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National Instruments Corp  (NASDAQ:NATI)
Q3 2018 Earnings Conference Call
Oct. 25, 2018, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, everyone, and welcome to the National Instruments Third Quarter 2018 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 Marissa Vidaurri, Head of Strategic Communications and Investor Relations; Alex Davern, Chief Executive Officer; Eric Starkloff, President and COO and Karen Rapp, Chief Financial Officer.

For opening remarks, I'd like to turn the call over to Ms. Marissa Vidaurri, Head of Strategic Communications and Investor Relations. Please go ahead, Ma'am.

Marissa Vidaurri -- Head of Strategic Communications and Investor Relations

Good afternoon. During the course of this conference call, we shall make forward-looking statements, including statements regarding future growth and profitability, our market strategy and our guidance for revenue and GAAP and non-GAAP EPS for Q4. 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 Security and Exchange Commission, including the company's Annual Report on Form 10-K filed February 22, 2018 and our quarterly report on Form 10-Q filed on August 02, 2018. 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, Alex Davern.

Alexander M. Davern -- President, Chief Executive Officer and Director

Thank you, Marissa. Good afternoon, everyone, and thank you for joining our third quarter conference call. Our key messages are record revenue for our third quarter, record profitability for our third quarter and continued expansion of NI's long-term growth opportunity.

I'm once again, very proud of our execution in the quarter. Our focus on industries and applications where our platform was most valued has driven strong results in Q3, with orders up 13% year-over-year. Revenue in Q3 was $346 million, a new Q3 record and up 8% year-over-year.

In addition, our backlog increased by $14 million during the third quarter, improving our future visibility. We're delivering on our stated goals with non-GAAP net income up 49% year-over-year in the first three quarters. In Q3, we delivered 17% non-GAAP net margin, a record for any quarter in the company's history. I believe that we will hit our 18% non-GAAP operating margin goal in 2018.

Our platform continues to position us well to both capitalize on strong market conditions and deliver greater systems level value to take advantage of the major growth opportunities in areas like 5G semiconductors and electric and autonomous vehicles. This differentiated market position gives me great confidence in our long-term ability to grow.

For over 40 years, we've helped engineers and scientists accelerate their productivity, innovation and discovery, through simplifying automation with the newest processing and measurement technology.

The differentiation of our software-based platform has helped customers designing 5G semiconductor products iterate faster to meet tight market windows, has helped automotive engineers bring more of their road testing of autonomous vehicles into the lab to accelerate progress toward the goal of safer driving, and has helped aerospace engineers optimize program management to reduce cost and complexity.

We've been able to help our customers deliver these disruptive technologies through intentional focus and execution of our entire organization. Our core strategic vision is to be the leader in software-defined automotive tests and automated measurement systems. This provides a framework for growth.

We've been very deliberate about the market opportunities we pursue. It is essential that we drive aligned execution through sales, marketing, and R&D to accelerate growth in the targeted industries where our platform offers highly differentiated value.

We continue to see strong growth in large orders with higher system-level value. With 21% year-over-year growth in orders over $20,000 in Q3, I believe that increasing our industry focus and deepening our expertise will allow us to significantly expand our served available market by better serving the mainstream needs in our targeted industries.

To take advantage of these growth opportunities, we continue to prioritize the system-level offerings that are needed to drive accelerated growth in semiconductor, transportation and aerospace defense and government industries, while continuing to innovate on our broad-based platform to serve all scientists and engineers.

As we evolve our strategy, we're promoting Eric Starkloff to the role of President and Chief Operating Officer to lead sales, marketing and R&D. In his new role, Eric will be responsible for further ensuring the alignment necessary across sales, marketing and R&D to implement our vision.

This is a force multiplier of the NI leadership team and will allow me to focus on the long term strategic direction of the company to drive accelerated growth, both organically and inorganically. Having worked with Eric for 20 years, I have great confidence in his ability to help accelerate our growth and continue to improve our operating performance.

And with that, I'd like to turn it over to Eric to share his vision for his new role and to share our performance from regional and an industry perspective.

