National Instruments Corp

F:NI1

Earnings Call Transcript 2021-Q3

[Operator]

Thank you for standing by, and welcome to the National Instruments Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] As a reminder, today’s program is being recorded.

I would now like to introduce your host for today’s program, Marissa Vidaurri, Head of Investor Relations. Please go ahead.

[Marissa Vidaurri, Head, IR]

Good afternoon. Thank you for joining our Q3 2021 earnings call. I’m joined today by Eric Starkloff, President and Chief Executive Officer; and Karen Rapp, Chief Financial Officer. We will start with an update on our performance in the quarter before opening it up for your questions.

Our discussion today will include forward-looking statements, including, without limitation, those regarding revenue, earnings, gross margin, operating expenses, capital allocation, targets, and future business outlook, and guidance, including expected demand for our products, supply chain constraints, backlogs, the potential for impact of COVID-19 on the company’s business and results of operations and successful integration of the acquisitions and execution on our strategy. We wish to caution you that such statements are just predictions and that actual events or results may differ materially and could be negatively impacted by numerous factors.

We refer you to the documents that the company files regularly with the Securities and Exchange Commission, including the company’s Annual Report on Form 10-K filed on February 23, 2021, and our quarterly report on Form 10-Q filed on August 2, 2021. These documents contain and identify important factors that could cause our actual results to differ materially from those contained in our forward-looking statements. We assume no duty to update any forward-looking statements to confirm the statements to actual results or changes in our expectation. A reconciliation of our non-GAAP financial measures disclosed in this call to the most directly comparable GAAP financial measures or related disclosures are contained in our press release and on ni.com/nati.

We recently announced new leadership changes that we believe support our focus in our core business and innovation of new disruptive software technologies to accelerate growth. First, we appointed Thomas Benjamin as Executive Vice President, Chief Technology Officer and Head of Product Analytics. In this role, he will utilize his external experience to lead NI’s development of software driven business models essential to driving new and long-term disruptive technology innovation for long-term growth opportunities, including new areas, tied to data, product analytics and enterprise software.

We also promoted Scott Rust, an experienced NI leader, to the role of Executive Vice President, Platform and Products. In this role, he will lead NI’s global development teams responsible for building the products required to meet customer needs through our core platform capabilities to create differentiation and leverage across NI’s business. Eric will discuss this in more detail. In the coming months, NI management will be hosting meetings at the virtual conferences for Baird, Stifel, Nasdaq and Needham. Please visit ni.com/nati for presentation time. We look forward to speaking with you.

With that, I will now turn the call over to Chief Executive Officer, Eric Starkloff.

[Eric Starkloff, President & CEO]

Thank you, Marissa. Good afternoon. We appreciate everyone joining us today. We reported outstanding results in Q3 with 30% order growth, 19% revenue growth and 83% non-GAAP EPS growth as momentum continued across our business for the fourth consecutive quarter. The strategic changes we made over the last several years are clearly paying off. We are committed to accelerated growth and our focus on secular growth opportunities such as 5G, autonomous and electric vehicles and new technology for space innovation is leading to high customer demand. The leverage and scale of our broad-based business enables us to continue to invest in these higher growth opportunities while significantly growing our profitability.

Shortly after taking on the role of CEO in 2020, I committed to a three-year financial model through 2023. Today, as we are in a position of continued strong demand, record backlog and favorable expense trends entering 2022, we expect to meet or exceed our 2023 expectations in 2022, a full year ahead of schedule. For 2022, our expectations are to deliver double-digit revenue growth even with flat backlog and to achieve another year of double-digit earnings growth. We also remain committed to increasing our recurring software revenue. We have had success with our subscription-based licensing and expect to increase that recurring revenue stream in 2022.

Today, we announced two acquisitions to strengthen our electric vehicle, or EV testing capability, which I'll speak to in a moment. We expect these acquisitions to add an additional $50 million to $60 million to our 2022 revenue and to be immediately accretive to our earnings per share. Looking ahead multiple years, we expect the investments we've made into the business will enable earnings growth to continue to exceed revenue growth.

