And the level of complexity, you have to add a lot of qualitative type scenarios. To get the interest, you have to provoke the customer, convince them that they are missing critical processes, not only bending, but probably broken and they don’t realize it.
And then you move through the customization of the system. Tune it to their application. A lot of times you have to plug it into their legacy systems before you get the sale and then on the support side of things, there’s a lot more open ended to ensure their customers’ success.
So at National Instruments, we are living in both of these areas and Geoffrey Moore said that it is pretty difficult to do both because these business models compete with each other. We look at it from National Instrument’s standpoint and we see the synergies from both models. By selling and transacting with every engineer and scientist on this planet, that’s a very high quality communication if you think of it. It’s better than just a lead, that turns into a quote and turns into an order, we are actually servicing them with some element of the platform and as their opportunities grow, they become more impactful at their company, building bigger systems.
They are already familiar with National Instruments and we can start exploring this next domain. Our sales and marketing expenses are spread out into supporting both ends of that [Chevron]. So, we have a large investment for instance in our web operations to make sure that we can have a very efficient mechanism to communicate with our entire field of engineers and scientists. We have a lot of web configuration tools. So, you look at all these new products coming out and you go on at the ni.com and you can make a lot of sense out of each one of those elements of the platform because you can use web configuration tools to start configuring your system.
You can go right to in order from there, but in most cases we are dealing with engineers and scientists who take that configuration and email it or share it with their purchasing department and say this is what I am interested and then the transaction happens between a business-to-business interface and purchase order and delivery and so forth.
Also we handle that high velocity Chevron, high velocity and these discreet transactions on the support side through the web. So most of our customers’ questions when they get into building systems with our products are interfacing to our application engineers through discussion forums and support forums. So, we invite all of our customers to post their question and we guarantee that within 24 hours you can have a response, either by one of our customers who are very prolific with their answers, our committee likes to support each other. But we will guarantee a certain service level with our own AE staff to make sure that the customers know when they posted on this discussion forum, they are going to get the answer to their question.
That keeps us very efficient and we’ve saved quite a lot of personnel bandwidth and we’re able to move that now as we enter into seeing the system level opportunities, we could take some of that optimization and start moving it more towards this intimate customer relationship.
We spent a lot of time developing the LabVIEW community, so we talked about our 600 plus alliance members that we are fairly intimate with. Their experts are using our tools, configuring our systems and deploying solutions to our customers as well as the other in-house experts of our tools. So in a large end user account plus we could talk about Lockheed Martin, you can talk about anyone that has thousands of engineers. And we look at them as a talent pool and take responsibility on not only how many LabVIEW users they have, but also their proficiency. How many are certified at various levels, all the way up to certified LabVIEW architects.
So this is also a part of the sales and marketing spend gets put into developing the marketplace as well. And in the end, what we try to do is attract a lot of people to our platform. The number one goal and the way we do it is again is very wide spread, high value add to the community and you can see some of the other elements of our eco system and when your platform has things like 9000 instrument drivers to make it much more productive, to pick up a piece of equipment and plug it into the platform, it attracts more users to the platform.
If you have more people that are willing to share their IP that they develop on this platform, you get more benefit and value from adopting the platform. So that’s the high velocity side and I want to move and spend most of the time today talking about the more complex level of business and we look at that in terms from a business metric, we see that in the form of purchase orders that are larger than the transactional high velocity. And we started reporting the orders, the revenue that are coming from orders greater than $20,000 as a metric, its not everything below $20,000 purchase order, its low touch and everything above it, its high touch, it’s a good position within the company to look at our resources and how they are applied to that business, how that's growing versus the transactional level, which has different dynamics and I will talk a little bit about those.
So by the numbers I will start from the bottom roughly six million visitors to ni.com in the second quarter. So going back to we've got to attract as many people to the platform as possible. We have to have the world’s best resource on the web for engineers and scientists who are out there trying to figure out how their solutions can map into our suite of tools and system design products. And you look at the number of transactions, 57,000 orders, that's in Q2 and that number is growing as our average order size increases faster than the rate of new orders, obviously we are not seeing as high a growth in the number of transactions because the growth is coming from these or scaling up as far as more elements on every purchase order that we are out there getting.
Average order size crept up to $4,400 and if you divide our revenue of $253 million divided by 57,500 you could see that it takes quite a bit of business to move that average order size as you are dividing that too. So when that average order size moves, it is showing quite a bit of dynamics and the shift or our ability to reach into these more complex systems and so.
So framing the problem in another way is if you look at our product line, we have got a lot of products. Most of our sales people are responsible for all of these products and there is numbers everywhere from 5000 that are actually published on the web with prices to 15000 skews that are available through our systems to place on a quote and give to a customer in some form or another. That’s a lot of products. And if you think its tougher you to comprehend every time you come in a week, that’s a little bit of the challenge of the sales person. Right, they have to figure out all these products and all their industries. Of course its glued together with the common platform element and that give a scale in that domain.
On the other hand there is 30000 accounts and we like to say that a General Electric, which is a global account with many sites that counts as one. So 30000 quickly becomes 300000 sites, which quickly turn into an order of magnitude greater from a prospects standpoint of the field of play that we are actually transacting with. So to build any kind of scalability is how do you bridge these two extremes and we have been building some focal points and trying to find these industry classifications because if we can take these 30000 customers and group them in their industry ecosystems, we can get some economies of scale and we can get some better value proposition that make sense for that grouping of customers and then at the same time we know all those 15,000 products, a lot of makes more sense together than not. You saw today the HIL system that [Ian Fountain] was demonstrating with Eric up there and that’s typically a real time system with PXI and CompactRIO. So its start becoming a subset of applications that becomes focused on a particular functionality. So this is how we can breach of the GAAP between these two extremes. So but as with a broadening a backup to the platform, we want these to be relatively thin layers on our platform, the platform stands ahead of everything else and then based on our dialogue with our customers or with the industry these things kind come together dynamically, they specializing customize for that particular opportunity whether its in industry trend or whether it’s a large opportunity in the account we can fairly quickly bring these things together, show the customer enough to get them over their risk [aversion] of changing a platform and then we can a lot of better leverage but just to broaden it out we are talking about a fairly wide application space that we can service with this common set of tools, this common platform that we can walk in to just about any every industry and TNM and industrial embedded and there is something in our platform that make sense for them. We do look for applications. We know we are highly correlated with the industrial production in PMI. So we want to be poised to go after those industries and focus areas that we know will be less dependent on the PMI and even within some industries like Energy, the Smart Grid we know it is getting funded and we will probably survive some of the cuts and some of the squeeze that will be put out there. The same thing in the communication so smart phones and the mobile devices, the tablet computing devices these are getting funded. These are getting new acceptance in the market place. This tends to be where the activity of new designs which turn into new opportunities for validation, which turn into new opportunities for production test we want to focus on that we want to focus on other alternatives and alternative energy. Academia tends to be a very solid, stable market place for us. Very strategic because of the roots of scientist and engineers who come from the university, so we want to be right there giving them a better experience of the discipline using our tools for their discovery and innovation, which they can take into industry but they are spending a lot of money, especially in the emerging countries on establishing a good footprint of the universities in their areas.