Eric Howard Starkloff -- Executive Vice President of Global Sales and Marketing

Thank you, Alec, and good afternoon. I'm very excited and honored to take on this new role and I'm looking forward to working with Alec and the rest of our team as we focus our strategy on growth and align our execution across sales, marketing and R&D. In my 21 years at NI, I've never been as excited about our opportunity as I am right now.

As Alec mentioned, in Q3, we saw broad strength across regions, products and industries, and now I'm going to take a few minutes to provide some commentary on our performance.

In Q3, we saw strong year-over-year order growth across all three regions. Our strongest order growth was in the Americas region, which grew 17%. Our APAC region grew orders 12% and our EMEA region grew orders by 11%.

We were very pleased with this broad strength across regions and the positive impact we've seen from our sales evolution and the deep relationships we are building with our customer account.

Now turning to industry performance. Our strategy has been focused on building on the strength of our platform by creating higher-level system offering to increase our available market in key industries. The strong growth in orders over $20,000 that Alec noted is an indicator of the success of this strategy.

In semiconductor, we continue to see very strong growth in orders in Q3 and double-digit order growth for the first three quarters. Over the past several years, we have built on the strength of our platform to create systems that increase the value we can deliver to semiconductor customers. And we're pleased to see the success of this strategy in our results.

For high mix and analog heavy semiconductor test applications, our platform continues to see strong adoption by providing software and hardware that can be leveraged across characterization, validation and production tests.

For example, Skywork Solutions, a global RF semiconductor company, uses NI to test their breakthrough Sky5 5G products. Kevin Walsh, Senior Director of Mobile Marketing for Skyworks said, "Skyworks is pleased to be utilizing NI's RF vector signal transceiver to validate performance benchmarks of our Sky5 solutions for 5G New Radio applications."

We also saw order growth in transportation in Q3 with particularly strength in automotive. Our orders in transportation are up double-digits in the first three quarters. Our customers in this industry are experiencing a major evolution of their technology from the influx of new electric and hybrid powertrains, increased software control and autonomous driving.

To address these emerging trends, NI customer Hyundai KEFICO, the electronic management system suppliers to Hyundai Motors, uses the NI platform in validation and production tests.

Min Kyung-Cheol, Manager of Manufacturing Technology at Hyundai said, "By adopting NI's automotive test platform, we achieved shorter development time and faster test speed required for functional test of powertrain ECUs in manufacturing. We reduced development time to one-sixth of the previous system and lowered system cost by 70%."

Our aerospace, defense and government business had positive order growth in Q3, despite weakness in our APAC region. The breadth of hardware, software flexibility and wide industry adoption ensures that PXI can meet the needs of aerospace test teams and provide high value as the default choice for factory measurements.

For example, Mark Keith, Chief Engineer at Honeywell Aerospace, was challenged to find a way to reduce operational cost and increase the flexibility of their global workforce by standardizing their equipment across hundreds of their products.

By leveraging NI software in the PXI platform, Honeywell Aerospace was able to simplify and standardize their test system fleet and achieve a 40% reduction in the total costs of delivering a test system.

In addition to these focused industry areas, our broad portfolio of customers in all other industries achieved double-digit order growth in Q3 and in the first three quarters. This set of customers and industries represent a broad impact of our platform and helps blend stability to our business.

We believe the continued strength in this broad set of customers demonstrates the impact of our continued product innovation, the increasing adoption of our platform and a generally favorable economic environment.

And now turning to product performance, we continue to see momentum across our product portfolio, driven by the success of many of the software innovations released at NIWeek. Software products continue to have very strong revenue growth, fueled by increased customer standardization on LabVIEW NXG and TestStand, while newer products including SystemLink, InstrumentStudio and FlexLogger drove new customer adoption.

Our customers are quickly realizing the value of combining NI application software with our systems and data management capabilities through NI SystemLink, where customers can centrally visualize product and system data and remotely manage assets to increase their efficiency and maximize their investments in people and capital.

These new innovative additions to our software stack, built over decades of investment, are enabling our customers to accomplish their jobs faster by providing a higher-level starting point for their application. Through the support of our differentiated software portfolio in Q3, we also saw year-over-year double-digit order growth in both our modular instrument and data acquisition and control products.