Now, I want to discuss how we're focused to achieve these results and offer clarity to how the recent leadership announcements that Marissa highlighted will enable us to accelerate growth. We will continue to focus on the core systems capabilities that have driven our growth, while also creating new business opportunities through product analytics and enterprise software.

We believe we are in a unique position with capabilities that link these two growth opportunities together to realize our full potential. So first, we remain focused on strengthening our core systems opportunity. We started this effort more than a year ago with focus through our 4S framework on software, systems, services and streamlining our operations. As part of this initiative, we changed the way we serve and support our customers.

We focused on higher level systems and services to our highest potential customers, while streamlining engagement with our broad based customers to drive leverage and scale. We believe the strong growth and success that we've seen across our business this year is a direct result of these changes. We are delivering on this strategy and it is leading to record revenue and operating income.

We have communicated that strategic acquisitions align to our strategy is a lever we are prepared to use to accelerate growth. And this morning we announced the acquisition of NH Research, a leader in high power test and measurement applications such as electric vehicles and batteries. We also entered into a definitive agreement to purchase the EV systems business of Heinzinger, a European leader and high current and high voltage power systems. The focus of these acquisitions is to accelerate growth in fast growing EV applications.

We believe combining the strength of NI’s flexible EV test platform with these companies, high power systems expertise will enable us to optimize testing workflows and accelerate the time to market for our customers in this critical technology inflection. We also plan to drive long term growth through new business opportunities and product analytics and delivering increased enterprise level value through data. This effort is critical as it represents a new level of value we can deliver to our customers and an opportunity to disrupt our industry for long-term growth.

This journey began with the combination of NI and optimal plus platforms last year. Our new CTO, Thomas Benjamin, has deep expertise in enterprise software businesses and will drive our product analytics growth opportunities across all of our business units. He's also working with my leadership team on how we can further strengthen our core systems across the business through software and the leverage of modern cloud and mobile technology.

This focus will make our business both more differentiated as well as more resilient. Our focus on NI core capabilities and new opportunities enables us to balance our short-term and long-term growth goals with the right investments needed to ensure their success. Our industry focus has strengthened our customer relationships and tuned our business to the secular opportunities that are driving our growth.

Our semiconductor electronic business continues to be a strong growth driver for the company, NI proof point of our more focused strategy. We believe the move to higher frequency bands for wireless applications will play to our strengths. In addition, we believe our connected lifecycle and analytics solutions open up new ways to support the needs of our customers throughout their product development flow, allowing them to use software to derive predictive data insights. In transportation, revenue for EV and active, safety or ADAS combined increased nearly 60% year-over-year in Q3, and we expect these two focus areas to represent more than half of our total transportation revenue by the end of 2022. We predicted this part of our business would strengthen and drive growth this year, and it has delivered.

Our aerospace, defense and government business remains a steady and profitable growth engine with growth in both 2020 and 2021. Our success continues with focus on new space innovation and continued strength in defense applications. Our focus on insights from data presents a clear opportunity in this area as well. And our portfolio business continues to deliver strong results with its third consecutive quarter of year over year revenue growth. We continue to exceed expectations across this broad set of customers as we focus on leverage and resiliency in this portion of the business. Our strategy of providing easy to use solutions through e-commerce and global distribution channels is paying off.

In summary, our customers are pursuing major technology inflections, including wireless communications and 5G, autonomous and electric vehicles and new technology for space innovation. Each is a major technology hurdle that for many customers is a once in a career inflection point. Our unmatched expertise in modular systems and test automation software across the workflow make NI uniquely positioned to help our customers navigate these challenges and to take advantage of the prevailing software trends so they can get more value out of their test systems and improve their development and manufacturing operations.

With that, I'll turn the call over to Karen to discuss further our Q3 results and our outlook for Q4. Karen?

