Apr 28, 2015
Executives
David Hugley - VP, General Counsel and Secretary Alex Davern - Chief Financial Officer, Chief Operating Officer, Executive Vice President, Treasurer James Truchard - Chairman of the Board, President, Chief Executive Officer Eric Starkloff - Executive Vice President, Director of Sales, Director of Marketing
Analysts
Patrick Newton - Stifel Richard Eastman - Robert W. Baird
Operator
Good day, everyone. Welcome to the National Instruments Q1 2015 Earnings Call.
Today's call is being recorded. You may refer to your press packet for the replay dial-in number and pass code.
With us today are David Hugley, Vice President, General Counsel and Secretary; Alex Davern, Chief Operating Officer; Dr. James Truchard, President, CEO and Co-Founder; and Eric Starkloff, Executive Vice President of Global Sales and Marketing For opening remarks, I would like to turn the call over to Mr.
David Hugley, Vice President, General Counsel and Secretary. Please go ahead, sir.
David Hugley
Good afternoon. During the course of this conference call, we shall make forward-looking statements, including statements regarding our opportunity pipeline, success in 5G commercialization and our guidance for second quarter 2015 revenue and earnings per share.
We wish to caution you that such statements are just predictions, and that actual events or results may differ materially. We refer you to the documents the Company files regularly with the Securities and Exchange Commission, including the Company's most recent Annual Report on Form 10-K filed on February 19, 2015.
These documents contain and identify important factors that could cause our actual results to differ materially from those contained in our forward-looking statements. With that, I will now turn it over to the Chief Executive Officer of National Instruments Corporation, Dr.
James Truchard.
James Truchard
Thank you, David. Good afternoon and thank you for joining us.
Our key points today are record revenue for first quarter, continued broad adoption of PXI and very strong growth in revenues from RF products and continued success in 5G research and prototyping. In Q1, we have delivered record revenue for first quarter.
This together with our disciplined expense management has allowed us to maintain double-digit non-GAAP operating margin despite this recent surge in the U.S. dollar.
The strength of our business model has allowed us to generate strong cash flow and deliver dividend of $0.19 for the quarter. While we continue to adapt to the impact of U.S.
dollar on our revenue and gross margins, I am optimistic about our long-term position in the industry and our ability to gain market share. The differentiation we have delivered to our customers through platform-based design helps engineers and scientists simplify problems and reduce costs while scaling and adapting to rapidly changing demands.
In our call today, Alex Davern, our Chief Operating Officer will review our results. Eric Starkloff, our Executive Vice President of Global Sales and Marketing will discuss our business and I will close with a few comments before we open up for your questions.
Alex?
Alex Davern
Good afternoon and thank you for joining us today. Today, we reported record revenue for the first quarter of $289 million, a 2% year-over-year increase in U.S.
dollar terms and an 8% year-over-year increase in constant currency terms. Obviously, we are disappointed with the effect that the strengthening of the U.S.
had on our revenue and profit performance, but from a year-over-year perspective and relative to our guidance. From a year-over-year perspective, the 6% year-over-year impact to revenue growth from strengthening of the U.S.
dollar amounted to a headwind of approximately $17 million and was one of the more severe currency impacts we have seen since our IPO in 1995. The impact of currency on our revenue and gross margin was greater than we had anticipated when giving guidance as a result of the continued strengthening of the U.S.
dollars in February and March. I will discuss the local currency pricing adjustments we have recently made in guidance section of my remarks.
In U.S. dollar terms, revenue was up 3% in the Americas, down 4% in Europe and up 5% in East Asia and up 6% in the emerging markets.
In constant currency terms revenues was up in all regions. It was up 4% in the Americas, up 10% in Europe, up 7% in East Asia and up 19% in the emerging markets.
The Q1 net income was $15 million with fully diluted earnings per share of $0.12, and non-GAAP net income for Q1 was $23 million with non-GAAP fully diluted earnings per share of $0.18, $0.05 below the mid-point of our guidance range. A reconciliation of our GAAP and non-GAAP results is included in our earnings press release.
Non-GAAP gross margin in Q1 was 75% and was still strong with 120 basis points from Q1 last year, primarily due to the stronger dollar. Total non-GAAP operating expenses were $186 million, up 2% year-over-year.