As we combine the strength of the broad capabilities of our platform, with focus on the customers and industry that can get the most value out of our disruptive capabilities, I'm very excited and optimistic about our ability to grow our served market and drive growth for our business.

Now I'll turn the call over to Karen for the financial update.

Karen M. Rapp -- Executive Vice President, Chief Financial Officer and Treasurer

Thank you, Eric. As Alex mentioned, we delivered record revenue for the third quarter with revenue of $346 million, up 8% year-over-year. Through the first three quarters of the year, revenue was $999 million, up 6% year-over-year.

We continue to deliver strong non-GAAP gross margin in Q3 at 77%, up 80 basis points year-over-year, driven primarily by the strength of our broad-based software and data acquisition products, as well as operational efficiencies.

We reported record operating income for the third quarter. Our non-GAAP operating margin was 20%, increasing 550 basis points from a year ago. GAAP operating margin was 13%, up 160 basis points from a year ago. Record Q3 revenue and deliberate expense discipline help drive a 53% year-over-year improvement in non-GAAP net income. Our Q3 non-GAAP net income was $60 million or $0.45 per share.

Moving to the balance sheet and capital management. We ended the quarter with record cash and short-term investments of $482 million at September 30, 2018. Our free cash flow, which we define as cash flow from operations, less capital expenditures, also continues to be strong at 16% of revenue through the first three quarters of 2018.

During the third quarter, we paid $30 million in dividends and the NI Board of Directors approved a dividend of $0.23 per share for Q4.

Now looking at Q3 orders in more detail. The value of our total orders was up 13% year-over-year in U.S. dollars. Orders with the value below $20,000 grew 5% year-over-year in the third quarter. As an indicator of continued strength in our system sales, we saw all orders over $20,000, up 21% year-over-year.

Backlog grew 4% of revenue in Q3, providing additional visibility and opportunity for operational efficiencies in Q4. We continue to see the benefit from our sales evolution and our intentional focus on making our customers successful.

Now I'd like to take a look at Q4 2018, which will include forward-looking statements. We are optimistic about continuing to deliver significant operating leverage in Q4. We currently expect revenue in Q4 2018 to be in the range of $360 million to $390 million.

We expect GAAP fully diluted earnings per share will be in the range of $0.35 to $0.49 for Q4, with non-GAAP fully diluted earnings per share expected to be in the range of $0.46 to $0.60. We expect the impact of tariffs to be immaterial in the fourth quarter. We'll continue to monitor the situation and any impact to our business.

As these are forward-looking statements, I must caution you that our actual revenues, expenses and earnings could be negatively affected by numerous factors, such as any weakness in global economy, foreign exchange fluctuations, expense overruns, manufacturing inefficiencies, tariffs, adverse effect of price changes and effective tax rate changes.

In summary, I'm very pleased with our continued progress on growth and profitability. We believe from focus comes growth, and with leadership's recent implementation of our core strategic vision, we have driven alignment to the top priorities that we believe will provide the most opportunities for growth.

With the entire company focused in one direction, we've been able to increase operational efficiency and flow through to the bottom line. We remain committed to delivering to our goal of 18% non-GAAP operating margin in 2018.

This clear focus and operational discipline has helped deliver 49% increase in non-GAAP net income in the first three quarters of 2018, as compared to the same time period in 2017. The NI management team will be participating in a series of conferences from now through the end of the year. We look forward to seeing you at one of these.

With that, I'll now turn it back over to Alex.

Alexander M. Davern -- President, Chief Executive Officer and Director

Thank you, Karen. In closing, we made great progress over the last two years, delivering innovative new products that drives value for our customers, improving results for our shareholders, securing new growth opportunities for our partners and expanding career opportunities for our employees.

I believe we are very well-positioned to take advantage of the major technology trends that are driving our industry. And I'd like to thank our employees for their hard work and alignment on our journey to be the leader in software-defined automated test and automated measurement systems.

We'll now open-up for your questions.

Questions and Answers:

Operator

(Operator Instructions) And our first question comes from the line of Vijay Bhagavath with Deutsche Bank. Your line is now open.

