Q2 2022 National Instruments Corp Earnings Call

July 28, 2022

Good day, ladies and gentlemen, thank you for standing by and welcome to the second quarter 2022 earnings conference call.

At this time all participants are in a listen only mode. After the speaker's presentation there'll be a question and answer session. Just a question. During this session you will need to press star one one please.

Please be advised that today's conference maybe recorded.

I'd now like to turn the conference over to your speaker host, whereas the Dubai head of Investor Relations. Please go ahead.

Good afternoon. Thank you for joining our Q2 2022 earnings call I'm joined today by Eric <unk>, 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 to your questions.

Our discussion today will include forward looking statements, including without limitation those regarding the company's expectations of meeting or exceeding financial targets, it's capital allocation financing and investment plan the payment of its quarterly dividend and its future business outlook and guidance.

Including demand for its products ability to realize revenue from backlog future results of acquired companies and execution of growth strategies.

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 22022.

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 statement to conform the statements to actual results or changes in our expectations.

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 I Dot Com slashdot.

You can find the press release and quarterly presentation to supplement today's discussion on our website and I got com Slash natty.

On May six we announced the closing of our acquisition of the test system.

Automation AG, we believe that this investment along with others, we've made in the space.

Accelerate our ability to serve customers in the high growth area of vehicle electrification. We view this acquisition that the tuck ins that will contribute to our software technology roadmap and puts us in a leadership position for vehicle electrification test system.

We purchased this business for approximately $57 million and we funded the transaction with cash drawn under our existing revolving credit facility.

In connection with the acquisition of approximately 200 employees joined Ni.

As is our annual tradition, we will host an investor conference in September with more details to be shared in the coming weeks.

In addition management will also be hosting meetings at the Goldman Sachs Conference in September and the Baird Conference in November we look forward to seeing you there.

With that I will now turn the call over to our Chief Executive Officer, Eric <unk>.

Marissa good afternoon, we appreciate everyone joining us today.

We're really pleased with our performance this quarter, our focus on areas, where we exhibit competitive strength is exceeding our expectations and we continue to drive strong momentum in customer demands delivering record Q2 orders revenue and non-GAAP earnings per share.

Key takeaways for Q2, our order growth of 20% year over year and revenue up 14% year over year, our focus strategy is leading to ongoing share gains.

Earnings growth up 15% year over year in the first half enabled by expense discipline, even as we navigate unprecedented short term pressure on margins due to supply chain constraints.

And we are reiterating our expectations for revenue in 2022, as well as our expectations to meet or exceed our guidance of 100 basis points of non-GAAP operating margin expansion each year from 2022 through 2025.

We view this as a foreign expectations and expect to deliver well above this level in 2023, I will comment specifically on our 2023 expectations later in the call.

Before carrying discusses the financial results for the second quarter I want to address a few key topics, including potential future headwinds that our industry. Why we believe we are performing well in the current landscape our industry results in the quarter and a preview of our expectations for 2023.

First let's discuss potential headwinds in more detail.

The outlook on our markets as mixed on the supply side the challenges in global supply chains continued in Q2.

<unk> is a certain components limited our ability to ship product in line with very strong demand.

However, these constraints did not get meaningfully worse from last quarter and we are now in a better position to navigate the short term headwinds.

I'm confident the decisions we've made over the past several months, including increasing prices, adding new suppliers promoting alternative products and redesign redesigning products to use available components with similar capability are positioning us well to succeed in the current environment.

In addition, the combination of our purchasing efforts and some loosening in the supply chain has the potential to drive financial tailwind into 2023.

Turning to the macro while our demand remains robust we acknowledged the likely softening of the macro environment compared to a very strong environment in 2022 and are anticipating and even planning for this headwind, particularly in elements of our portfolio and semiconductor businesses.

Despite these potential macro headwinds, we believe that our intentional focus on higher growth markets very strong bookings growth over the last six quarters.

<unk> backlog position.

Growing recurring revenue and the steps we've taken to manage our expenses gives us the ability to achieve significant revenue and earnings growth even in a potential down cycle.