For Q1, our non-GAAP operating margin was 11%, down from 12% in Q1 last year and non-GAAP operating income was $31 million, down 10% year-over-year. Now taking a look at order trends, for Q1, the value of total orders was down 1% year-over-year.
Included in that total is $3 million in orders received from our largest customer compared to $12 million in Q1, last year. Excluded in this customer, our orders from all other customers were up 2% year-over-year in U.S.
dollar terms in Q1. Now, breaking down our Q1 order values, excluding our largest customer in U.S.
dollar terms, we saw a 5% year-over-year decline in our orders with value below $20,000, while orders with a value between $20,000 and $100,000, declined 4% year-over-year. Orders with a value over $100,000 grew 37% year-over-year.
Adding some color to this data, we saw challenges in our longstanding broad-based businesses of software, data acquisition and instrument control as a result of the U.S. dollar strength and the lengthening of the PC replacement cycle.
Now, turning to cash management, inventories were up $5 million in Q1 and accounts receivable were down $11 million from December 31st. During the quarter, we used $24 million to pay dividends and $25 million for acquisitions.
Our cash and short-term investments totaled $443 million as of March 31st. Now, I would like to make some forward-looking statements.
The context I would like to give an update on two items, expected revenue from our largest customer and our business response to the strengthening of the U.S. dollar during Q1.
Regarding our largest customer, year-to-date, we have received a total of $6 million in orders from this customer, compared to $32 million when we released earnings at this time last year. We continue to be very actively engaged with this customer in multiple new applications, but we now expect it down year in revenue from this customer for 2015.
Regarding the recent surge in the U.S. dollar as many of you are aware, approximately two-thirds of our revenue is recognized in currencies other than the U.S., with a heavy concentration in Europe.
We have a natural hedge of approximately 50%. Over the decades, we have built a business model that is managed through a lot of currency volatility to deliver sustainably strong gross margins.
Our core strategy for sustainably managing the impact of currency volatility relies on strong product differentiation to enable us to adjust local currency pricing quarterly to help mitigate the currency impact for which we do not have a natural hedge. Over the 20 years since our IPO, this strategy has generally allowed us to mitigate the unhedged portion of any currency movements through pricing, with a delay of approximately one quarter.
In Q1, however, the rapid strengthening of the U.S. dollar after we had made our pricing adjustments in January, resulted in a greater than anticipated adverse impact on our revenue, gross margins and operating income.
As a result, in early April, we continue to execute on our long-term strategy by adjusting local currency prices. Now looking to specific revenue guidance for Q2, starting with our largest customer.
Given the orders received to-date, we are expecting revenue from this customer to decline from $20 million in Q2, last year, to between $5 million and $10 million in Q2 of this year, reducing our year-over-year revenue growth in U.S. dollars by approximately 4%.
As a result, we are guiding for total revenue in Q2 to be in a range of $290 million to $320 million. At the mid-point, this represents a 2% year-over-year decline in U.S.
dollar terms and 5% year-over-year growth in constant currency terms. We expect GAAP fully diluted earnings per share will be in a range of $0.14 to $0.26 for Q2, with non-GAAP fully diluted earnings per share expected to be in the range of $0.20 to $0.32.
In summary, while Q1 was a challenging quarter due to the rapid strengthening of the U.S. dollar and weak PC market, we continued to execute well and maintained good spending discipline.
We expect to continue to experience a drag on our revenue from currency headwinds and lower orders from our largest customer through Q3. However, entering Q4, we expect to have more favorable compares on both factors, which should allow the strength of our broad-based business to show through.
Looking forward, we are working hard to take advantage of our existing investments and continue to be committed to our long-term operating leverage targets. As these are forward-looking statements, I must caution you that our actual revenues and earnings to be negatively affected by numerous factors such as any weakness in the global economy, fluctuations in revenue from our largest customer, expense overruns, manufacturing and efficiencies, foreign exchange fluctuations, adverse effective price changes and effective tax rates.
In closing, I would like to mention National Instruments will be attending the Baird Conference in Chicago on May 7th, the Jefferies Conference in Miami and the Oppenheimer Conference in New York on 13th, and the Stephens Conference in New York on June 2nd. We look forward to seeing you there.