Vijay Bhagavath -- Deutsche Bank -- Analyst

Yeah thanks. Hey good afternoon again, Karen, Alex and congratulations Eric.

Alexander M. Davern -- President, Chief Executive Officer and Director

Thanks Vijay.

Vijay Bhagavath -- Deutsche Bank -- Analyst

Yeah hi. Two questions, the first is for Eric and Alex, Karen, please jump in too which is -- how would you scale the seat in the sense of if you have a set of customers, what's the strategy to up-sell NI portfolio to current customers? And then also add new logos and use cases? So that's the first part of the question.

And then the second part of the question is, help us understand, how should we think about product gross margins, OpEx and also, mix as we head into the New Year? Thanks.

Eric Howard Starkloff -- Executive Vice President of Global Sales and Marketing

Okay, Vijay, I'll take the first one. I think your question is about sort of scaling our position within the customer account and then also getting new customer accounts. And so that is absolutely a part of our strategy and I have referred to, some of the evolution that we've been going to with our sales organization, which is targeted at exactly at this point.

The strategy, I'll just say a few words, is predicated on our software position and it really starts with getting a software position in accounts and as I think you know, we have a very strong software position across the industries and customers that we serve.

And we've been building on that over the last number of years by getting enterprisewide agreements of our software at many of our top accounts and that continues to be a focus of our sales organization. And we believe that gives us a strong position for getting product and system-level sales in those accounts.

Going forward as I've said, we're putting more focus on delivering higher value. What we mean by that is providing more of the systems capability in the target industries and applications that we think will drive the most growth ads another play to get more value into the accounts that we are already serving.

We also, of course, have a focus on getting more customers over time through extending some of the applications we serve and do our broad touch of the way we serve the market through inside sales and through our partner network. We have a very broad reach and a healthy pipeline of new customers that we're also bringing in. And Alex, will you take the --

Alexander M. Davern -- President, Chief Executive Officer and Director

Yeah. Sure. Just want to build on that and endorse what Eric said, we've always led with software and I'm really pleased to see this year, the best order growth through software, our best new seat growth that we've seen in quite a number of years.

And I'm really pleased with the rollout of LabVIEW NXG as well as the new higher level of applications that we talked about it and as Eric said, really broadening and deepening our footprint with our best customers and that's a great leverage opportunity for us going forward.

In terms of thinking about operating margin, as Karen laid out at the Investor Conference in May, our goal is to deliver 18% non-GAAP operating margin through the cycle. That implies that we want to be able to exceed that when times are good.

I'm really, really pleased that we're here delivering record revenue, record profit and as I said, on track to deliver our 18% target this year, a year ahead of our original plan. Looking forward, we do intend to continue to drive operating leverage into 2019 and we'll build on that strong software position and strong gross margins to deliver that going forward.

Karen M. Rapp -- Executive Vice President, Chief Financial Officer and Treasurer

Yes, thanks, Vijay, and as we continue that journey in 2019, we're really happy that we've been able to accelerate some of that into 2018 and the success that we've had. Our goal is to continue to provide that 50% flow through over the two-year period. So we're still working on the target of 19% in 2019. But of course, as we are more successful, there'll be more variable pay that flows into these numbers as well.

Vijay Bhagavath -- Deutsche Bank -- Analyst

Yes. Very helpful. And a quick follow-on for you, Karen, in terms of M&A and inorganic growth, how much flexibility do you have on the balance sheet and also in cash flow generation to explore M&A growth versus organic growth? Thanks.

Karen M. Rapp -- Executive Vice President, Chief Financial Officer and Treasurer

Yeah. We're really happy with our cash position right now. $482 million is a great place to be. As you know, as our balance sheet continues to be really strong. That gives us of a lot of flexibility. Also we were able to bring a lot of that cash to the U.S. this year and continue to do that, which provides even more flexibility going forward. Really gives us the opportunity to look for the right things that fit with our strategic direction.

Vijay Bhagavath -- Deutsche Bank -- Analyst

Okay. Thank you.

Operator

Thank you. And our next question comes from the line of John Marchetti with Stifel. Your line is now open.