We believe our strong performance over the last several quarters is directly correlated to the strategic shifts we've made it our business to drive growth.

Our highly differentiated modular hardware and industry standard automation software align well to the critical customer needs and segments with powerful growth drivers, including electric and autonomous vehicles wireless communication and new space technology.

Our order growth of 22% year over year through the first half and over 50% over the first half of 2020 as both a leading indicator of our business and a proof point to the success of this strategy.

Now onto results by industry, the second quarter.

Across the industries, we serve we have honed our strategy to focus on top accounts to increase our share of wallet ensure operational efficiency and better target our offerings to key customers.

In return we've seen an increase in program wins and standardization on Ni technology as well as expansion of cross workflow opportunities from R&D to production test further increasing our served available market.

Semiconductor and electronics reported all time record Q2 revenue up $116 million up 17% year over year with orders up 10% year over year.

So we expect some future slowdown in the growth of our semiconductor business. We believe the areas that we're focused on wireless mixed signal and industrial will remain much more robust than consumer devices in particular the needs of the wireless market will continue to drive demand for test capability for wireless infrastructure, including millimeter.

Right.

As we've noted before approximately 50% of our semiconductor and electronics business unit revenue comes from production test and the other half of the segment is in R&D, which is considerably less exposed to the fluctuations of the semi cycle. In fact, we have been intentionally forward investing and standardized automated test systems for R&D validate.

<unk>.

As well as supporting the semi industry is large fab investments and expect these areas to be ongoing growth drivers.

What are the biggest challenges that wireless device makers faces the sheer complexity of wireless devices, which drives up validation time.

Our technology enables customers to get their products to market faster by reducing this time.

For example at Qualcomm, we enabled a reduction in measurement time for validation systems of 40%.

This team also uses ni software and data analytics across their workflow and there is a lead user on our next generation millimeter wave test technology.

We believe the combination of our exposure to R&D test and our ongoing progress in delivering software across the semiconductor workflow will soften the impact that a semiconductor downturn will have on our business.

Transportation reported record Q2 revenue of $66 million up 35% year over year with orders up 62% year over year.

Our strategic shifts in focus to EV, and Adas, where our customers are making significant investments has changed the trajectory of this business and we expect that we will continue to deliver market leading growth rates.

In Q2, EV and <unk> represented approximately 40% of our transportation business and we expect will exceed 50% of our transportation business by the end of this year.

One recent success is at GM for their partnering with Ni and our data management and analytics platform to allow them to connect all of their battery test data and quickly develop the insights they need to bring their battery technology to market at scale.

Aerospace defense and government delivered outstanding results with record revenue for Q2 of $100 million.

Up 15% year over year with orders up 25% year over year.

Our growth here continues to be fueled by defense spending and the current demand backdrop in this area is healthy and along with our growing relationships and top atg accounts gives us confidence in the continued growth of this business.

We also continued to see rapidly accelerating opportunities in new space technologies, including launch vehicles and satellites.

And our portfolio of business, which serves the majority of our broad based customers achieved revenue in Q2 of $113 million up 2% year over year with orders up 6% year over year.

As I mentioned earlier. This is an area. We think is most susceptible to a softening macro environment.

Our focus on utilizing global distribution to better position, our offerings and optimizing our digital channel to these broad customers has gained traction.

Further providing leverage and scale in this portion of our business.

Today distribution represents 15% of total orders for the company up from 10% last year.

Longer term, we expect our transition to software subscription will improve the resiliency and growth opportunity for this business.

Across the industries, we serve our business is well positioned to both R&D validation and production tests, we estimate across industries that approximately 60% of our business is in R&D and 40% in production, our software and data analytics platform enable us to uniquely deliver value across these two areas and gain more share.

Wallet at key accounts.

Now look ahead to 2023.

We remain confident in our ability to meaningfully increase our operating margins. It is a top priority for me and my team and there are many key initiatives underway to ensure we deliver on our commitments to expand margins. This.