With that, I will turn it over to Eric Starkloff, Executive Vice President, Global Sales and Marketing.
Eric Starkloff
Thank you, Alex, and good afternoon. I was pleased with our ability to deliver 8% revenue growth year-over-year and positive growth in each of our regions on a constant currency basis.
We had record first quarter revenue for our PXI products and saw a very strong revenue growth in RF. In Q1, we began the rollout of new tools for opportunity management and collaboration across our sales organization.
The rollout has gone smoothly [ph] as it is adversely affected by the recent decline in oil prices. We expect to continue to see headwinds in the energy industry as long as oil prices remain low.
We saw strength in our sales for the semiconductor industry attributable to the successful release of our semiconductor test system, which is built around standard NI PXI chassis, controllers and modules combined with LabVIEW testing software to serve high-volume production test of semiconductor chips. Because it is based on the same standard products that we sell to the broad test and measurement market, we get significant leverage and cost advantages from these economies of scale.
Early customer response has been strong and we are encouraged by the pipeline of opportunities. For example, on semiconductor, Dow Jones is using an NI PXI, in our semiconductor test system that has high end image sensors with unprecedented test performance while providing flexibility for their future needs.
Looking at our product, PXI and RF had very strong sales in Q1. As Alex mentioned, we saw a decline on a dollars basis in our broad-based software and data acquisition products as a result of the strengthening of the U.S.
dollar and the lengthening of the PC upgrade cycle. Our instrument control products, which connect third-party box instruments to the PC, saw a significant year-over-year decline, indicating relative weakness in the test and measurement industry.
The combination of strength in our PXI sales and weakness in instrument control, suggest that the market is continuing to shift from traditional rack and stack instruments to PXI, and National Instruments continues to lead that that shift. Compact RIO products saw modest growth in Q1 in local currency impacted by the weak oil and gas market.
We continue to see strong adoption and deployment scenarios outside of oil and gas. One example of that National Grid in the U.K., where they are using LabVIEW and Compact RIO to provide additional data insight into the power grid and adapt to the new alternative generation sources coming on to their grid.
National Grid is the transmission operator to over 20 million customers in the U.K. and the and NI based system allows National Grid to add more intelligence to the power grid.
Peter Haag of National Grid UK commented the high processing power of Compact RIO allows us to gather and analyze large amounts of data from anywhere on the grid as well as compile and analyze all the data to see gird wide trends to optimize our investments to meet the energy needs of the next generation. As mentioned previously, sales of our PXI and RF products were particularly strong in Q1.
Our position in PXI remained strong as we have by far the largest PXI product portfolio in the industry, a unique and differentiated software position for creating PXI systems, a focused sales and support channel that provides significant value to our customers and a very strong network of integration partners trained on NI software and hardware. During Q1, we further strengthened this partner network doing agreement with Cobham Wireless.
Formally, the wireless test business the Aeroflex, which NI acquired PXI RF product line from Cobham. Cobham will migrate to use NI PXI products, including our vector signal transceiver and Cobham is now NI's global preferred partner for cellular and connectivity test.
This partnership combines Cobham's strong presence and expertise in these domains with NI's best-in-class product allowing both companies to be more efficient, profitable and competitive in cellular and connectivity application. We believe this partnership reinforces our strong position in PXI as the industry continues to shift from rack and stack boxes to modular software-defined platforms.
Our RF products once again saw a very strong year-over-year revenue growth. While our RF products have been central to many of our largest application wins, they all serve a very broad set of customers and applications.
In addition to production test of wireless devices, our software-defined platform is also used to prototype and validates a very broad set of wireless components and systems. We recently enhance and further differentiated our product offering in RF with our new LabVIEW communication system design suite, software which dramatically simplifies and speeds the prototyping process and powering designers of wireless technology to focus on their innovative algorithms instead of on complex embedded programming.
This product was a key highlights for us at the Mobile World Congress in Barcelona last month as this event, and I demonstrated real-world prototypes of five key networks and our platform was demonstrated by industry leaders such as Nokia networks and Intel. We believe our long-term investment in our platform has given us the ability to take a strong lead on this key emerging communication technology.