And so we see a lot of business in our emerging countries as government spend their money to build better laboratories, to bring their education system on par with the rest of the world. And so that continues to be a focus area for us life sciences, electric and hybrid vehicles. So even within a pretty steady automotive sector then there is this various new designs, new funding that create opportunity for a new platform to upset the incumbent platform and autonomous vehicles.
So I wanted to take you through a few just to give you some color on how we sell and how these new field of resources tend to approach the marketplace. So the one target area is the smartphone design production lifecycle. So this is the measurements and the design flow. On the left hand side, you have the design test, the component level, design validation. So as soon as they want to bring in new silicon, that same day they want to test something in circuit test, functional test, end of line test, repair test. So a lot of test and support and we can start anywhere in an account.
So if the opportunity tends to be, if the opportunity is production test, we will go service the operations side of the business and before we are done, we are getting network into the design because in this ecosystem measurements are and design actually flow through design into test and there is a high correlation between the measurements being made at the production line as well as what is being validated with the first silicon or in the first module. So we can once we penetrate one area in an account, we can move horizontally with our platform.
And then when you look at it from an ecosystem, currently there are several key influences in their marketplace. A lot of these smartphones and devices share branded silicon from some of the major players that are on the left hand side. These are fairly complex devices that are coming out of these organizations. They are systems on a chip; they have a very unique and complex method of communicating them. And they all have special codes that you can put them into test functionality to shorten your calibration and test through the manufacturing process. So each one of these have we call it DUT control, Device Under Test control.
And in Qualcomm’s case we signed a license with them. They have a tool-set called the factory test tools licensed and it is proprietary codes that communicate to that chip that put it into test mode. And so when they sell that product to one of the OEMs out there they have an intimate relationship with it, we are allowed to sell that code to that particular manufacturer and we can optimize the test because then they can use those test tools within our platform to make their tests more efficient and makes sense so we can work with these, focused areas, get to the influences in the marketplace and then we get a lot of leverage as this thing moves through its ecosystem. And then when the OEMs typically work with contract manufacturers, we have to coordinate, facilitate, negotiate between watching these designs move from their facility into another and be ready to deploy systems to support deployments wherever these things are in the world.
So going back to our investments in the field, this is where some of that investment is being applied. And you could see the results that we are having, so we are confident; when we work with the customer, that's got a big problem who’s incumbent legacy platform is showing a lot of signs of breaking and inefficiencies. When we work with them we can get the type of cost, footprint, weight, power. We have a lot to offer these customers. And then they become reference account, we put them on the stage at NIWeek and get leverage from everybody else that says if we aren’t on board we are in trouble.
Another industry area that is showing quite a bit of opportunity for us is in fracturing the shale, to get at the gas reserves that or gas reservoirs I guess. And this is still in the fossil fuel domain, so we don’t want to get into the environmental impact or not, but basically this is an industry where it requires quite a bit of sophistication. It requires directional drilling, which is a lot more equipment and data acquisition and control intends than just drilling a pipe straight down.
And then on top of that there is the actual fracturing process which is pushing high pressure fluid down through that perforated pipe to create veins in the shale so that you can extract the gas. And there’s a lot of activity you can see the quotes down there that they can’t get to it much fast enough because of the lack of equipment out there, we have a strong play with our products.
This is a typical fracking site and you can see the yellow circles around the pumpers; those are large diesel engines that are on the back of eighteen wheelers. They pull up in parallel, also cup to a manifold and then there is a data van and this is inside the data van and you can see a CompactRIO in this one which is basically the supervisor that is balancing all of these diesel engines and the pressures to make sure that thing is nicely under control doing what its suppose to do at the particular pressures and volume and everything else. And this is a pretty active area for us right now and we have some products that are being accepted into that that application.
This is along the Smart Grid area. This is in India. This is one of the States in India that was dealing with a lot of the power loss, whether it is in a decaying grid environment or in theft which is a big deal down there. They wanted to basically generate power with a lot less loss. So they needed to put more measurements on the grid and cRIO with a third-party product was able to be basically placed throughout the grid, communicate back to the central office and they are able to lower their power loss through this entire state distribution of the electricity.
So part of getting involved at this level is, again it’s not necessarily just if you have a question, post your question on a discussion form. We have to have a lot more intimate support with these customers, both through the proof-of-concept phase as well as the post-support and ensuring their success. And some of the investment of the field is in system engineering, are typical model for hiring sales people – hiring engineers into my side of the business as we hire directly out of school, we put them on these phones in discussion forums with our high-velocity volume customers and they for a period of the year they start learning how people are using our products. They start working with other groups to do various projects, prepare for NIWeek, prepare for our seminars that we do, but for the most part we are paying top dollars for these top engineers to be on the phone and on the discussion forums where we get value added that of course is when they move from that position and they become sales people. They would become marketing professionals they go into R&D and become product development and product management.
Over the past four years we have expanded career of a senior application engineer or we call him a system engineer. So they stay in a role of supporting the customer and they are available for a much more sophisticated proof-of-concept. All of our sales people are engineers, so they all have the capability of opening up their tool box and doing a LabVIEW demo.
And years ago it was sufficient to go in and in an hour you are doing what we call a three icon demo; put down an icon that did some acquisition, bring it into the computer, put it on the screen, do some analysis and impress the customer with the size of application that they were interested in using us for and we walk out with a quote and an order.
Now the sales cycle that we’re seeing are opportunity for in this domain is a lot longer right; it could take a year or more to develop the opportunity work through a proof-of concept and then close the deal. So this application engineering, system engineering we’re up to 110 people. So it’s a sizeable investment; these are resources to our field who use them as part of their business plans; there are resources to help them meet their objectives and their numbers and then also they are obviously very intimately involved with this customers as they move from their incumbent platform to our platform.
They are distributed as you see, so they are not all centralized into call centers like our application engineering staff that they are spread-out available to – accessible by our customers. So when you look on what are we looking for as far as impact from this investment, I think this curve shows what impact this investment is having and we are seeing our large order growth, growing very quickly and you can see in the 2006, 2007. There is quite a bit of growth coming from that large area, the large system level business compared to our transactional business which is very highly co-related to the PMI and the expansion and contraction of that market and remember where about 46% in Q2 of our revenue was coming from orders greater than 20,000.
So that number is a significant portion of the business that National Instruments, from a transaction level it is not the number of transactions, the number of touches we are doing with each customer is a lot greater in the transactional level as compared to the business in the large order.
So but any way that’s the impact that we want to see from these investments in the field. Another way to look at it, here is a plot of the headcount which is in grey and you can see in 2007, we were beginning the plan to double the field, basically moving investments. We started investing heavily into 2008. Of course we were prudent and when we saw the economy get swept out, we tailored or tempered our investments and now in 2010 we are starting to complete that plan.
And then on the top you can see the large order growth in millions of dollars and so you can see some leverage there with the number of people versus the actual business and then finally, I wanted to plot this out as well and this is not necessarily additive expenses from a overall sales and marketing model at National Instruments.
So, it’s more of a re-tooling of our organization, optimizing what we can in the transaction and automation side of that business, taking leverage points from the web and the discussion forums and things that are very high value support elements to our customers and take that investment of people and move it towards the customer facing larger systems level.
So, we are still from a long-term model perspective, we are able to afford this new dimension to realize that opportunity and yet stay committed to the long-term business model. So, back to the summary points again, trying to get impact at the strategic accounts, find those fast growing industries and have an impact at the ecosystem levels, find the influencers within that ecosystem that gives us leverage and also provide a lot of qualitative feedback back to Phil and his group to make sure that our product pipeline is matching the opportunities that we see it at hand.