This includes channel optimization, increasing share of wallet at top accounts driving scale and leverage in our broad based customers increased R&D efficiency in G&A cost management.

We are committed to achieving an increase of our non-GAAP operating margin of 100 basis points each year for 2022 through 2025 with potential for upside should our revenue and share growth continued to exceed our expectations.

Fact, even though we are currently planning for a weaker macro entering 2023, we expect to deliver revenue growth on the order of 2020 two's growth rate and operating margin well above our previous expectations with approximately a 300 basis point increase over 2022.

There are several factors that we believe will drive our performance.

Our exposure to key growth opportunities and secular cycles, particularly in transportation and AVG.

Our expectation for strong backlog entering 2023.

Favorable gross margin impact as supply chain pressures ease.

The growing impact of recurring revenue.

And the full year impact of our expense management focus.

We plan to walk through these elements to our model and discuss our three year strategic plan at the Investor Conference that Marissa mentioned and I hope to see you all there with that I'll turn it over to Karen to discuss Q2 results in more detail and our outlook for Q3 Darin. Thanks, everyone.

In Q2, our GAAP revenue was $396 million up.

A 14% year over year and ahead of the midpoint of our guidance.

Dollar had a negative impact to revenue of approximately 2% in Q2.

Core revenue growth, including the benefit from price increases was up approximately 13% for Q2.

Approximately 3% of Q2 revenue growth was from our recent <unk> acquisition.

Their test system business combined with the previous acquisitions of NH research and Zinger accounted for approximately 17% of transportation revenue in the second quarter.

Pleased with the strong customer demand and revenue synergies that we're seeing from the integration of these companies with Eni.

Demand remained strong in Q2 with orders up 20% year over year.

For the second quarter orders were up 33% year over year in the Americas.

Up 7% year over year in EMEA.

And up 16% year over year and Asia Pacific.

We ended the quarter with backlog of approximately $250 million up about $40 million sequentially.

We continue to have competitive lead times of approximately eight weeks.

Demand continues to exceed our expectations and supply chain constraints.

This firmly see the growth in backlog as a revenue timing issue only.

Confidence in customer demand and our ability to eventually realize this revenue when the supply chain disruptions ultimately he's remained strong.

Because our solutions are often a capital expense and provide unique capabilities for our customers.

Not typically incur any double ordering risk and we have not seen anything that would indicate a change to that historic pattern.

Q2, non-GAAP gross margin was 71% down 4% year over year, driven by broker pricing for difficult to find components as we continue to prioritize the needs of our customers.

We expect these temporary headwinds to continue through the second half of the year, while the supply chain constraints.

However, we saw some improvement in our ability to procure components from our traditional suppliers in Q2.

And anticipate a sequential decline in broker buys in Q3.

We expect to reduce broker purchases to benefit our 2023 margin.

In Q2, we generated $21 million of GAAP operating income and $61 million of non-GAAP operating income.

Our non-GAAP record for our second quarter translating into a non-GAAP operating margin of 15% for the quarter.

We reported Q2, GAAP net income of $12 million and diluted earnings per share of <unk>.

And record Q2, non-GAAP net income of $48 million and record diluted non-GAAP earnings per share of 36.

An increase of 3% year over year.

Now, let me comment on capital management.

Our balance sheet remains strong with $111 million of cash at the end of the second quarter cash.

Cash flow from operations was minus $41 million in the second quarter.

Given primarily by $36 million of inventory growth as well as the timing of revenue in the quarter.

As anticipated in Q2, we continued to invest in inventory to enable us to ship systems to customers as soon as the final components are available.

In Q3, we expect the net pre tax cash inflow of approximately $31 million. This represents the proceeds from the sale of unused property offset by a contribution to our donor advised fund to support our corporate impactful.

The income statement impact is included in our GAAP guidance.

We expect our inventory position to turn into a tailwind for future cash.

The supply constraints ease and the need to build inventory of tests, we expect.

To bring inventory down, enabling us to generate cash at historic levels or better.