[Karen Rapp, CFO]

Thanks, Eric. Hello, everyone. NI delivered another quarter of strong financial results. Q3 revenue was $367 million, up 19% year over year and a record for the third quarter. We continue to navigate through supply chain constraints with results aligned to our expectations. Unplanned freight issues at the end of the quarter, resulting in revenue slightly below the midpoint of our guidance. However, customer demand continues to be strong. Q3 ended with backlog of $143 million, up $160 million from the start of the year.

Total orders in Q3 were $404 million, an all-time record for the company and up 30% year-over-year. In the Americas, orders were up 28% year-over-year, and EMEA orders were up 23% year-over-year. And in Asia-Pacific, orders were up 39% Year-over-year. For the third quarter, orders from focused accounts were up 27% year-over-year, and orders from broad-based accounts were up 37%. Due to the negative impacts of COVID in 2020, we believe it is also helpful to compare results to pre-pandemic performance. For Q3 2021 versus Q3 2019, total orders were up 21%.

Orders for focused accounts were up 25% and orders for broad-based accounts, which were hit the hardest in 2020 were up 12%. We're pleased to see double-digit growth for the two-year compare and believe this is another solid proof point that our customer focused strategy is working. Our lead times remain competitive and an average of approximately five weeks. And we are seeing less than 1% of cancellations due to this expansion.

We also converted the vast majority of our Q2 ending backlog into revenue within the third quarter. Despite the ongoing supply chain constraints in the short-term, the momentum in customer demand for our systems, combined with the durability of our backlog, gives us confidence for continued revenue growth in 2022. Q3 revenue was strong across all business units. Semiconductor and electronics revenue was $95 million, up 31% year-over-year, with ongoing strength across wireless customers in Asia.

Transportation revenue was $51 million, up 41% year-over-year, with continued success in our focus areas of EV and ADAS. Aerospace, defense and government revenue was $91 million, up 3% year-over-year in Q3, building on the strong performance delivered by this business unit in 2020. And we are pleased to see the third consecutive quarter of revenue growth in our portfolio business unit at a $131 million, up 16% year-over-year a testament to the success of our broad based initiatives.

Year-to-date, software and related services revenue increased 16% year-over-year compared to our total company revenue growth of 14% year-over-year and represents 21% of total revenue. Annual recurring revenue now represents 18% of total NI revenue. In Q3, we generated $67 million of non-GAAP operating income, translating into a non-GAAP operating margin of 18.2% for the quarter and 18.1% on a trailing 12-month basis.

Q3 non-GAAP gross margin remained solid at 75%. Non-GAAP operating expenses are up 10% year-over-year, driven by an increase in variable pay. As previously discussed, our variable pay is tied to the annual revenue and profit performance of the company. We reported Q3 GAAP net income of $27 million and diluted earnings per share of $0.20. Q3 non-GAAP net income was $55 million and diluted non-GAAP earnings per share was $0.42, exceeding the midpoint of our guidance and an increase of 83% year-over-year.

Now, let me comment on our capital management results, starting with our cash generation, cash flow from operations was $86 million year-to-date. We've built inventory of $43 million during this time period as a result of the continuing supply chain challenges. We expect inventory growth to continue through early 2022. We defined free cash flow as cash flow from operations, less capital expenditures. Free cash flow on a trailing 12-month basis was $119 million. In the quarter, we paid $36 million in dividends and repurchased approximately 600,000 shares of our stock at an average price of $41.73. In total, we have returned $176 million to our shareholders in the past 12 months, reinforcing our commitment to shareholder returns.

Our balance sheet remains strong with $231 million of cash and short term investments at the end of the third quarter. The NI board of directors approved a quarterly dividend of $0.27 per share, payable on November 29, 2021, to stockholders of record on November 8, 2021. The acquisition of NH Research was funded primarily through our existing credit facility in October 2021. Our history of positive cash flow allows us the flexibility to fund future M&A through either the remaining undrawn balance on our existing credit facility or through access to other capital markets.