So, how about questions? We have a microphone out there as well.
Pete, can you talk a little bit more about the investments post sale, meaning service and support and especially as you try to penetrate this larger production test opportunities around semiconductors and wireless test. Are you seeing any pushback from your customer base? Is there maybe typically more accustomed to having service folks on that floor or are you investing there?
Yeah so the question was about the post sale, post deployment support and service and are we seeing any pushback from the customers. I wouldn't classify it as pushback, I would see it as an escalating demand as we work with them and develop these systems and solutions. These are mission critical and so we have to be in a dialog on how they are going to keep this thing up and running. And so we have been building out our service offering and that too spans from transactional hardware warranties, extended warranties, all the way up to configuring a system through the manufacturing process to configure a system, test it as a system and get it out there.
And into the field as far as sparing offerings, escalated service plans with them. So we are investing in that area of the business, we don't feel like that's a pacing item of it, we are building it as the demand and as our deployments are successful out there. We do have a global footprint, our team is all over the field with application engineers, with system engineers, so we have the resources. So I don't think it’s a pushback, I think its more, it’s coming involved, it’s becoming part of the deal itself. And we just piece it together depending on the needs of the customer.
Two questions. First I'm hoping you can talk a little bit about the academic end market, that's held up, that market held up very well in the recession which maybe we would expect, but it’s also held up very well in the last year when we've seen state and local government’s pressure and some technology companies that are exposed to education have had a very difficult time. So is NI somehow impervious to this or is it late cycle or just something else going on that’s allowing you to have success and then I have follow-up.
We were just committed to the academic space into the universities. We have a deep relationship with the academic community, both from the research end as well as through developing of curriculum. The success that we’ve had when you look at the monitory success, these are coming from everything, from installing our ELVIS product and (inaudible) into the learning and into the curriculum area of the business as well as dealing with their research budgets where they need, it could be as complicated as system as anyone in the industry that we have to help them configure and install.
And then there’s a third element which is in these emerging countries where again we’re working with ministries of education who are trying to transform their education system and build world class laboratories and when they look at experiential learning, this end of the academic and curriculum that we’re very heavily involved with, they come looking to us to help them, what is the perfect laboratory. What is the state-of-the-art instrumentation that we need to put in place. So we’ll work with a partner and put a whole laboratory configuration together with curriculum, with documentation and it becomes again in the large system level where we have system engineers working with our partners to build that complete solution for them.
So we’re committed to, we’ve got a lot of focus as I mentioned before. There’s a lot of synergies with that marketplace, the more successful, the academic marketplace is in educating students to discover and innovate using these techniques, we benefit on that side. And so it keeps our field highly motivated to service that sector.
So just one follow up if I can. When we look at these other markets that you talk about in this slide life sciences, hybrid electric vehicles and these other markets that perhaps are new targets, rapidly growing markets, do you ever consider hiring sales people that aren’t engineers? I think you said before that all of your sales people are degreed engineers and perhaps, I am telling this a little bit with our discussion from last night, but that they come through college, through this kind of training program, if you will. Some of them go off to sales and they go after these markets, have you considered or do you currently hire domain experts that are deep in the industries that can accelerate your time to those markets?
We have hired domain experts. Most of the domain experts that we find that are valuable and fill like a gap within our organization are engineers. But engineers may be that are, have an influence in that industry, right. So for the most part it’s still, we are still finding that an engineer tied to their domain is pretty valuable as we expand into that. I don’t see the need yet or I haven’t found any talent. Let’s say that’s not an engineer that offer some professional level selling or some executive level communication, that is the gap that what we were talking about.
But we are looking for domain experts. We have hired some domain experts in some of those interesting target areas for us, to help us quickly establish and get to the network of influences out there in the marketplace. That also now the pain of let say the encumbered and legacy systems that our customers are dealing with. Now, in this business we have to provoke our customer, we have a lot of customer that live with a lot of pain before they fail enough or something breaks in up or there they are finally ready to make the move. So we have the provokes so this domain experts to supplement our organically grown to help us develop this value proposition to provoke. For both this targeting the customers so I think there is a.
On the Timfex systems that are you showing a few questions generally what I am sure there is what percent their overall cost is made up from the products divine from you and then when what are the reason that cost – that you win business in those large orders as it – you know as a prices functionality and then what would be some other reason is that you wouldn’t win that business.
Okay. Let me takes the first one so what percent of NI content typically is in the large systems very difficult question to answer its all of the above on the NI key note stage you saw see RIO and embedded in that Siemens enclosure so when you look at the total cost of that PNI component is fairly low but every valuable element of that since the things that controlling the opening and closing which is as pretty valuable I guess switching 38,000 volts safely is also a critical but anywhere our in that case we’re fairly low percentage of the content. Then when you look at the ability to test a set-top box or a communication device with lot of RF equipment we tend to be the dominant share of that complex system. So really can’t categorize one or the other and give you any more color than it spans the spectrum. And then the other question was?
Yes okay. And why do we win and some of these focus areas why and what do we have that promotes the sale and why do we win and so forth. So again let me give you some examples. So that scenario where again where we are typically dealing with an incumbent system of some bolted on configured system that they’ve have grown with over time and it starts showing weaknesses and they see some element from our platform that has the ability to do something like, may be they are all old system there is just no way to disconnect it from the wires and make it wireless and they see our wireless data acquisition and they say, boy, if I can take my truck that typically needs to cable in and I can actually make it mobile and have data acquisition and control with connectivity through WIFI and I see the WIFI abilities of National Instruments platform may be we get called in and they say tell me what’s going on and we’ll apply some of the system level, system engineering after the sales person qualifies and says this is big. So, lets work through a proof of concept, lets get the customer to give us somewhat of a challenge, give us some measurement or control or piece of that application that we can prove and then we team it up with a system engineer and a lot of times with the productivity of this graphical system design, I mean we preach that a lot but when we are proof of concept with our system engineer, we can come up to speed very quickly and meet the specifications of the incumbent system and start showing them new elements that our platform can do. And so, the system engineering group and at this level, we are really living and depending on that productivity gain that LabVIEW and our graphical systems design platform gives us. And so a lot of times will delight the customer. They wont believe that will be able to demonstrate that much of the system in that short proof of concept time. And that’s a lot of times why we get the go ahead to go the next mile in and have a complete platform change and really now work on the solution.
Could I follow up to his question?
Over time, has the NI content of system sales, in about the same risen or fallen?
So, percentage of business coming from that system level? No, sorry.
Percentage, he asked about system sales.
So, you are making system sales all the time. It’s going from the small, from a quarter to almost half of your sales like essentially, if we think about the 20,000. Of systems that you sell, when you are selling a system as opposed to a standalone product, has the NI content changed as a percentage of the sale? Is it the same percentage of the sale? Is it larger? Is it smaller?
Overall so if you look at some of the metrics our average order size keeps going up and our large system level metric continues to grow. I think its safe to say that our content continually increases on one hand as we invest heavily on to the RF and once we start plugging RF instrumentation of course the percentage of business increases dramatically. So on the automated test side of the business clearly our content continues to grow. And then if you get into the actual product design, the OEM space, the industrial embedded, it continues to grow but again as we impact larger systems within our customers its so could be a fairly small part of their overall solution. So it’s a little bit harder for me to pin that metric down.
