National Instruments (NATI) Q2 2016 Results - Earnings Call Transcript

| About: National Instruments (NATI)

National Instruments Corp. (NASDAQ:NATI)

Q2 2016 Earnings Call

July 27, 2016 5:00 pm ET

Executives

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

James J. Truchard - President, CEO, and Cofounder

Alexander M. Davern - Chief Operating Officer, Chief Financial Officer & Executive Vice President

John M. Graff - Vice President-Corporate Marketing

Analysts

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Operator

Good day, everyone, and welcome to the National Instruments Second Quarter 2016 Earnings Conference Call. Today's call is being recorded. You may refer to your press packet for the replay dial-in number and passcode.

With us today are David Hugley, General Counsel and Secretary; Alec Davern, Chief Operating Officer and Chief Financial Officer; Dr. James Truchard, President and CEO and Co-founder; and John Graff, Vice President of Marketing.

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

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

Good afternoon. During the course of this conference call, we shall make forward-looking statements, including statements regarding the impact of currency exchange rates and our guidance for revenue and earnings per share for the third quarter of 2016. We wish to caution you that such statements are just predictions and that actual events or results may differ materially.

We refer you to the documents the company files regularly with the Securities and Exchange Commission, including the company's most recent Quarterly Report on Form 10-Q filed on May 2, 2016. These documents contain and identify important factors that could cause our actual results to differ materially from those contained in our forward-looking statements.

With that I will now turn it over to the Chief Executive Officer of National Instruments Corporation, Dr. James Truchard.

James J. Truchard - President, CEO, and Cofounder

Thank you, David. Good afternoon and thank you for joining us. Our key points for Q2 are revenue growth, improved gross margins and continued success in next generation 5G wireless research. In Q2 we saw a revenue growth despite the decline in the Global PMI and continued impacts from foreign currency exchange. I'm confident in our business model and our ability to drive long-term success for NI and our shareholders.

The depth of our software position and the strength of our ecosystem allowed us to continue to grow market share in the test and measurement market. Being able to measure or generate almost any signal and provide control with the same platform gives us a unique capability to foster the ecosystem required to address the challenges of the convergence of technologies in applications such as the industrial Internet of Things, smart mobile devices and the connected car.

In our call today, Alec Davern, our Chief Operating Officer, will review our financial results, John Graff, our Vice President of Marketing, will discuss our business, and I will close with a few comments before we open up for your questions. Alec?

Alexander M. Davern - Chief Operating Officer, Chief Financial Officer & Executive Vice President

Good afternoon and thank you for joining us today. Today we reported Q2 revenue of $306 million, up 1.4% from Q2 of 2015. Core revenue, which we define as GAAP revenue excluding the impact of our largest customer and the impact of foreign currency exchange, was up 3% year-over-year in Q2. Orders in total were up 2% year-over-year, and given the decline in the Global PMI in Q2 to the lowest quarterly average since 2012, we are pleased to have exceeded the midpoint of our revenue guidance range.

Non-GAAP gross margin in Q2 was 76%, up 110 basis points sequentially. Total non-GAAP operating expenses were $194 million, up 5% year-over-year. Decrease in expense year-over-year was influenced by a $2 million drop in capitalized software, compared to Q2 of 2015. Our non-GAAP operating margin was 13%, up 380 basis points sequentially. I'm pleased that we returned to revenue growth in Q2 and believe that we are positioning NI to be the leader in our space.

For Q2, net income was $20 million, with fully diluted earnings per share of $0.15. Non-GAAP net income for Q2 was $29 million, with non-GAAP fully diluted earnings per share of $0.23. Our earnings were negatively impacted by a $1.3 million or $0.01 per share loss on foreign exchange as a result of the volatility of currency markets in Q2, especially after the Brexit vote. This loss had not been anticipated in our guidance. A reconciliation of our GAAP and non-GAAP results is included in our earnings press release.

Now, taking a look at order trends. For Q2, the value of our total orders was up 2% year-over-year. Included in that total is $18 million in orders received from our largest customer compared to $10 million in Q2 of 2015.