John Marchetti -- Stifel -- Analyst

Thanks very much. A couple of quick questions, if I can. Just to follow-up maybe real quick on that last one, Karen, on the flexibility around M&A, would you guys consider going to the debt markets or raising some additional capital to do something maybe large or something along those lines? Or when we think about M&A, should we consider it to be largely tuck-in, maybe a little bit on the software side, something along those lines?

Alexander M. Davern -- President, Chief Executive Officer and Director

Yeah. John, it's Alex here to help answer your question. I think we've made a lot of progress in these last two years and critical for us on this journey over the last two years is to hit our own profit goals so that we can generate the cash flow necessary to create new opportunities and new options.

We've also been focusing our strategy very, very deliberately and that focused strategy and significantly improved profitability creates a much better platform for us to consider the use of our M&A as a strategy accelerator and that's what we've been doing as we move forward.

John Marchetti -- Stifel -- Analyst

So just following up there for a second, Alec, obviously, with the promotion of Eric and congratulations Eric, but with his promotion and kind of your focus there talking about looking for ways to accelerate, so should we take it and you feel like the company is in that spot now where it can start to maybe cast a little bit of a broader net to look for some of these opportunities?

Alexander M. Davern -- President, Chief Executive Officer and Director

Yes, I think we are operating and performing at a very high level. We have an aspiration and an ambition to be the leader in software-defined automated test, automated measurement system that implies scale. So we're very focused on achieving that as part of our long-term goal.

And certainly, we value organic growth incredibly highly. That is our primary strategy. But as we focused our strategy, it's given us more of an opportunity to consider tuck-in acquisitions or other as a -- in a way to accelerate our achievement of that strategy.

And so we'll be open to what is effective at driving us toward our goal and while I have the floor, I do want to congratulate Eric also myself. He and I worked together for the last 20 years and I'm really looking forward to him taking on his new role and allowing me to be able to play a higher level role from a strategy point of view as we move forward.

I think that's management's bandwidth, we've got a lot of thing to execute on, lot of great opportunities and so I welcome this evolution of our structure that, I think, will make us much more effective going forward.

John Marchetti -- Stifel -- Analyst

Great. And if I can maybe just throw one more in there then for Eric. You've done a lot of work over the last year or two on that sales force transformation. Can you just -- where do you think that stands now? Have you got all of that sort of behind you? Are there still areas to address? Just, obviously, you're starting to see some of the results from that on the systems level. Just curious where that whole process stands at this point?

Eric Howard Starkloff -- Executive Vice President of Global Sales and Marketing

Yeah. Thanks, John. So as we've characterized before, it is a multi-year journey. We have made significant progress. We believe we're starting to see some of the impacts of the progress we've made in our results. And we -- but we still have opportunity to continue to grow in that dimension. So it's going to continue to be an area we're working on.

The thing that I'm most excited about in this timeframe is really connecting these multiple different areas of evolution that we're going through as a company, together to align all the way from the needs of our customers, through the way we're developing our platform to meet the needs that we think and the opportunity that's out there in the market, and to meet the ambition that Alec described. So these things are all being done at concert, but we're very pleased with where we stand on the sales force evolution.

John Marchetti -- Stifel -- Analyst

Thank you very much.

Eric Howard Starkloff -- Executive Vice President of Global Sales and Marketing

Thank you, John.

Operator

Thank you. And that does conclude today's Q&A session. And I'd like to return the call to Mr. Alec Davern for any further remarks.

Alexander M. Davern -- President, Chief Executive Officer and Director

Thank you for your time today. We hope to see you at one of our Investor Conference over the last three months. Thank you very much.

Operator

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

Duration: 25 minutes

Call participants:

Marissa Vidaurri -- Head of Strategic Communications and Investor Relations

Alexander M. Davern -- President, Chief Executive Officer and Director

Eric Howard Starkloff -- Executive Vice President of Global Sales and Marketing

Karen M. Rapp -- Executive Vice President, Chief Financial Officer and Treasurer

Vijay Bhagavath -- Deutsche Bank -- Analyst

John Marchetti -- Stifel -- Analyst

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