We expect our cash flow from operations to improve in Q3, two sequential revenue growth and reduced broker part purchasing.

We anticipate this improvement will help deliver double digit cash flow from operations as a percent of revenue in Q3.

In the second quarter, we returned $76 million to shareholders through dividends and stock repurchases.

We repurchased approximately 1 million shares at an average price of $39 six.

Keeping our share count flat to Q2 2021.

Approximately $190 million remains on the repurchase authorization approved by our board of directors on January 19 2022.

The Ni board of directors approved a quarterly dividend of <unk> 28 cents per share payable on August 29, 2022 to stockholders of record on August eight 2022.

The board of Directors also approved the company expanding its existing credit facility and increasing the total amount available for borrowing from $500 million.

To a maximum of $1 billion.

We have begun related negotiations with our lenders and expect to secure their commitments in the near future.

On the guaranteed once the deal is actually side.

This will provide additional borrowing capacity and flexibility in anticipation of supporting future growth and our commitment to deliver shareholder value.

Our capital allocation strategy strategy remains thoughtfully balanced we will continue to invest in organic capabilities to ensure we stay ahead of our customers' technology needs and prioritize inorganic investments strategically aligned to the business in order to drive growth.

At the same time, we will continue to look for opportunities to return cash to shareholders through our dividend and stock repurchase programs.

Now shifting the guidance for Q3 and beyond.

For the third quarter of 2022, we expect revenue to be in the range of $410 million to $440 million.

At the midpoint this represents 16% revenue growth year over year.

Our guidance takes into consideration the best information, we know today about the deliveries from our suppliers.

We expect GAAP diluted earnings per share will be in the range of 34 to.

<unk> 48 for Q3 with non-GAAP diluted earnings per share expected to be in the range of 46.

<unk>.

An increase of 26% year over year at the midpoint.

We expect our tax rate in 2022 to be between 16% to 17%.

We've been actively transitioning our single seat licenses to a subscription based model and believe this shift will improve our ratio of recurring revenue through software and related services drive more predictability and a meaningful uptick in customer lifetime value to ni.

We're on track with this transition and as we've said in the past, we expect a headwind of approximately $30 million to our 2022 revenue and operating profit, which is factored into our guidance.

We expect Q4 revenue to be stronger than normal seasonality due to the work we've done to reduce the impact of supply constraints.

We remain confident in our ability to continue to navigate the situation and our expectations for the full year are in line with current consensus estimates for revenue and earnings per share.

As Eric mentioned, we see the opportunity to meaningfully accelerate our profitability next year.

From a revenue perspective on top of the strength of our focused market area, we will be leaving 2022 with excess backlog that we intend to reduce in 2023, assuming the supply constraints ease.

We also expect our shift to subscription based software licenses become a tailwind.

In addition, we will benefit from the price increases implemented in 2022, and a full year of the revenue synergies from our acquisitions.

We expect significant tailwind in gross margin in 2023, with the easing of supply constraints and reduced need for broker purchases.

This alone is expected to be a 400 basis point headwind in 2022 that we believe will begin to moderate significantly in 2023.

And we continue to see the benefits of the actions we have taken to increase scale into our business model.

The temporary headwinds to gross margin, we have improved non-GAAP earnings per share by 15% year over year in the first half of 2022.

Looking ahead, we will continue to sharpen our.

Realigning processes for greater efficiency.

With many key initiatives underway, we are confident in our ability to deliver on our commitment to non-GAAP operating margin improvement even in a potential recessionary environment. We now expect to increase our non-GAAP operating margin by 300 basis points in 2023, followed by 100 basis points of additional improvement each year through 2025.

Okay back to you. Thank you Karen in summary, we are confident in the actions we have taken a better position the company to perform despite the headwinds that may occur we remain committed to our goals for long term growth and profitability and see the current momentum in orders and revenue as a proof point of our strategy.

We believe strong customer demand is a direct result of our technology differentiation.

Leaving software that enable our customers to get fast moving technology to market faster and.

And we believe we are well positioned within large and growing markets, including electric and autonomous vehicles wireless communication and new space technology.