We expect to fund the Heinzinger EV Systems acquisition through cash on hand. We view our strong cash position as a way to provide returns for our shareholders through dividends and share buybacks. We will continue to prioritize inorganic investments to accelerate long term growth when aligned to our growth strategy and industry focus.

Now, shifting the guidance for Q4 2021. Though our backlog and customer demand continue to be strong across all industries and regions, supply, pricing and logistics dynamics remain a challenge. We believe Q4 revenue will ultimately be a function of supply, so we are widening the range of our guidance. With our current visibility for the fourth quarter of 2021, we expect GAAP revenue to be in the range of $385 million to $425 million.

At the midpoint, this would be 13% revenue growth in fiscal year 2021, at the high end of the expectation, we outlined in our August investor conference. Demand exceeds this guidance and we expect backlog to end the year in the range of $180 million to $190 million, representing over $130 million of future profit and competitive lead times of approximately six weeks. This guidance is based on our current understanding of impacts of COVID-19 and supply issues.

With this outlook, total orders in 2021 would exceed $1.6 billion for the year, up over 20% year over year. We expect GAAP diluted earnings per share will be in the range of $0.17 to $0.31 for Q4, with non-GAAP diluted earnings per share expected to be in the range of $0.47 to $0.61. Our GAAP earnings per share includes $0.09 related primarily to restructuring and other costs, driven by a consolidation of one of our R&D sites in Germany, impacting less than 1% of our head count. At the Q4 midpoint, non-GAAP earnings per share for the full year 2021 would be up 30% year over year. Our Q4 guidance includes a partial quarter from our recent acquisition of NH Research. The operating margin of this business is accretive to NI and the flow through to earnings per share is also included in our guidance.

Looking forward to 2022, we're encouraged by the strength of our customer demand, durability of our backlog and our current view of the macro environment. However, we expect to see supply chain constraints continue through at least the first half of 2022. We expect our pending acquisition of the Heinzinger EV Systems business to be complete in Q1 2022. Combined, we expect NH Research and Heinzinger to represent 3% to 4% of total and NI revenue in 2022 due to the complementary nature of these companies to NI’s priorities we expect that there will be minimal cost synergies from these transactions. The focus is to accelerate growth and utilize the expertise of these two leading technology companies to broaden our reach to customers in the fast growing space of electric vehicles.

For 2022 given the investments we've made to scale and grow the business and the current market assumptions in our focus areas, we expect another year of double digit revenue growth in the range of 16% to 18%. We expect component pricing pressure on gross margin offset by continued robust expense management and minimal impact from variable pay to drive overall improvement and operating margin. We currently expect to exceed our 2023 goal of 20% operating margin in 2022. For 2022, we are targeting earnings per share growth above our revenue growth.

In closing, we will continue to strengthen our competitive advantages and make our business stronger and more resilient. We remain committed to accelerating growth, improving profitability and maximizing shareholder value.

Now, I’ll turn the call back over to Eric for some closing comments.

[Eric Starkloff, President & CEO]

Thank you, Karen. We demonstrated the strength of our business and our strategic focus in Q3 and believe we have good momentum to close out 2021 and enter 2022 in a position of strength. We continue to focus on delivering on our commitments by strengthening our core and investing in new disruptive technologies that help our customers improve their businesses. We believe our software and systems capability cannot be easily duplicated, creating high barriers to entry. And as our customers’ problems become increasingly more complex and challenging, we believe we are best suited to ensure their success in the market.

I am confident that through this intentional focus, we can accelerate growth and maximize shareholder value. And I want to once again thank all of our employees for their perseverance and the multiple years of focus and hard work that has put us in this position of strength.

With that, we’ll now take your questions.

[Operator]

Thank you. [Operator Instructions] Our first question comes from the line of Mark Delaney from Goldman Sachs. Your question, please.