The amount of tests that you are gaining share here on the balance and business is growing so rapidly you might not [inaudible]?
Yeah that's probably safe to say, and in the test side we continue to win more content. So share of that particular application configuration, absolutely and then the other one we are, its probably a little bit all over the place but again if you are configuring there's the reason why we are coming out with large slot counts for CompactRIO because these systems also are demanding higher channel count, more flexible I/O. So I would anticipate the same on it. Okay.
A few questions around gross margin. As you sell more systems, is it harder to maintain that big gross margin and do customers ever look at that and raised questions about or is the value adding so great that they don’t even think about it and our sales have been compensated and all on gross margin and….?
Okay so let me take the later to and then I’ll turn it over to Alec on the gross margin by category because I’m not sure what we report. So the customers we really don’t get challenged or push back from the high margins from our customer. Purchasing agents on the other hand though use every tactic in the book to do their job but for the most past we have high margins because of the value that we’re delivering to our customers. I mean this stuff work, the value of this stuff working together when they take our platform and start driving towards their success and if they can get it done on time or ahead of time, or they can add more features into their product than they thought they could that’s the premium that they’re buying from National Instrument. So the other one was that the sales people get paid on the margin. For most of our sales people, their record is based on the revenue target.
Now we talked to and communicate about their discounting practices, so they see right in front of them but they don’t get compensated other than just on top line revenue. That’s really the rest of us that are communicating with them to put their controls in place to monitor that and then on the margin, Alec?
I’ll be able to address the margin in a bit more detail right after Pete’s session.
Okay. That’s it. So you spent a lot of time I think may be indicative so your organization in sort of doing missionary sales working with that clients, trying to get this product, these new products and all of that. But can you give us an understanding right now of where we are there in terms of push-versus-pull like after all this evangelizing and start using your product, there must be some pull. So some rough percentage value-added resellers and integrators, how much they ordering directly without your sales people being overly involved? And then another proxy for that, you know though it might be a small sub-segment would be online sales. You know you have an online catalogue, you do sell online, how is that being drawing and where is that as a percentage of your overall sales right now?
Okay. So first question is this push and our putting energy into the sale and versus are we getting any kind of pull after we have made the impact is there any easier sell out there, any orders to take.
So my response to that is that every time we turn around and add new products to our platform, it opens up more application space for us to solve. And so, if a constant push and a lot of energy to take advantage of all these new spaces and then there are cases right now, it’s rack-and-stack instrumentation where there is quite a bit of market trends now that is realizing that the era of rack-and-stack has really showed that there is this tipping point into this modular instrument domain and you see that. So there is a lot less push to show off the capabilities and the longevity and the commitment that PXI has in the marketplace now. So in that case there is quite a lot of, lot less energy that we have to put into that, into that element of the sale. But that’s countered by opening up these new markets and having to…..
As a percentage mix, what would that look like?
I can’t give you a percentage. I have no real way to put a percentage on that.
Okay. And then the second is online transactions?
So the online transactions, we’ve talked about that in back of the room but, we have couple of categories for our online transaction. One is when someone places a credit card order and that’s typically an end user that is either has a company credit card or their own personal card that’s a relatively small amount of our business, although we do have online commerce for that.
More often its web enabled, most, all of our customers are using the web as some element of their investigation and they are determining that we are right company. There is another middle ground where they actually use these configurators and they issue request for quotes and we call those web enabled sales. And that’s a relatively large portion of our business, I don’t know Julie or Alex if you have the actual numbers for that or not. But it’s a significant amount of our businesses this web enabled quote to order type like transaction.
Okay. I think we are going to do the transition, I am going to jump into my section Pete, and Dr. Truchard and Eric will be back up later in taking questions in a little while.
Okay. I can get some.
And with that I’ll jump in; I just want to keep things flowing because these guys have got another schedule events later. I want to thank Pete and his team, as they did yesterday and my keynote to the sales forces on Friday, I think they have done a tremendous job of driving large order business. The system level business despite the weakening PMI seen over the course of last six months and that’s been a real key to enabling us to deliver record revenue in Q2 record profit for the second quarter.
Now, I am going to talk about a couple of things, today I want to talk long-term, I want to short-term. Everybody has a different perspective on timeline; everybody has a different view of which timeline relevant. From a National Instruments point of view we try to be really clear on who our stakeholders are and what time then it is the company is trying to operate on.
Our goals to the company are business goals that drive most of the compensation metrics internal. Internally, to get at least 20% revenue growth each year that is what we are driving 20% revenue growth is our target; it doesn’t mean we are going to hit it every year, but that’s what we are always striving to achieve. We are targeting this 18% non-GAAP operating margin. And the stakeholders we have chosen to let inside the national Instruments intend are all aligned around the need for us to hit those goals.
Our customers need us to be grow and be profitably because when they make a decision to invest in developing IT in LabVIEW, they want to know that they have the ability to deploy that intellectual property in the future. On future generations of the operating system that will available Windows 12, whenever that’s going to come out at some point in the future. The next set of processors from Intel, FPGA’s in the future; they want to know that their investment in the IP that they develop is protected and they have an opportunity to leverage that and deploy it again in future generations of technology. They know if we’re growing profitable, we’ll be able to invest and deliver that.
Our shareholders want us to grow and be profitable for obvious reasons that you are well aware of. They want to get a good return on their investment, they want to make sure that we’re stewards of the business in delivering a return commensurate with the opportunity. Our partners and suppliers want us to grow and be profitable because they want to grow and make their businesses profitable. They want to align with us, we get the best pricing, we get the best early access to technology, we have relationships like you saw this morning with Intel, with Zarlink, with analog devices, with TI that gives us early access to technology, we get very good pricing because they see NI as a vehicle to grow their business. And there is a way to get tremendous feedback from the market.
And then our employees most of all, NI is an intellectual property company. Half of our employees are engineers. We have been one of Fortune’s 100 Best Companies to work for the last 12 years in a row. One of very, very few technology companies that has sustained their presence on that list in that timeframe. 90% of the technology companies that were on that list in 2000 are not on it anymore. There is only 10% of companies that have managed to sustain that positioning. And we are an intellectual property company. Our talent, our capital is our talent. Our talent is our capital. It’s vitally important that our employees see the opportunity to grow and be profitable so that we can provide them with as good a career pie internally to NI as they can get externally. And this is really the glue that holds the whole company together.
Now one constituent that’s does not inside our tent are the bankers or the bond holders. We have chosen – in the significant amount of cash at NI, we have chosen to have a deep profitability to ensure that we have strategic control of decision making at the times that are most important. And the great recession we saw in ’09 was one of those times. We want to be certain that when we are making decisions in challenging times that it is a long-term view of the business that comes to the fore, and we don’t have to sacrifice our strategic decision making to an external private party that’s not frankly aligned with the timeline or objectives of NI as a business.
Our business goals we laid out at the beginning of the year are very straight forward. We want to deliver strong profitability and want to optimize our operating expenses. We want to maintain our gross margins and we want to drive organic revenue growth. We frankly see an opportunity for an inflection point in this industry over the course of the next three to five years. There is every opportunity and every evidence that modular is going mainstream.