And looking ahead to 2023, we expect the existing momentum and actions we've already taken to enable us to grow revenue and exceed our previous margin expansion commitment even in an uncertain economic environment.

Finally, a big thank you to all of our employees, who are working tirelessly to drive demand beyond our expectations, while also ensuring customer success.

Employees in manufacturing and operations in particular had been working very hard to navigate unprecedented challenges in our supply chain.

Sincerely appreciate your hard work determination and perseverance.

With that we will now take your questions.

Ladies and gentlemen.

Wanted to ask a question you wanted to Westar one one.

It's also a reminder, please limit yourself to one question and one follow up if you have additional questions. Please re enter the queue.

One moment, while we compile the Q&A roster.

Now first question coming from the line of Mindy Hosseini with <unk>. Your line is open.

Okay.

Thanks for taking my question two follow ups.

Could you. Please elaborate what your revenues would be if there was no supply chain disruption.

Yeah, maybe maybe the way to think about that as well.

Backlog position that we have with the with it being about $250 million.

In about eight weeks of lead time to our customers, we have historically carried much less than that.

Yes.

We've talked about it before but our goal is not to take that down to the levels. We've been at historically, we as we shift to more of a systems business and solutions for our customers that that we do expect to have longer lead times. There is still a significant portion of that debt that we would've expected to flow through into revenue.

During this year without the supply constraints that we face.

The increase in the quarter alone <unk> was $40 million. So you can think of that as <unk>.

Maybe a model for what would have ultimately been revenue.

Got it okay.

Then with.

Software revenue and more and more subscription.

Remind me is that the factor that would dampen your software revenue in the near term.

It is growing.

Lower rate compared to product revenue and I'm just curious.

Has to do with just how youre signing news subscription.

<unk> revenues.

That's correct.

So as we as we shift our.

Seat licenses to a subscription model, we do expect to see some of the our customers declined to renew and that model and.

And that loss, we've estimated at about the $30 million for the year. So that has an impact that would have flown through into into revenue. This year that we are anticipating as a loss.

And then in the future years.

And we mentioned that's a tailwind.

In future years going into 2020.

Three and beyond where we are recognizing that subscription revenue.

I apologize it quick photo so should I assume a $120 million annually.

<unk>.

First software revenue that is now.

Into the future years.

The right way to think about quick follow ups, so should I assume a 120 million annualize.

So software revenue that is now.

Spreads into the future years is that the right way to think about.

Because you are taking.

Alright.

Right.

So $30 million of software revenue.

Were pushed out due to changing.

The license agreement moving to subscription models.

I'm just wondering just want to make sure I understand.

The tailwind impact over.

Over the next few years.

Should I assume that.

Sure.

There has done much of the revenue recognition software that is pushed out.

$30 million a quarter.

So $30 million is the total impact for the year that we estimate from the transition and the single seat licenses to subscription at that point, a substantial majority of all of our software revenue will be on subscription the rest of it we had previously transitioned with our larger enterprise agreements and then.

Then.

Most all of our software business will be annually recurring revenue maybe I'll. Just say also that that conference. We're going to do in September . This is one of the topics we want to delve in a bit deeper so that we can create the longer term model for recurring revenue because we do believe thats going to be a bigger portion as we as we move forward over the next several years.

Got it thank you and I apologize just misunderstanding.

No problem no problem. Thanks.

Thank you one moment for our next question.

And our next question coming from the lineup Mark Delaney with Goldman Sachs. Your line is open.

Yes. Good afternoon. Thank you very much for taking the questions.

It's been a better understand the comments on 2023.

Understood correctly in terms of the topline you youre looking for something like mid teens revenue growth and I believe youre breaking into a slowdown in a few areas.

Semi production test in parts of the portfolio.

Make sure I understand that correctly.

How much are the weaker areas actually contracting.

Obviously, there are some offsets.

The revenue view.

A little bit more of it would be helpful.

Mark Yes, absolutely so first purchased some context.

As we've said in the prepared remarks, the business has stayed really really strong.