In summary, although unfavorable currency market has had a significant impact on our dollar reported revenue in Q1, I am pleased with our ability to deliver 8% constant currency revenue growth. We have a strong opportunity pipeline for our new product and the differentiation of our platform-based offering continues to help us drive growth in the markets we serve.
With that, I will turn it back over to Dr. T for some closing statements.
James Truchard
Thank you, Eric. I am pleased with [ph] Q1 in a difficult market.
We maintained strong gross margins trends forcing the value of customers seeing our product and resulting in strong cash flow despite the Jones from the strengthening of the U.S. dollar.
We have built and continued to run our company for this long-term sustainable growth. Over the course of several decades, we have successfully managed the business through various economic and currency cycles and have always exited those cycles in a position of strength.
I am confident we will continue that track record. Our focus has always been to provide a software and hardware platform that leverages commercial technology to increased performance and lower.
This disruption shrinks the markets we target while also providing an opportunity to grow our business through differentiate products with high gross margin. I was especially pleased with our success in RF.
As Eric mentioned, in Q1, we saw continued strong growth in RF. We are hitting stride with our new generation of FEJ based RF instruments, which are fueling much of growth.
These products are more focus of our increased investment in R&D over the past several years and I am pleased with our continued growth, adoption and penetration in the large RF market. Our product successes led to better efficiency in R&D, and we have increased focus on areas which we had the most leverage of our differentiated platform.
We are [ph] particular strength in growth in the area of software-defined radio; an unique ability to serve these application through acquisition LabVIEW and FEJ has led to our leadership in 5G research and prototype. Earlier this month, I delivered the keynote at the Brooklyn 5G Summit on a topic of next-generation tools for 5G research.
The Brooklyn 5G Summit is an invitation-only summit that is jointly organized by Nokia Networks and NYU Wireless Research Center, that brings together wireless and mobile industry research and development leaders in academy of business and government to explore the future 5G wireless technology. With the help of Nokia, we demonstrated the first 5G prototype to achieve 10 gigabits per second peak data rate system over-the-air, a key milestone to achieve the goals of future 5F networks.
I believe our successes such as these in the early stages of 5G technology cycle will lead to tremendous opportunity for us to test 5G products as the technology comes to market in the future. This has been our approach throughout our history to disrupt in growing markets, where our software-centric platform offers tremendous value to us and productivity benefits to our customers.
Our success in the most challenging 5G prototyping applications is a prime example of how our software position and FEJ-based approach enable NI to address the long tail of unique applications, which are poorly served by the traditional approach to vendor-defined hardware. In closing, I want to thank our employees for their concerted efforts, deliver innovative new products to drive our growth while managing expenses as we continue to work on long-term profitability goals.
I am confident that we are building a new product pipeline, channel, operational excellence to drive the long-term growth and profitability of the company. Thank you.
We will now take your questions.
Operator
Thank you. [Operator Instructions] Our first question comes from Patrick Newton with Stifel.
Your line is now open.
Patrick Newton
Yes. Good afternoon, Dr.
T, Alex and Eric. I guess just jumping right in, if I could get the housekeeping question.
The number of employees actually in the quarter and then your average order first.
James Truchard
Sure. Patrick.
Number employees exiting quarter is 7,145 and the average order size was the work 4,945.
Patrick Newton
4,945. Okay.
Then I guess should we think about headcount now is starting to march back up a little bit with the normal hiring back half of the year. I think this is the first time your headcount has grown on a year-over-year basis in about three quarters.
Eric Starkloff
Yes. Just a modest uptick there, Patrick, part of that was the small acquisition we did in Q1 that we announced a couple of years ago, so I think any headcount change from here is going to be relatively modest through the rest of the year.
Patrick Newton
Okay. Great.
Then I guess on the acquisition front, can you help us understand the revenue contribution from the Cobham deal in Q1 and also what is embedded into 2Q guidance?
Eric Starkloff
In Q1, Patrick, given the transition, as we transition the production of these devices and ultimately they transitioned our platform. It gives the revenue kind of a delay, so there was no revenue contribution in Q1.