Now somebody talked early on about the burden of proof, or to push or pull of sales. We have had many years as we entered new categories, where we have a big burden of proof with the customer. We have to prove to the customer that our solution is as good as the traditional solution that they had in the past. We have to deal with the concept of well, you know if I buy this box and the guy would be buying boxes forever I won't get fired. If I go introduce to my manager this PXI modular thing, he may not know what I am talking about, he maybe uncomfortable.
Now its happening overtime as our success with engineers tends to be a little bit connected to age, younger engineers tend to be more open to the concept of software eccentric, software-based modular instrumentation. And we've been doing this long enough to allow those younger engineers to become older engineers, to become section managers, directors of engineering, VPs and that willingness to engage in a new paradigm is propagating up the management chain.
At the same time, our capability from a performance and price point of view is rapidly expanding and that gives us the opportunity to create a dynamic where at some point in the future I personally believe we will have managers that will say, why are you buying those expensive box, why aren't you buying PXI. That day will come and I think that day is rapidly approaching. And when we reach that point we are going to get a lot of leverage and we are going to see the opportunity for us to continue to be the leaders in that space.
So we are very focused in the next number of years in ensuring that we are making the strategic investments in R&D necessary to deliver on the promise of the platform. We are also obviously significantly scaling up our field sales resources, part of that is – today and part of that is to take advantage of the opportunity we know is going to be in place in two to three years.
Scott Rust is here with us today, Senior VP of R&D, join us for some questions later and we know what is on our product roadmap in the future. We know what products we’re going to be deploying and we want to have the field sales force trained and capable to leverage those products when they come to market. So it’s partially about driving revenue today and it’s partially about leveraging the future opportunity that we know will be coming at NIWeek 2012, at NIWeek 2013.
Now if we take a look at our track record. We’ve had a tremendous track record of growth and profitability, 25 years consecutive double-digit revenue growth through 2000 and we had a down year in 2001, down 6% recovered in ‘02 and had a record in ‘03. And in that three-year time period through the last recession, we had a compound annual growth rate of 1% from 2003, so not a tremendously great performance. And we learnt a lot of lessons in that timeframe. Up till then, we were spending about 12% of revenue in R&D and we’re getting quite a lift from the overall technology bubble.
And we made a decision in that timeframe that we were not robust enough in the face of a moderate recession. We wanted to improve that situation. So we raised our target R&D spending from 12% to 16, we sustained at a debt high over the course of the last decade. That enabled us to then leverage that strength of product portfolio and from ’03 when the economy finally stabilized to 2008, we doubled the size of the company.
15% compound annual growth rate and we were really still at that point still really getting started to building up our pipeline of products, making the investments needed in the core architectures to enable the products you saw today. Well, then in ‘09, obviously we saw the great recession. That had a significant impact on our business, but we recovered much more quickly than we did in the earlier recession.
The great recession of ‘09 was far worse than then downturn we saw on ‘01 and ’02, but we bounced back much faster and if we hit the midpoint at the first call of consensus, revenue estimates we show in green here will have an 11% compound annual growth rate from ‘08 to ‘11. Much, much better than the performance we had in the earlier recession, because we invested deliberately to achieve that goal.
Now key to that has been a shift in the mix of our business. Pete talked earlier on about the rate of growth of these larger orders are system level business, are a proxy for our system level business and our smaller orders which is a proxy for our transactional business. And one of the things that’s interesting about this. If you take a look at how the downturn unfolded, we had seen rapid growth of ‘05, ‘06, ‘07 through the third quarter of ‘08.
So we saw a tremendous amount of growth in this timeframe. And you see that as the system level business was scaling over the course of those four years, the rate of growth was actually accelerating because we are getting more acceptance, we are becoming more the norm, we are getting more pull of our systems into our customers.
And the recession in US started in Q4 of ‘07 and despite the PMI going negative, we continued to grow that business without really skipping a beat for the next four quarters. So on a moderate industrial recession from Q4 of ‘07 to Q3 of ’08, we were able to continue to grow the business record revenue, record profit, double digit revenue growth throughout that time period. It was only when we went from a moderate industrial recession to the great recession that we saw an impact on our large order business that survived for a couple of quarter. And then we rapidly came back to new records and seeing tremendous results and bounce back over the course of last number of quarters.
Now when we take a look at this business, it’s shifted quite a bit and it has an impact on how NI will respond to variety of economics circumstances and I will show you some correlations that echoing what Pete said earlier on.
So that’s gone, the system level business has gone from 26% of our revenue back in ‘05 to today at about 46% of our revenue. And that’s a pretty meaningful shift in the mix of the business. And I will talk about gross margins in a minute, as we’ve driven that system level business, we have been able to systematically drive up our overall gross margins because the value proposition we bring to the customers is dramatic.
You saw today with the ST-Ericsson application, ten times faster at a third to cost, a 30 times value proposition for that customer. That is a very, very compelling value. And our customers’ are aware of our gross margins. I get involved in conversations relatively frequently, but the reality is the value that we bring relative to the pricing that’s in the market today is outstanding.
We are the disruptive price player in the market because we are using disruptive technology enabling disruptive applications and that allows us to capture that value and make this investment. Now we take a look how we went through this recovery on a gross margin front in particular. You can see and I often call this by this is most boring gross margin slide you are ever going to see and so then internally I drill down a little bit, get a bit more resolution.
So you can see what’s actually going on in terms of the trends of the business. Now at high gross margins, obviously we have very differentiated products. We are really a software company in reality and we deliver a tremendous amount of value to our customers and differentiation, do that consistently over a long period of time.
Now as our system level of business started to take off in the ‘04, ‘05, ‘06 timeframe we’ve been able to leverage the volume, leverage that value proposition, continually drive up our overall gross margins to reach new all time records, delivering a non-GAAP gross margin of 78.5% in the first half of the year. And that is a tremendous success for the company. This is one of the key elements that has enabled us to out invest our competitors, which we believe will drive systematic organic growth as we go forward.
Now the other thing we’ve been doing is we’ve been addressing our cost space. The world is becoming a much more global company, a much more global place. We are becoming a much more global company and we’ve again systematically leveraged the emerging countries as the way to add significant amounts of talent and bring down our average costs, not only in production, but in areas like back office operations.
We’ve recently opened up a customer support center in Costa Rica to help support the Americas. And we have done similar things in Hungary to help support Western Europe. So we have continually been looking for ways to make that investment while at the same time optimizing our cost structure, so we can afford to make these critical investments in driving long-term organic growth.
Now one of the topics of conversation last night at dinner and is the continuous topic of conversation between myself and the investment community is the chart and the rate in which we are investing in the future. Now when you look at this chart on field sales and you look at it on R&D, specially the CFO, it could be a little scary.
These are significant commitments that we are making to bring staff on board to drive long-term revenue growth. And there is a certain amount of risk involved in this. We are making these investments at a time when we don’t know exactly how the global economy is going to unfold when we start into the budget year.
But when we look at the dynamic in the industry today, when we look at the opportunity to shift the industry from the traditional view to bring modular instruments with LabVIEW software mainstream, it is obvious that this is the right thing to do. We have talent available to us today and Phil and his team is under tremendous job of investing in R&D, bringing in select experienced talent and then putting a team of young engineers around that talent in order to drive new product introductions that will enable us to bring products to the market in the future that can drive our long-term revenue growth.