Now breaking down our order values excluding our largest customer, we saw a 3% year-over-year decline in our orders with a value below $20,000, in line with the weakening PMI and a declining PC market. On the systems side, orders with a value between $20,000 and $100,000 were up 8% year-over-year, and orders with a value over $100,000 decreased 12% year-over-year.

Now, turning to cash management. During the quarter, we paid $26 million in dividends and we ended the quarter with cash and short-term investments of $340 million at June 30.

Now, I'd like to make some forward-looking statements. Given current trends, we are assuming in our guidance that the global PMI will continue to be weak in Q3. And as a result, we're guiding for total revenue in Q3 to be in the range of $291 million to $321 million, up 2% year-over-year at the midpoint. We currently expect GAAP fully diluted earnings per share will be in the range of $0.11 to $0.27 for Q3, with non-GAAP fully diluted earnings per share expected to be in the range of $0.18 to $0.34.

We're expecting our non-GAAP effective tax rate to be approximately 17% in Q3 and 23% in Q4. In Q3, we expect the rate to be positively impacted by the release of tax reserves related to prior years. For 2017, we are expecting our non-GAAP effective tax rate to be in the range of 18% to 20%. On other housekeeping items, we estimate that given current exchange rates the drag in our revenue from currency headwinds should be approximately 3% year-over-year in Q3.

In summary, while Q2 was challenging due to a number of factors, including currency and a weak PMI, we continue to execute well and we remain committed to increasing our net income this year. As these are forward-looking statements, I must caution you that actual revenues and earnings could be negatively affected by numerous factors such as any further weakness in global economies, fluctuations in revenue from our largest customer, foreign exchange fluctuations, expense overruns, manufacturing inefficiencies, adverse effect of price changes and effective tax rates.

We'll be hosting our annual investor conference as part of NIWeek, next week and we look forward to seeing you there.

With that, I'll turn it over to John Graff, Vice President of Marketing.

John M. Graff - Vice President-Corporate Marketing

Thank you, Alex. In Q2, we delivered revenue growth despite a challenging economic environment and we are encouraged by the performance of our core platform. With NIWeek quickly approaching, we are excited about our opportunity to bring even more capability to our customers through new hardware and software releases and to host some of the world largest technology companies as they demonstrate how the NI platform helped them solve their hardest engineering challenges.

Next week we will hear from engineers at Audi about automotive radar, researchers at the University of Bristol regarding 5G communication, and from leadership at Hewlett Packard Enterprise about a collaboration with NI that had high performance processing and measurement into their IoT systems at the edge. With hundreds of technical presentations, thousands of engineers in attendance, and representation from the press and investor community, we have an exciting week planned, celebrating innovation and technology.

Now let's turn to product performance. Data acquisition products were adversely impacted by weakness in both PC sales in the lower PMI. However, within data acquisition we saw strength in sales to electromechanical and electrical power simulation and test systems.

An example of electromechanical test system comes from an academic lab using NI hardware and software to simulate and test different load scenarios on an electrical grid. Because the NI platform can tie models and algorithms directly to IO, students and researchers see physical results faster and quickly iterate on software design. Moving prototyping and test of these control systems into the software realm can drastically reduce development time and increase test coverage beyond the most common test scenarios.

This helps enable manufacturers to drive out bugs and release more robust systems, which is absolutely critical for many industries including transportation and infrastructure. For PXI and modular instrumentation products, we saw continued adoption of our platform in Q2 and continued to grow our footprint in RF. The proliferation of smart devices has challenged the test organizations responsible for characterizing and testing these complex devices.

We believe we're in a unique position driven by having an ecosystem of the industries most flexible software design environment over 600 PXI modules, over 1,000 integration partners, and 10,000 instrument drivers. Additionally, we've recently passed 5 million downloads from our tools network. This ecosystem supported by focused sales and support channel, amplifies the individual efforts of our customers and helps ensure that they can meet the characterization and testing demands created by smart connected devices.