We think it's prudent to plan for.

For some of these things so that we are we're planning for a downside scenario.

Prepared for that even if that's not what happens but to calibrate it something if you think about from a demand point of view.

What does the downturn potentially look like what 2020.

We were minus 5% in demand so that's like.

Potential put a downturn scenario as Karen commented when you look at this year we've had.

Very very strong bookings growth a strong backlog position, we expect to end the year and a strong backlog position in fact, we expect the backlog position to be above.

What level of backlog, we think is appropriate to sort of efficiently run the business and meet customer commitments and so we expect that to come down some in 2023, so that.

Even in a downside scenario that means that revenue.

Downside scenario being potentially negative bookings revenue translates kind of into that mid teens.

Teens revenue.

Rate of growth. We also we also get to layer in a full year of the acquisitions next year Mark.

And some of the pricing that we've seen the benefit of this year will also be another part of that benefit next year from a revenue growth standpoint.

Okay, No that's helpful and looking forward to getting into more at the Investor Day, and then a follow up just on the EBIT margin.

The very substantial EBIT margin increase and.

That's the expectation.

<unk>, maybe you can help us understand where we would see that in terms of that.

Different driver and maybe how much is.

Topline leverage how much is maybe better gross margins is there anything on operating expense reductions that are piece of it and to the extent revenue is lower than that mid teens.

Are there structural things that you are considering to do hydrogen variability of your cost structure of that perhaps in the light has been margins, even if revenue doesn't grow in that mid teens level.

The perfect, Yes, we did just that.

A little bit about the revenue pieces, and where we see that could be.

We've modeled that in different scenarios as Eric mentioned to understand in a recessionary situation versus different growth scenarios, what that would look like and and.

One of the biggest factors that makes a difference on that to think through is the gross margin tailwind that we expect next year are very significant do you see that this year, where we've had about 400 basis points of impact from the broker pricing that we're absorbing this year.

We're going to start buying less from brokers in Q3 than we have been.

But that timing of when that flows through to the P&L is delayed because we've been buying them.

Previously and we expect that to actually start flowing through probably early 2023 in terms of having used the parts with that excess pricing.

No.

So that 400 basis points of impact that we see in gross margin. This year becomes a tailwind next year that enables a tremendous amount of leverage the other thing that we've done is made.

At our cost structure much more variable we continue to make it.

A more variable cost structure and that provides benefit going into 2023 as well depending on what we see the top line doing so that we can match our expenses with the revenue throughout the year.

Thank you.

Thank you one moment for our next question.

Now next question coming from the line of Marshall with Morgan Stanley . Your line is now open.

Hi, This is <unk> on for Peter just a quick question. So last quarter, you sort of noted maybe ramping up your semi business.

So I was just wondering if you've seen any sort of traction on growing that business in the quarter and maybe how you would think at a higher level of how the lab business versus production business perform in a recessionary environment.

Sure sure I'll take that yes, so we've always had a real strong position historically in labs, especially our software position is sort of a de facto standard for automated validation systems.

But to your point, we have been focusing on that it is about half our business in semiconductor and electronics as an as an R&D labs and the other half in production.

And as I noted on the call, we certainly expect that.

That lab business to be.

Sort of less volatile in terms of the semiconductor cycle.

R&D spending tends to be less correlated to those cycles and so that's been a deliberate area of focus and it's an area that we are actually the technology and offerings and products, we are delivering into that space and we're pleased with the traction I noted one particular customer on the call as an example of the kind of kind of customer.

In that space. The other important point is that our software, particularly the analytics and the newer piece of software that we have actually scale across both theyre used in both in in labs and in production and we think that's a real differentiator.

For us in that space, while we're on the topic I will make one more comment just on semiconductor market volatility as I said in the comments, we're not we're not in.

<unk> for the.

To the potential down cycle, we're looking at that very closely I will say that our business. We think we're well positioned from an end market point of view, our focus is primarily wireless and mixed signal and industrial applications less direct exposure to.