They maintained sufficient inventory to be able to manage through the first quarter and revenue contribution will commence in the second quarter. It is relatively modest in Q2 and then we hope to build from there.
Patrick Newton
Okay. Then if we look at, I guess, embedded in the June quarter guidance, there appears that is either, A, an aggressive snapback in your gross margin or flat to maybe even declining OpEx on an absolute basis, sequentially, just to meet the mid-point of guidance.
I guess, could you help walk us through the puts and take and how we should think about those line items.
Eric Starkloff
Yes. Sure.
I am going to tell you how I think about here. If you look at the away Q1 results came out and we reported 2% revenue growth in dollar terms and then we had a 6% FX hit, and about 1% decline in revenue growth as a result of our largest customer which we discussed, that gives you kind of a local currency growth of our base business of about 9%.
We do that math in Q2, mid-point of guidance is minus-2 in dollar terms, so slightly bigger foreign exchange hit in Q2, seven points and the bigger impact from our largest customers, so you get back to about 9% local currency growth of that base business excluding our largest customers. Now, when you look at from a guidance mid-point is 5% sequential increase in revenue, which is roughly in line with our historical norm, excluding our largest customer.
We are expecting modest sequential improvement in gross margin. Just like the FX has a bigger impact on our top-line in Q2 than it did in Q1, it will also have the impact of modestly reducing our expenses in Q2, because of the greater impact of exchange rate, so that is kind of a March [ph]
Patrick Newton
That is very helpful, and I guess just kind of last line of questioning is on that largest customer that you are talking about. One is, you give us the $3 million order flow in Q1.
Could you provide us with revenue and then on the Q2 and 3Q revenue contribution, thank you for the details but with that downtick year-over-year is it a matter of design cycle for the customer or is a matter of reuse of prior products, is it a matter of share loss, what is driving that pretty significant downtick?
Alex Davern
Your first question, Patrick, revenue from the largest customers was about $5 million in Q1 and portion of that will be deferred services revenue in terms of the carryovers from prior years. In general, the largest customers we have a great relationship.
We continue to be engaged with them in more new applications. As you know, we have helped this customer significantly reduce their test spend over time and that has, I think, been a great value to them.
We know the revenue is going to lumpy and the cycles are probably most likely to be related to transitions to major new standards as they come and there is just going to be something that it is going to have on years and off years and our perception at this point is that this year will be a down year.
Patrick Newton
All right, then I guess you talked about the strong wireless demand in your prepared remarks. I guess this one is for Dr.
T, Alex or Eric, so you talked about strong wireless demand in the prepared remarks, but we just talked about your largest customer expected to see year-over-year decline in 2015. Can you speak to wireless trends excluding this customer and help us understand the relative size of your overall wireless business?
Eric Starkloff
Sure. Patrick, I will take it.
This is Eric. As I mentioned, before it is really helpful to understand in our wireless and our RF business is a pretty broad play for us.
We do serve wireless production test that is an important space, but it is quite a bit broader than that. It includes the areas of testing and MIL/aero applications, areas like radar.
We have introduced products last year that a pretty relevant in that space and it includes a really growing part of this area we call software-define radio has been very successful for us. We highlighted 5G prototyping as a particular area of success and that is a growth area that is a part of that RF pie, but the diversity and I wanted to say that what is unique about National Instruments in the space is the nature of our platform-based approach.
It is the same core technology component that are serving those various different application spaces of our customers, so we are able to serve a very different spaces with a whole lot of leverage on the investments that we make into the platform and our channel.
Patrick Newton
Great. Thank you for the details.
Good luck.
Alex Davern
Thanks, Patrick.
Operator
[Operator Instructions] Our next question comes from Richard Eastman with Robert W. Baird.
Your line is now open.
Richard Eastman
Yes. Good afternoon.
Alex, could you just walk through maybe just real briefly? The gross margin declined about 140 bps year-over-year, so some of that is going to be currency but how much of that is mix relative to the large project.
I presume large project sales track buyers as well as orders?
Alex Davern
Hi. Rick, Alex here.
Most of that impact is really on the currency change. If you look at it from the year-over-year point of view, on the revenue line we took a $17 million impact from currency.