Pete and his team have done a tremendous job of bringing in new engineering talents as well sprinkling in experienced talent that can enable us to go into these large accounts and shift the standard from boxes to PXI, from custom design to serial. When we look forward to what we are going to deliver from R& D, it is pretty clear to us that we have the opportunity to accelerate the shift to the market and bring modular mainstream and we see a huge amount of shareholder value if we can be successful and that’s what we are going forward with that investment.
Now we take a look at our operating model going back to IPO in 1995 and our target is 18% non-GAAP operating margin. The blue line here represents our actual non-GAAP operating income. And then the grey line, light grey line, represents our R&D as a percentage of revenue. And as I said early on, in the late 1990s of the IPO to 2000, we were very successful. We grew our revenues very strongly. We were delivering strong operating income and I call this the fat and happy period.
So, we were investing modestly, getting a great return and we didn’t fully realize the scale to which the overall technology bubble of the late 1990s was creating a tide. It lifted us up. And when the tide washed back out in 2000, it became pretty clear, we were under investing in creating new market opportunity. So, we said about changing that. We raised R&D investment as I said earlier and we accepted the fact that that was going to cause a short-term drop in operating margin while we went through this restructuring process. That came to bear.
But once we started to get the product, the value of that investment coming to market in ’03, ‘04, ‘05 time frame, we were able to steadily improve our operating margin back towards our target and in fact we are right on track to get to 18% in 2008, up until the point when Lehman Brothers went bankrupt and the world took a sudden turn downward.
We then saw the impact of the downturn on our model in ’09, but you’ll notice that we returned to profit rapidly, much more rapidly than in the last downturn. In this recession, we were not trying to fundamentally restructure the business as we had in the early 2000s, we were trying to sustain our business model. We were able to take advantage of new products that came to market, the new field people that we entered market in ‘09 and ‘10 and able to rapidly come back to record revenue, record profitability very, very quickly.
In the current year 2011, we’ve obviously targeted to drive our operating margins relatively stable as we execute on an aggressive investment plan. But if you look at the first half of ‘10 versus the first half ’11, our operating margins are up about 200 basis points from the first half of last year to the first half of this year despite the fact that we've increased our headcount by 15%.
So in the first half we've been able to do both, we've been able to drive operating leverage, organic growth and make significant investments and that's the pattern we would like to achieve as we go forward. Now when you look at Q3, hiring in Q3 investment plan, we have a bit of a timing issue. Our strategy is to recruit a significant amount of talent out of school, bring them into the company as they graduate and most students graduate in May, June and July and that's when they start to work.
And this creates for us in this particular timeframe, we have a little bit of a snake swallowing an egg. It’s a little tough digestion. So we are taking on a significant amount of staff in this timeframe and this is not something we were doing back in 2010. In 2010 we had not yet ramped up our investment until the September timeframe.
So when we look at our operating expense guidance for Q3, we are guiding to non-GAAP growth and our operating expense is at 28% at the midpoint, and we are guiding to revenue growth at 22% at the mid point in the third quarter. And that obviously creates an optical problem that investors get uncomfortable with.
In Q3 for the first time in quite a long time we are going to be growing our expenses faster than our revenue from a year-over-year point of view and that's absolutely true and something I share as a concern but I also see the value of executing on that as we go forward. And when you take a look at that comparison over time, when you compare our sales growth to a non-GAAP operating expenses we are usually very, very good at keeping these things aligned.
They came a little bit out of alignment in the downturn, we recovered that in the recovery and here in Q3 you are going to see the gap emerge, the widest gap of expenses over revenue for quite a while. But it is a temporary phenomena. . We will not be hiring 400 people in Q4, in last in 10, we’re starting to ramp up spending as we got into September timeframe. So when we look at our expectations, we expect modest sequential growth and operating expenses in Q4 and the GAAP we expect between operating expense growth or revenue growth is going to narrow significantly in the fourth quarter. We expect our operating expense growth to be a lot closer to 20% than the 28% we’re seeing in Q3.
So certainly we ask of our investor’s patience. We know it’s something that a little nerve-racking when you see a company make a deliberate decision to raise the spending in a particular quarter faster than revenue but I want to you understand that this is part of the long-term plan and it is the timing issue really highly isolated to the third quarter and these will revert much more back to normal in Q4.
If you look at the long-term balance we’re driving as a company I think it’s useful to take a look at this comparison we’ve got, our employee count going back to 1985 matched up to our revenues in that same time period. And you can see that’s restructuring that we did in the early 2000 timeframe when we stepped forward into driving up that R&D. You can see that our headcount and personnel increase at a rate much more rapid than our revenue and it took quite a number of years for our revenue growth to catch up with the commitment we made in hiring.
And you see the most recent recession in 09 and you’ll see again we’ve maintained that commitment to our employees. We continued to invest to the downturn. We saw revenue fall but in the next few years we see them come right back in the balance very, very rapidly. So I believe we’ve done an excellent job of managing and maintaining that balance and we’re balancing here between short-term operating profit, short-term net income and long-term organic revenue growth. When we look at this chart, I see this timeframe between 03 and 08. Once the economy stabilized after the last recession in 03, next five years we went on to double the size of the company. If we’re successful in hitting the first call consensus revenue estimate this year, then we’ll need about 13% to 14% compound annual revenue growth to double the company, to get to $2 billion in the next five years. An internally we are setting our sights at $2 billion by 2016.
Now when I compared that rate with compound annual growth rate would be 11%, compound annual growth rate, we delivered between ’08 and ’11. You know we are setting an expectation that is higher, an internal expectation higher than what we were able to deliver in the last three years. But we did also go through the worst recession in modern history in that timeframe. And as we make these investments we anticipate our ability to continue to gain market share to drive adoption to create that pull in our customer base and we set our targets internally to get to that $2 billion level. When we get there, we expect to have very high gross margins and we believe as a company if we are able to deliver on that $2 billion target, if we are able to deliver on high gross margins, we will be in a position where our ability to invest in this market is unparalleled by any of the other players. And now we will create a position where we believe we will be able to execute and deliver on the opportunity for leadership that we have in the market place.
Now when I compare our investment discipline with that our competitors it’s a very different picture. I continually get questions where investors ask me, well, competitors X has taken this strategy, why are you taking a different strategy. And it’s a very reasonable question. But I would point back to our success. Our results in driving organic growth and improving our gross margins and improving our operating margins and in delivering a significant return to our shareholders for the investments we made over last seven, eight, nine years. And if you carry this chart forward five years, I don’t know exactly what is going to look like but I am reasonably confident that our market position is going to be stronger five years from now than it is today.
Now pause and take a quick look at economy and our plans as we go out into this year and second half and into 2012. Many of you are familiar with the global PMI, it’s a metric that I have used to compare to our business for the last decade or more. It includes the data point that we got from yesterday and so to answer the question when ever we’re going to get to tell you now that the drop is on the PMI yesterday was very much in line with expectations I had when I set guidance last week. Our GPIB business internally is a pretty good proxy, pretty good predictive to PMI. So what we saw in July is very much in line with what we anticipated when we gave guidance. My personal expectations as I said on the call last week as we expected PMI to be weaker in Q3 and it wouldn’t surprise me at all if dips below 50 at some point during the third quarter. so we are seeing the cycle and some people view at as a mid cycle pause. I don’t think anybody really knows. So I won’t to try to predict beyond the third quarter commentary that we have made last week.