At NIWeek, we will be showing the results of a tremendous amount of work by our development teams with new products further expand the measurement capabilities at PXI. We will be introducing the industry's highest precision PXI SMU with revolutionary source adopt technology for characterization and test of low power integrated circuits. We will also demonstrate a new digital pattern instrument for higher level digital starting point of small device tests – of smart device test that brings more digital capabilities to our robust analog measurement offerings and expands the range of devices under test that can be address by our Semiconductor Test System.

Additionally, we will be showing the next generation vector signal transceiver. With the introduction of the original vector signal transceiver in 2012, we moved RF system design from iterative hardware development into software. The software design paradigm helped to accelerate the pace of innovation and has helped enable engineers, and semiconductor test, aerospace and consumer electronics. This NIWeek, we will be showcasing the second generation VST that improves on the first generation in nearly every way including increased speed and bandwidth, smaller footprint and a more powerful FPGA.

When we introduced the new VST, Olga Yashkova, Program Manager for Communications Test & Measurement Practice at Frost & Sullivan said, "The second-generation VST demonstrates NI's continued empowerment of engineers with software-designed instrumentation to stay ahead of the complex and rapidly changing wireless technologies and requirements with the most innovative RF test, measurement and prototyping solutions in the market."

At NIWeek, expect to see multiple exciting applications from early access customers of the next-generation VST, including an automotive radar application from Audi engineers who are using the new VST to emulate a wide range of driving scenarios to find bugs in this safety-critical system.

Turning to sales of CompactRIO and other embedded products. In Q2, we saw encouraging revenue growth despite continued weakness in sales to oil and gas customers. In fact, we celebrated shipping our 1 million C Series module. Since 2004, this platform has enabled advanced monitoring, control and prototyping applications, through modular measurement hardware, a robust real-time operating system and an open FPGA.

One application example comes from a customer in Singapore retrofitting existing industrial stamping machines with CompactRIO. In this system CompactRIO measures vibration and signals from the machines to calculate if thresholds have been exceeded. This data can be used to make real-time decisions to stop the machine for safety or product quality issues. Additionally, relevant trend data can be forwarded to the enterprise level to inform preventative maintenance measures. This application highlights how outfitting existing assets for the sensing, intelligence and connectivity, helps manufacturers improve uptime, yield and safety.

Now for software. At NIWeek we will introduce LabVIEW 2016 with improvements that will further enable our users to connect with the latest hardware, integrate more of their system design into software, and extract more value from in-depth data analysis. With 30 years and over 10,000 person years of development, LabVIEW is the enabling technology at the core of our platform. In 2016 we were both expanding the number of customers we can serve and increasing our share of complex designs by adding features that improve the development experience for veteran programmers and new ways to gain proficiency in LabVIEW for those just starting. In addition to new features developed by NI, we were also excited to unveil the latest tools developed by our ecosystem of partners.

One example from our partner, Enthought will enable tighter inner operation of Python in the LabVIEW development environment. Python is an open source tool used across a wide variety of applications, including machine learning, natural language processing and security. And this new tool from Enthought demonstrates the strength of the LabVIEW open ecosystem. With LabVIEW and Python closer together, engineers can use the tools and IP that best match their application needs.

We have demonstrated how our differentiated platform and extensive ecosystem position us to serve a broad variety of customers and applications. A key channel for reaching both the broad based and larger complex applications is our partners. In Q2 our partner channel saw double-digit revenue growth. The strength of our partner program enables us to make the focused investments in sales and support resources to better serve larger customer accounts, especially multi-nationally, so that they can take full advantage of the expanded capabilities of our platform.

To close, we are looking forward to a busy and exciting NIWeek. As always, we'll launch exciting new products and highlight customer success stories. We're expecting over 3,000 customers to join us this year in Austin to see our new products, learn about industry trends, get trained by the product experts and network with their peers and industry thought leaders.

Following key notes by Dr. T and Executive Vice President Eric Starkloff on Tuesday, we'll begin our investor conference. This year's conference will focus on our commitment to growth by serving more customer needs through the expansion of our platform capabilities. Key NI leaders will be taking a deeper dive into the opportunities in software, automated test, data acquisition and embedded systems, highlighting both near-term and long-term trends such as 5G communications, the industrial Internet of Things and the connected car.