When we talk about the natural hedge that we have built in our business model, a vast, vast majority of that comes with the operating expense level. The vast majority of our cost of goods sold is from components that are priced in dollars, so there is very little natural hedging, the manufacturing or the cost of goods sold at portion of the business model.
The vast majority of that decline came directly from currency change and you will notice when you look at the details in the P&L. I mean, you will see the software versus little products makes them the cost of goods sold has changed, so with 9% increase in our base volume are you seeing an increase in cost of goods sold and then you see in the majority of the value we create from that being consumed by the changes in exchange rates.
Richard Eastman
Again, you referenced to adjusting prices where possible. April 1st should help us out here a little bit sequential as well?
Alex Davern
Yes. Our pricing as I said in the call, Rick you have been around the stock and covering NI for very long time through multiple currency moves, so you have seen this before.
Exchange prices generally once a quarter and then as pricing strategy is generally been anchored on the U.S. list price.
We usually adjusted to keep a relative ratio to our global pricing in a various different regions to be aligned to that ratio that we have said and that helps the channel stay efficient. Another thing that helps channel efficiently [ph] not to change pricing to frequently and that is why we have settled on the strategy of changing pricing once a quarter.
Additionally, we typically honor quotes for a period of 30 days post-change, so it can take a while before we make a decision to change pricing before that rolls into the revenue and to the gross margin and we are anticipating that will allows to see a modest improvement in gross margin in Q2. Then we will see how that plays out into Q3.
Richard Eastman
Okay. Then a quick question on the orders, in U.S.
dollar terms can you just give any color on the orders of strength in the greater than $1,000 orders I mean, is that reflective of your wireless business or what industries are kind of driving that?
Alex Davern
Yes. To give you a broad based - when you get down into the orders below 20,000 and below even 100,000, your chart dealing with a very large number of high volume of orders, where you are going to see the impact of currency play through pretty directly until we can successfully managed the change in pricing, so it has a real direct impact on that different broad base of business.
In the orders over 100,000 out these scenarios that is more involved with the channel directly and certainly as Eric said, we saw a tremendous momentum behind our RF business in Q1, strong growth for the PXI platform. They would both play a very significant role and the growth in those orders over 100,000.
Obviously, we broke out the growth with our largest customer and without and you can see the success in that category of above 100,000 despite the drop in orders from our largest customer, the strength of our product position and our channel in this market area was very pronounced in Q1. Just to add-on, it has been a pretty deliberate strategy, Rick.
As you know for us to deliver higher value with a system platforms there are hardware and software areas by PXI and CompactRIO and even CompactDAQ. As we deployed systems in RF or for a high channel count systems or large deployments of CompactRIO for condition monitoring.
Those are the types of system that fall under their higher order buckets and where we are seeing a lot of growth.
Richard Eastman
Okay. Then just one last question, I am curious on BQ [ph].
Obviously, it gives you an instant position in the 5G space. Being a, I presume to be a value-added reseller, but can you give us get any sense of revenue that this would bring in?
I mean, is this $10 million of revs? How big of a business is this?
Alex Davern
Rick, we obviously have not disclosed the size of the revenue, but I would tell you it is pretty modest.
Richard Eastman
Okay.
Alex Davern
It is a relatively small company and good technology and I will ask Dr. T to talk about the strategic value.
James Truchard
Sure. Basically their technology ducktails to our technology very well, they have a deployment platform FPGA base.
They have got deployment, infrastructure software and we have the software for actually the algorithm development for 5G, and we have been prototyping new systems on PXI system and this gives us a platform that is more able to be deployed in the field for field trials and alike and we view it as a very complementary to the position that we have now.
Richard Eastman
Do they have access to one or two key customers or they are pretty broad-based themselves or is that…
Alex Davern
I would say a few key customers. That is pretty complementary to the ones we have been working with 5G research, so it looked like it is a very good fit for us.
Richard Eastman
Okay. Very good.
Thank you.
Operator
Thank you. That concludes our question-and-answer session.
I would now like to turn the call back to Alex Davern for closing remarks.
Alex Davern
Thank you for joining us today. We hope to see you at one of our investor conferences in Q2.
Good evening.
Operator
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program.
You may all disconnect. Everyone, have a great day.