Now, Pete showed early on our rate of revenue growth for our smaller orders and large orders, that transactional business our system business tie to the PMI and its real clear historically our transaction level business where we have significant presence in the market has been highly correlative with the global PMI. Where we have a rapidly accelerated our investment both in R&D and in the field, in driving our system level business we’ve been able to sustain a very different rate of revenue growth relative to global PMI. And as that mix has shifted overtime from 25% of our revenue back five years ago to 46% of our revenue today it creates a different dynamic a power business response to the broader economy. And as I said early on if you take a look at the start of the recession and December of 07 for the next four quarters our system level business continued to grow at a pretty much on unaffected pace because we are taking market share, we are leveraging our R&D investment for creating tool and we are able to drive the record revenue, record profit to whole business while a transaction level business respond a pretty much as normal to the decline of PMI. Now we come to five years later, it is bigger percentage of our revenue we are again faced with declining PMI and we will see how it plays out. Obviously our 22% revenue growth guidance for the third quarter indicates that we expect this strong growth of our large orders to continue in the third quarter and as I said through the earnings call last Wednesday we saw no indications that wouldn’t be the case.
So our strategic plans for the next few years is pretty straight forward it is not a lot different than we done for last five years. It is an Intense R&D investment to drive platform completion and intense investment in sales resources to drive revenue and create that adoption. We are bound and determined to create an inflexion point in the industry where industry shifts over from previous decision in the boxes to an obvious choice of marginal instrumentation is the way to go.
And we intend to achieve that goal. We don’t know how long it will take us but that is what we are pursuing. We are going to maintain our operating income, we are continuing to target 18% today. I have received commentary from investors over the course of last year they really like to see us raise that operating target today at this meeting or sometime very soon and we have given a lot of consideration to what that operating margin target should be. However, when we look at the current economic environment we are seeing the PMI should shift down to very low levels it does not make any sense to either myself or Dr. Truchard or any one else in the management that we should change that metric today.
Now as we continue to hopefully to scale the company going forward we will consider what the operating margin targets should ultimately be but for now at this point in the cycle we are going to stick with 18% and we will continue to review that and bring it up for discussion again in the next year. So my message to the whole company and key note I deliver on Friday we need great intensity on the face of this little bit of head wind we are going to see economically. We need to drive platform completion as strong as possible in R&D and we need to make certain to building services and sales capability that we can meet our customers rightly elevated expectations. They want to move from small deployments to very large deployments. They want to move from single site to global deployments. They expect us to be there to support those operations as they come to market and we will continue to invest and delivering it.
So, I leave you with this slide and take a look at our history of growth and profitability. Our internal target is not guidance but our internal target is to drive the business to try to double between now and ’016. We will see if the economic circumstances play out like ’03 to ’08. We believe we are in a significantly stronger business position today than we were back in 2003 and we intend to do everything possible to leverage that to the benefit of our shareholders.
With that, I’ll ask Dr. Truchard to join me, Pete to join me, Phil to join me, and we will take your questions before we close out. We will start with Joe Des.
Thanks Alec. Question about some of the new market opportunities that you talked about and what different rate of penetration you expect based on the existence or lack of existence of an incumbent like something like fracking or solar cell manufacturing or hybrid autos. Makes sense maybe there is not an incumbent sort of entrenched application. People can use your stuff to come up with those solution pretty quick. I mean, compared to that though, Smart Grid, transformer monitoring, things like that. It just seems that there would be a big opportunity that are a lot tougher in terms of there is entrenched dedicated software packages for transformer monitoring, there is systems integrators who are active in that space. How quickly can you penetrate something like that and they were the first ones in Indiana, not like North Carolina or something?
Because we are starting from a very low level of sales royalty over the next year is to grow fairly rapidly, its very good. There’s lots of different things going on, lots of change, lots of expectations of the use of energy and so forth, so I would say that's pretty much a green field for us, it’s a lot of different things we are doing there and it feeds on itself, once you get one success, you can move to the next one, and then trench players are usually pretty slow moving too in that space. So all that portends well for making a difference. So I think we will do well in that space.
Is that a reason that we drive the options or you get different situations like in semiconductor where the incumbent is delivering an economic proposition that's no longer viable for the customer and the customer needs some of our first applications where the customer felt they couldn’t continue to compete in that business unless they dramatically change their cost of test. And it was a matter of survival in that business that they came to us because they saw the opportunity for a very disruptive price alternative and they had to take the risk in order to stay in business. So there's different economic innovation reasons that will drive customers to National Instruments’ platform. Once we are in adoption of these marquee accounts as Pete said earlier on we then take that success, we leverage it to the next one and the next one, the first one is tough, the second one is tough, it gets progressively less difficult as you go forward.
There's another source of innovation for us and that's academia. We have this very large footprint from 6000 universities around the world, we had record attendance at our academic day here. So our footprints in academia across the board all the way from embedded design, robotics, mechatronics, on into communication, telecomm has been growing quite well and those, the research that goes on gets propagated into industry. So that's a very big source of innovation for us. [Mark].
Yeah, can you talk about the hiring that’s going on, mostly undergrads?
Yes, the majority of the staff is that we’re in the timeframe are undergrads, yes.
So with green undergrads how it’s that going to drive new product development in even two years, it may be a long-term, especially if you are talking – is that three of resources that guys are working now that probably undergrads in the less critical applications or how does that work?
So in terms of absolute numbers, it is true that fresh-out school undergrads and also master cadets and some PhDs have highest percentage. But there’s also 300 elements that go with that. The second one is very experienced people and that’s a small handful may be 10-15 people something like that worldwide, but these are people they have 10-15-20 years of experience. They get to help us in different segments while mentoring and developing the new people. Third category is acquisitions. So where we want to go after a key intellectual property and sorting cases key physical property like manufacture these hybrid microcircuits, we will do acquisitions. Even the fourth element is where it makes sense both from a protected intellectual property, quality design and economic efficiency we’ll use third party designers for hardware and software.
So we tend balance kind of all four of those. The first one is largest by its numbers, but if you don’t do there is three things, you can effectively use the people if you are hiring brand new.
Now on the field side, I would view it as a pipeline. So as we bring in new grads into the application engineering group, the people who have been in the application engineering group for a year and a half or graduated of that go into the field. So there’s a pipeline and this allows us to push through that pipeline to get the experienced internal people out into the field replacing with new grads, we’ll take on that’s appropriate.
Now, the acquisitions we made also have mostly very experienced people and we can balance it with some junior people especially in the software area. [Ajit]? You’ll get a mic up there.
Yeah. Looking at what you told us last year which was you know, you said that you would be growing your revenue faster than the expenses and then you have made a change now. So I just want to understand what drove that change in your thinking, you have been very consistent in talking about 18% operating margins, but last year you said we are going to see in the foreseeable future the revenue grow faster than the expenses, so what are the opportunities that you saw that you made you change your mind in terms of stepping it up?
The second thing was….
Let me take the first question first, I might forget it later, so let me come back to them. The answer to that question is we have not changed our strategy. Our operating margin in the first half is up 200 basis points. The strategy will not be valid in the third quarter in particular because of the nature of our hiring cycle. But as I said in the Q4, we will see the rate of growth of expenses come back down, much slower to the rate of growth of revenue. So if you measure it in a per quarter basis, it looks like a change. If you measure it on the full year, it is very much inline with the strategy we laid out last year, so you had a second question?