I will moderate a customer panel during lunch, which will include leaders from Intel, the University of Bristol, Flowserve Corporation and a key LabVIEW champion. This will give attendees an opportunity to hear from our customers' first-hand, with a focus on the business benefits of our platform through faster time to market, cost savings and increased competitiveness. We look forward to seeing you next week.

With that, I'll turn it back over to Dr. T.

James J. Truchard - President, CEO, and Cofounder

Thank you, John. Given the economic conditions, I'm encouraged by our performance in Q2. Our platform and the ecosystem that enables – it enables – continues to provide our customers with the solutions for their toughest challenges and provides us with a unique position within our industry. Over the last 40 years, we have leveraged the most powerful trends and technology to bring new capabilities to test and measurement.

Beginning with GPIB instrument control, we have brought the power of the PC to test and measurement by connecting instrumentation to software, measurements became data that can be processed and automated to improve insight, increase yield and reduce errors. With this data centric view to world, we introduced LabVIEW with a goal to do for test and measurement what differentiates this for financial analysis.

The spreadsheet transforms financial analysis by bringing manual calculation, data trending and report generation into the PC. Calculations that would have been difficult with a calculator could now be solved with a few key strokes and trends that would have been impossible to spot on pen and paper could easily be visualized and extrapolated.

In the 30 years since the introduction of LabVIEW we have singularly transformed our engineer's type measurements and interact with data from lab automation as a single instrument to grid monitoring systems with thousands of measurements to helping cutting edge technology like BIO-key communication. LabVIEW has scaled and evolved to address our world's engineering challenges.

Today trends like 5G, a connected car, smartgrid and the internet of things are driving the world to become more software centric. As the hardware of these systems converge into devices with more sensing, computing and connecting technology, the software will be what creates value. For example, the connected car will include measurements from thousands of onboard sensors, real time processing and control of vehicle systems and connectivity to infrastructure.

Therefore, the operation of the system, for example, whether there is an entertainment system or a nominal – autonomous vehicle control will be defined by the underlying algorithms. This means the majority of investment and prototyping and tests of these systems will be in software. This is particularly true in the emerging technologies like 5G communication. Given that the available spectrum is limited and the laws of physic are constant, the benefits of more throughput, lower licensee and more supported devices will come from new transmission schemes and different network technologies.

This research base is highly iterative and many researchers from industry and academia have standardized on the NI platform of modular, IO, open FPGA, and LabVIEW system design software. At the University of Bristol, researchers have used NI software defined radio and LabVIEW communication system designs to prove the viability of Massive MIMO as a candidate technology for 5G.

By starting with a software defined platform they were able to move between theory and the real world prototyping as their research progressed. In that prototype system, the team demonstrated a record 22 times more spectral efficiency than 4G communication, meaning more devices per base station. This convergence of technology has also created new opportunities for collaboration. As the challenges from informational technology become linked with the challenges of operational technology through division of the Internet of Things, IT providers must consider the analog domain.

Our new collaboration with HPE, an announcement of the Edgeline converged IoT system addresses the challenges of two converging worlds. The industrial-grade Edgeline includes up to 64 cores of Intel Xeon processing and four PXI slots for adding PXI instrumentation for FPGA co-processing at the edge. This collaboration strengthens our ecosystems and opens up more measurement, processing and decision making capabilities to both NI and Hewlett-Packard Enterprise customers to drive better engineering, scientific and business outcomes.

With 40 years of connecting analog measurements to processing, we have a unique opportunity to support engineers and scientists with a software defined platform that scales with the iterative design process of this converged world. I will explore these topics in more depth in my key note next Tuesday at NIWeek. During the week we will also introduce exciting new products for PXI, wireless tests, embedded systems and the latest extension of our software platform. I'm excited this year to share our new products and hear about our amazing ways our customers are using our platform to solve many of the world's greatest engineering challenges. I hope you are able to join us.