[Mark Delaney, Goldman Sachs]

Yes. Congratulations on the good results and outlook, and thank you for taking the questions. First is on the acquisitions, both tied to electrification and EVs. I'm curious, is there a reason you're announcing them both at the same time and how important is it that you do both of them in order to have the full set of solutions you'd like to build or do each of them make sense independently and you spoke to the revenue side pretty specifically from the deals, can you elaborate a bit more on the margin and EPS impact of the acquisitions?

[Eric Starkloff, President & CEO]

Yeah. Mark, I'll start. Thanks for your question. I hope you're doing well. Yeah. These are really important deals. Let me characterize the opportunity here. First of all, as I mentioned, this is the fast growing space, the market itself growing 30% to 40%. We've already seen this as a major growth driver for our business in the portion that we serve today. The thing to understand about these two businesses is one is they're highly complementary to our existing capability.

And what I mean by that is we have existing capability for measurement and software and analytics and these two companies have high powered electronics, which is really needed to complete the whole system. And then they're highly complementary to each other, primarily in their geographic footprint. NH Research, primarily serving the US market and Heinzinger is primarily serving the European market. So doing those together, we view as an opportunity to rapidly scale our solution capability in this space.

And as I've said, in an area that's growing really fast and our customers have a lot of urgency. You've heard all the announcements from various EV companies. There is a ton of urgency for them to get this technology in the market. And so we see a strong demand and it's our goal to be in a position to service that growth in demand with this complete capability. Karen, you want to comment on the margin side?

[Karen Rapp, CFO]

Yeah. Sure. From a profitability standpoint, they are so complementary in the way profitability standpoint, they are still complementary in the way that they are expanding our revenue and reach with customers that were actually looking them, at them combined, which is why I commented on the fact that we're pleased that they are immediately accretive to our current margin position. So if you look at where we are from an NI perspective, they will actually continue to increase that percentage of operating margin combined for NI.

[Mark Delaney, Goldman Sachs]

That’s really helpful. Yeah, if I could just add one follow-up on the 2023, excuse me, the 2022 outlook and meeting the 2023 target model a year ahead of time, just given the supply constraints and I'm curious what gives you the confidence to be getting out your revenue and it's a very impressive number and so good to see that. But yeah, if you could talk a little bit more, I was giving you that confidence, that’d be helpful.

[Eric Starkloff, President & CEO]

Yeah, Mark. Good question. So yeah, we laid out that model as I mentioned back in 2020. I don't know if everyone believed at the time that we would be able to hit it. So it's pretty exciting that we find ourselves in a position of confidence to hit it a year early. Let me describe a little bit of the confidence and then Karen can chime in as well. First of all, if you look at where we're going at, we believe will end this year based on the guidance, the bookings number at about $1.6 billion. So you can see that even with a sort of one – a book-to-bill of 1% million that provides double digit growth going into 2022. So we think that's just a very, very favorable position. We expect the demand to stay strong certainly in the first half of the year.

And then while the supply will continue to be a challenge, we expect that for the first half of the year. We do believe during calendar year 2022 that that will moderate during the year. And so that is also built into that expectation that gives us that confidence of the 16% to 18% top line growth.

Last one I'll say is just and Karen mentioned it, but we think we're also in a favorable expense position as well. We had a pretty challenging compare to this year, when you look at going from a negative year to a really strongly positive year in terms of variable pay. We have absorbed that expense increase this year and as we look into 2022, we would expect that that's a flat and that gives us a really good expense position as we go as well. And that's why we also expect to exceed that operating income target that we set for 2023 a year early.

[Mark Delaney, Goldman Sachs]

Thank you.

[Operator]

Thank you. Our next question comes from the line of Rob Mason from Baird. Your question, please.

[Rob Mason, Baird]

Yes, good afternoon. Nice job. Nice job. Just to go back to the acquisitions. Eric, where do these companies play, maybe just in the value chain, is it more focused on design validation or is it the production floor and then I guess when we look at your overall solution, where do you expect the majority of the opportunities to reside?