Processors, and consumer kind of the consumer part of the market going into laptops and phones and so forth and so we think that those also tend to be the more resilient parts of the market.

Okay got it that makes sense and then just a follow up to the operating margins in sort of the 200 bps.

I know you mentioned that the gross margins maybe is.

A fair a fair portion of that upside, but I guess, if youre looking at sort of areas within the operating margin line sort of like the channel, becoming more effective or larger relationships picking up is there a way to rank order sort of those factories, if you sort of take out the gross margin tailwind.

Hum.

You've called out the ones that are that are pretty impactful.

Transition that we've done to distributions.

It's been incredibly successful and we find that there is a tremendous amount of leverage there. It does a couple of things.

Right.

Our ability to focus on our chocolate counts and really make sure that those relationships are robust.

We're expanding and creating additional Sam building out new opportunities on the top customers.

And that leverage continues to flow through from an operating expense standpoint, because we don't have to invest at the same rate to support that customer growth that we had historically.

From an operating expense standpoint.

We're really we're really focused on making as much of our incremental cost as variable as we possibly can and distribution fits right in line with that.

That enables us to do exactly what our goal is which is truly align our expenses with the revenue and how it flows through even in short time flows like even quarter on quarter as it fluctuates, we want the ability to align our costs with that revenue profile.

Yes, I think a way just to add on a way to think of this is that we have.

We've had to take that we've taken a number of actions over the past many years, including this year on our on our cost structure and the variability of our cost structure the efficiency of SG&A and other areas of the business.

This year some of the impact of those are sort of muted by the fact that the revenue is supply constrained as we've said and theirs.

Four two.

$4 to 500 basis point impact from both the broker pricing and freight and so really what we're talking about is the investments and the things that we've done to improve our efficiency from an operating expense point of view really starting to show through show through more.

And operating income as those two issues start to moderate we start to get the flow through to revenue and the margin starts to reverse so it's not so much about future actions of course, its something we will always focus on it's about actions, we've actually already taken to get our cost structure in a substantially more efficient position.

Got it thank you.

Okay. Thank you.

Thank you one moment our next question.

And our next question coming from the line of some maintenance shutdowns <unk> with J P. Morgan Your line is open.

Okay.

Hi, This is Angela entre Sonic thanks for taking my question.

My first one would be looking at your 2020 revenue guide of sort of mid teens growth.

They're a way to sort of ballpark estimate or rank order the largest drivers of our outlook between the synergies from the acquisitions Youre pricing increases.

Working down the backlog and so on and then I'll have a follow up.

Yes, Matt I'll take that this is another one that we do have plan to we do plan to layer that on more specifically frankly, an investor conference and update some of our end market models, we've talked about our objectives by end market in terms of growth. So one of the things that we'll do in September sort of give a refreshed <unk>.

Look not just for 'twenty, three but for us at a three year time horizon, and we will also kind of in a more detailed way to walk through the bridge that we were discussing on one of the previous questions between sort of different booking scenarios and how it stacks up the revenue because we do think that there'll be a.

Pretty a big turnaround from a book to Bill as we go into 2023, so you have to take that into account as well.

What's your follow up.

Great.

Quick question so.

For broker and for your pricing being sort of a 400 to 500 basis point impact on your gross margin does that imply as you sort of work through that and that comes down that you can go back to sort of that 75% gross margin level exiting 2023.

Yes.

The intent is to bring it back up to historic levels, probably right in that range I don't know the exact timing in 2023, because we still will be.

But can you just spike in straight through the end of this year, we're not at a point that I have a full outlook on what that looks like but the goal is to get back to our historic gross margin.

<unk>, which is 70%, 75% probably over more than just that one year time period.

Yes, our expectations, yes, so it'd probably be a tailwind for more than one year.

Got it.

Mhm alright, thank you.

Thank you.

And our next question coming from the line of Ross <unk> with Baird. Your line is open.

Hi, yes, good afternoon.

Eric I wanted to ask hi.

I wanted to spend a second on the portfolio business of course, we are well aware that thats.