In closing, I want to thank our employees for their hard work to deliver innovative new products to drive our growth while managing expenses as we continue to our long-term profitability goals. I'm confident that we're building the new product pipeline, channel and operational excellence to drive the long-term growth and profitability of the company. And I look forward to seeing you at NIWeek.

We will now take your questions.

Question-and-Answer Session

Operator

Thank you. And our first question comes from the line of Richard Eastman of Robert W. Baird. Your line is now open.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Yes, good afternoon. Alex, could you just speak for a second to the large customer revenue in the second quarter?

Alexander M. Davern - Chief Operating Officer, Chief Financial Officer & Executive Vice President

Sure, be happy to, Rick. We had revenue in Q2 of $14 million from the largest customer, compared to about $9 million, I believe, in Q2 of last year. As we look out to Q3, which might be your next question, our expectation is between $5 million and $10 million in revenue in Q3.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Okay. And then the rest of that $18 million of orders, did some of that ship then in Q2? And then the second quarter orders were $18 million, so some of that shipped in Q2, the rest will carry forward. Is that...

Alexander M. Davern - Chief Operating Officer, Chief Financial Officer & Executive Vice President

Yes, obviously, the bulk of that shipped in Q2 and then some of the revenue will move into Q3.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Okay. And then when you look at the business geographically, and I was just trying to quickly sift through this, it looks like perhaps the Americas and Europe maybe didn't show quite the seasonality that historically they would have. I mean, if you look at your total revenue, geographically, where were we a bit short here relative to plan or at least the high end of plan for the second quarter?

Alexander M. Davern - Chief Operating Officer, Chief Financial Officer & Executive Vice President

Yes, obviously we came in slightly ahead of the midpoint of guidance, Rick, for Q2: $306 million versus $305 million. We look at it from a local currency point of view, a couple of issues I think that are worth noting. Obviously, in EMEA, we're still seeing close to six percentage point impacts on currency as we come through year-over-year. We're seeing strong growth in APAC that is somewhat helps by the fact that essentially all of the revenue from our largest customer is recognized from an accounting point of view in the APAC region.

So that's just a little bit of insight in that. In the Americas, Q2 is a tough quarter, a couple of factors are at play there. Number one, it was our toughest compare with last year. We have a significantly easier comparing Q3. In the Americas, as we saw the impact of FX in oil prices hit the Americas last year. So we look at that that was an issue.

Second area was that within the LATAM, part of the Americas we saw a significant impact from lower oil prices and kind of a direct impact of that was significantly lower spending in the academic space in that region, which had a negative impact. So as we look to Q3 I think given the improved PMI in the U.S. in particular and in the month of June in particular actually and a significantly easier compare Q3 we're expecting to see a better performance from the Americas in the third quarter.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

I see, okay. And then just the last question very quickly, I think maybe I'll direct this to John, but you had mentioned the 2016 LabVIEW version is being released here. Is this – can you just characterize how major of a release this is or is this again kind of next-generation LabVIEW?

John M. Graff - Vice President-Corporate Marketing

Well, I'll say, Rick, first we have to see it next week and you'll get a lot more of the details. And one of the areas we're going to focus in on next week is software. LabVIEW 2016 continues our kind of annual release cycle. Every year what we talk about internally is we're giving our customers the best version of LabVIEW that has ever existed. There are some very exciting features and technology. We are going to talk some about that. And kind of give you outlook of where we see our software platform going in the future.

Alexander M. Davern - Chief Operating Officer, Chief Financial Officer & Executive Vice President

Yes. I think you would get more of an insight into the future of LabVIEW next week than maybe most NIWeeks for the last quite number of years.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Okay. All right, excellent. Thank you very much.

Alexander M. Davern - Chief Operating Officer, Chief Financial Officer & Executive Vice President

Thank you very much, Rick.

Operator

Thank you. And I'm showing no further questions at this time. I'd now like to turn the call over to Dr. James Truchard for closing remarks.

James J. Truchard - President, CEO, and Cofounder

Thank you for joining us today and we look forward to seeing you at NIWeek next week.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.

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