[Eric Starkloff, President & CEO]

Yeah. Thanks. Thanks, Rob. So don't do - don't play in both areas, although mostly in validation. So if you think about both batteries and things like inverters and electric motors, there is a really intense focus on the characterization and testing of those in validation. The battery, in particular, is the most expensive component in electric vehicle and being able to understand the characteristics of that, the quality of that, the lifetime of that becomes an essential element of the performance of the vehicle. So there's a huge focus by OEMs, as well as suppliers of batteries, inverters and other components of the electric vehicle. So mostly validation, but the technology also scales to production as well.

[Rob Mason, Baird]

I see. And then the other question is just around your semiconductor test business that's been a source of strength for a bit. You kind of suggested all your markets are strong, all your regions are strong. But as you look into that one in particular, you're seeing some hints around – concerns around inventories and whatnot starting to get up a little bit. And I'm just curious, how do you think that if there is some type of inventory pause mid-cycle, pause or whatnot given where your position, how that businesses position, how do you think that plays through to your demand levels if that resides somewhere in 2022 or as we go through the year?

[Eric Starkloff, President & CEO]

Yeah. I understand your question, Rob. And that's sort of built into our expectation. It's of course, there's at some point that that semi-cycle will moderate. But I want to characterize a couple of things. We've shared this before, but our semi business and that business unit is semi and electronics, by the way. So it includes both the semiconductor portion as well as sort of the downstream electronics that we include. And then within semi, we said before it's about half production and about half validation.

So and then now with OptimalPlus and that technology, we have the data analytics that also scales across validation and production. The point there is that we are to some extent insulated from the pure production cycle and we see a pretty favorable long-term picture in semiconductor when you think of the strong investments that are being made around the world to build additional semiconductor capacity in multiple regions, as well as some of the secular drivers on wireless and the new frequency bands that are coming for 5G and other wireless standards.

There's a lot of lab equipment, as well as production equipment going into that, that we think our will help moderate what will eventually be some sort of down cycle on the production side of semiconductor, in semiconductor production. And so, that's all built into some of the expectations that we shared for 2022.

A - Karen Rapp

Yeah, Rob, this is Karen. The core of NI is to automate processes and so what we're seeing across semi and all of the industries that we serve is, as things tighten in their space, labor shortages, whatever that may be, the desire for more automation feeds right into an area where NI can really come in and help. And as I mentioned, that's where data plays a key role as well coming in and providing that that view to their process that they haven't had in the past. So we feel really good about the opportunities in those areas across semi and the other industries.

[Rob Mason, Baird]

I see. Just lastly, one quick question. There was a reference earlier in the commentary around backlog being flat next year, but I was not sure if that was the assumption that's built into the kind of 16% to 18% revenue growth?

[Eric Starkloff, President & CEO]

Yeah. So I made that comment. And so, I’ll just – yeah, my point there was that kind of the point I was also answering in Mark's question is that given the strong bookings, the $1.6 billion plus what we expect to have this year, we expect to be able to achieve double digit even with that backlog. We don't know exactly where backlog is going to end this year. Karen gave a range and so whether it will be flat or not sort of depends on where we end this year, it is a – of a strategic interests for us to have certainly larger backlog as we have more of our systems business, we expect that to be a larger number. So exactly where it will be, we'll see how it plays out. But certainly, we have the ability to achieve a strong double digit growth, even if that number is flat in 2022.

[Rob Mason, Baird]

Understand. Understand. Okay. Thank you.

[Eric Starkloff, President & CEO]

All right. Thanks, Rob.

[Operator]

Thank you. [Operator Instructions] And now I’d like to hand the program back to Eric Starkloff for any further remarks.

[Eric Starkloff, President & CEO]

Okay. Thank you all for joining us today. Have a great day and stay safe.

[Operator]

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.