Where you have a lot of PMI sensitivity at least historically could you just remind us what some of the larger end market exposures are within that piece I know academic is there some of that maybe some of the medical health care exposures, there, but what are some of the larger pieces that are in that.

Is that part of the segment and then I'm just curious how it trended as we've gone through the quarter and into July just because the order rate was lower is it responding in kind of real time to the PMI.

Yes, Thanks, Rob, Yes, let me put some context points first just to answer your direct question is part of the reason, we collected together and portfolio.

A pretty long tail of industries.

So none of them are particularly large but it does include academic is one of them are life Sciences.

Energy is in there, but it's pretty small.

As well as a number of other smaller industries I will just say that from a just to contextualize. It some youre right and as I mentioned that is that it is more exposed to the macro that is still our expectation.

If you look back a few years that was 50% or above 50% of our business. It's now about 30% of our business. So as a company the mix if you will in the exposure.

Is significantly less.

And then on sort of the trajectory of the business. If you look at Q2, we're at 2% revenue, 6% orders so really.

In line with our longer term expectation, we said thats kind of a mid single digit kind of market growth rate area now did slowdown from Q1 to Q2, but still in a pretty good territory in terms of in terms of growth and then finally, what are the things we're working on to create more resiliency.

It's been a big big focus on that area.

The channel work, we've done for distribution.

And.

Making <unk>.

Product and offerings that better fit distribution to digital channels. Those those are really gaining traction we're real pleased with how that's going.

The reception of customers' response to the business and then the software the single seat license transition and software that Karen spoke of.

That sort of disproportionately impacts.

Portfolio.

Certainly in a positive way, we believe going forward in terms of the the steadiness of a higher percentage of recurring revenue now all that being said it is not our expectation that that means that that 30% of our business is completely immune to the macro so what we think of it is just more we are a smaller percentage of our business that will be less impacted by the macro than say in the.

The last cycle and that is that is our expectation going forward.

Okay, Okay understood.

And then just a quick question around your backlog.

Is it proportional to your revenue mix your current backlog or what you would expect to be your backlog and then just how do you think about cancellation risk within the backlog.

Revenue risks do you mean by end market.

Oh, yes, yes, yes.

Yes your question Rob.

It always.

Yeah, and it fluctuates by end market, because because it's all due to component availability and so it just really depends on a quarter to quarter, which components have shortages in terms of where the backlog sits so it does fluctuate between the business units quarter to quarter, but overall gen.

<unk> speaking it's proportional.

<unk>.

If you look over overtime and then your question about cancellations, we watch it real closely.

<unk>.

Significantly less than a percent.

<unk> of orders that are canceled due to lead time.

So as Karen mentioned in the remarks, we still have confidence on the durability of that backlog and the expectation that that backlog ultimately turns into revenue and we think our lead times are still highly competitive I mean.

Eight weeks.

A lengthening of lead time, certainly for us, but if you compare it to peers in the industry, it's still stacks up quite well significantly better than most of our peers and even though I know many of our customers would like the product sooner, we're able to deliver them sooner than most of our competitors in the industry.

I see if I could sneak in one quick one sure Karen what is the what's the underlying.

Gross margin within the third quarter guidance expectation within the third quarter guidance.

I expect it to be pretty similar to Q2.

Alright, thanks, everyone.

Okay.

That case operating expenses would be down sequentially.

Correct correct number in Q2, we had our large customer event and I connect that won't repeat in Q.

Okay.

I just want to verify that thank you.

So let me let me correct margin I think it's I think it's I think too.

70% 71, maybe 75% somewhere in there yes.

Great. Thanks, Rob Thank you.

Thank you and I'm showing no further questions at this time I would now like to turn the call back over to Mr. Eric Sockol for any closing remarks.

Okay. Thank you all for your questions. Thank you for joining US today, we hope to see you at our Investor Conference in September have a great day.

Ladies and gentlemen that does conclude our conference for today. Thank you for your participation you may now disconnect.

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Q2 2022 National Instruments Corp Earnings Call

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