So you also talked about a 17% headcount increase this year despite of the acquisitions, now post the acquisitions are you going to update that what that headcount is going to look like at the end of year, is it going to be up 20% or will it still be up only 17%?
In the end, it is going to probably be very close to 17. You know we had an ambitious hiring program. In reality we probably, at this point we don’t actually expect to deliver on all of that recruiting, we have kept our barrel for hiring very high. So I think in the end with acquisitions we are probably still coming very close to that 17% target.
And then the third question would be the hit to your gross margins that happened when you set up Debrecen, what kind of hit can we expect relatively to that when Malaysia comes on line, so the third quarter of next year is when it is scheduled you might you know push it forward or pull it in?
So in relation to the Malaysia facility, our current target is to bring that facility online in July of ’12, on the assumption that we continue to need that economy stay strong we’ve been able to continue to drive revenue growth. One of the things that crucial about now versus 2000 is the company is a whole lot bigger. So we’ll be roughly three times the size we were the last time we added a facility and the operating cost in Malaysia we’ll actually be somewhat less. So our current expectation is as we get into the second half of 2012, we’ll probably looking at somewhere around 13 basis point impact to gross margin in the second half of 2012.
Now in the meantime we’ll continue to be driving our internal business goal number six which is designed around designing out costs; it’s been very, very successful over the course of last three years. We’ve hold that around about $45 million in annual expenses out of our operating cost and material cost in production and that’s enabled us to continue to drive up our gross margins.
So we’ll see how it plays out in the end that’ll be a bit of tug-o-war if you like between an incremental overhead that’ll come to market in the second half of ‘12 and our ability to continue to drive down our operating expenses in the production side. So I think that the impact in the end will be probably some thing less than 30 basis points in the second half of ‘12. By the second half of ’13, we believe the leverage will be there toward the impact of operating our gross margin will be de-minimus.
Yeah, two more questions, [Fosston].
Thanks. You laid out an internal revenue growth plan till 2016, but that seems like a public or external facing plan on the margins, on the operating margin; is there an internal plan to get actually to get some operating leverage so you get higher than start of 18% target. And if so would be in the gross line or one of the operating lines and if the answer is no, at what revenue level do we start seeing costs actually grow kind of in the long-term slower than revenue, so we see operating leverage in the model?
Sure, it’s very reasonable question well. Over last six, seven, eight years we have delivered a lot of operating leverage and we have consistently grow our revenues and gross margins in excess to the rate of growth of investment and investment have started to become self perpetuating and that’s allowed us to drive the amount of operating leverage that we have successfully delivered in the last number of years.
And obviously as we get closer to this target of 18% it becomes much more of a topic; is that going to be the level when we’re going to consistently shoot for a long period of time and that’s something we will continue to discuss internally, but the current economic environment, we have seen some of our competitors raise their operating margin targets in the test business. We think that’s a mistake in this timeframe and want to be certain that we don’t miss out the opportunity to grow revenue and so for the foreseeable future we’re going to stick with that 18% target. And we will continue to consider that as a way to go forward.
Hi thanks. How does NI measure its productivity of field sales person; meaning you cited large order trends earlier, but how do you separate the impact of R&D and new products through out sources and how productive that field sales forces actually and then I guess finally is that a typical once your new hires transition to more of the field opportunity is an instantaneous productivity gain or does that take another couple of years to actually see that go through?
Perhaps I can address a little bit in person and I’ll then hand over to Pete. This issue of how you separate the leverage that’s going to come from new product introduction and the leverage that comes from a new sales person is really, really difficult to try to divide between the two it’s pretty much almost impossible. When we look at the business model as you see we continually put up their R&D in the field together and you look at that transition and that scaling and there is a need for balance to scale the field without new products coming in that create opportunity, will create a lot of in-efficiency. To scale R&D without a field sales force that can bring the product to market and close the sale will create a lot of inefficiency.
So we have to try to find that balance. But I will be honest with you. It’s not a formula that we are using to drive it. It’s really a reflection of I think the opportunities that our sales guys can close up. Pete has metrics around that and field people so you can raise questions.
Well typically, as Alex talked about there is a pipeline. So when the new graduator, the new graduates from the ELP program moving in the field, we can free up some of the senior people who are servicing both ends of the business and focus on a little bit more into strategic accounts that might have leverage because their influence in an ecosystem which we can reference across that or there are just large end-user accounts where we can focus a little bit more of energy to get deeper penetration. But we get a relatively quick response to the new hires that are going out into the field because we do have – we can free up some resources to do more business development.
Now, that’s coupled with these larger system level opportunities tend to be longer sales cycle. So even though we can immediately start applying the resources there and uncover opportunities, larger opportunities maybe at high rates, you have to couple that with a longer selling cycle so you will see a little bit of a delay. So we tend to look at a sales person coming on line and really within a two-year period that’s when we expect them to be pretty much at their full proficiency level. And whether that’s a new hire going out there or system level to selling.
Okay, we’ll take one more question. [Dinesh] And maybe after this question the management will be around for a little while after, but our webcast is going to cut off. So we will take one more question and then we will go to logistics.
Very quickly, Alex, on capital deployment, there is cash and balance sheet and between now and 2016 you will be generating a lot of cash, how are you thinking of deploying it; I know your thoughts about dividends, share buyback and M&A but if you can just provide color on what kind of dividend growth can we expect, what kind of…
Sure. As most of our priorities for use of cash is number one, dividends as long as they remain very tax efficient to our shareholders and in thinking about dividends we are targeting roughly about 30% of our net income as an appropriate dividend amount. Now that is going to be an approximate number is going to move up and down as you go through downturns. In ’09 it was much higher; in ’10 it was a little bit lower, but as a guide that's the kind of number we are talking about on the assumption that it continues to be tax efficient for our shareholders. We introduced the dividend when the tax rate was reduced to 15% and that was the core reason for a shift in our capital deployment strategy at that point in time.
Number two is opportunistic stock repurchases. So we've chosen not to go with a mechanical approach as some companies use the, hey, my goal is every quarter to have an equal share count, we do not take that approach. We look for opportunities where the expectations in the market relative to our future expectations are fairly dramatically different and we choose to use that as an opportunity to capture value for our long-term shareholders when they arrive.
Strategic M&A is the third focus. That has been a consumer of a relatively small amount of our capital over the last number of years. Dividends and stock repurchases has been a much bigger consumer of our capital. We did two acquisitions that Eric talked about and Phil and Pete and Dr. T earlier. This year that were collectively the largest amount we paid for acquisitions in any year since the company has been founded. Both those companies we have inactively quoting and engaging with for a number of years. When I look forward I think it’s unlikely in next number of quarters that we will see acquisitions of that scale. So I would focus on dividend and stock repurchase as our primary targets for capital deployment in the near-term.
With that I am going to it over to Juliet, she’s going to talk a little bit about logistics for the tour of the show floor and logistics for dinner tonight and then the management team will be around after Juliet’s little pep-talk and happy to take any continuing questions you may have.
I would like to again extend my thanks to you all for coming to Austin, it’s a long journey, it’s a hot state, hopefully the keynotes you saw this morning and Gary contained in an absolutely outstanding job. And if you’re here tomorrow for the keynote, don’t miss it. It’s going to be every bit as good. Thank you.