Jan 26, 2017
Executives
David Hugley - VP & General Counsel Alex Davern - President & CEO John Roiko - Interim CFO Eric Starkloff - EVP of Global Sales and Marketing
Analysts
Richard Eastman - Robert W. Baird Patrick Newton - Stifel Nicolaus
Operator
Welcome to the National Instruments' Fourth Quarter 2016 Earnings Conference Call. Today's call is being recorded.
You may refer to your press packet for the replay dialing number and passcode. With us today are David Hugley, Vice President General Counsel; Alex Davern, President and CEO; John Roiko, interim CFO; 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.
Please go ahead, sir.
David Hugley
Good afternoon. During the course of this conference call we shall make forward-looking statements, including statements regarding the impact of currency exchange rates and our guidance for revenue and earnings per share for Q1 2017.
We wish to caution you that such statements are just predictions and that actual events or results may differ materially. We refer you to the documents the Company files regularly with the Securities and Exchange Commission, including the Company's most recent quarterly report on form 10-Q filed on October 31, 2016.
These documents contain and identify important factors that could cause our actual results to differ materially from those contained in our forward-looking statements. With that, I will now turn it over to the Chief Executive Officer of National Instruments Corporation, Alex Davern.
Alex Davern
Good afternoon and thank you for joining us. As I begin my role as CEO of National Instruments, I'm honored to have the opportunity to build on our accomplishments over the last 40 years.
I'm energized by how we're making the world a better place through empowering engineers and scientists to be more productive and innovative and as we move forward I want to ensure that we leverage the strength of our people and our platform, while embracing the need to evolve and make changes to achieve our goals. My priorities as CEO are building on 40 years of success through platform innovation, accelerating growth from system-level sales while optimizing our broad-based business and delivering operating leverage.
Turning to performance in Q4, I'm disappointed that we missed the midpoint of our revenue guidance. Looking at performance within the quarter,, we were encouraged by a very strong October that transitioned to a surprisingly weak November with a modest recovery in December.
That being said, we saw continued core revenue growth in Q4. Additionally we maintained our strong gross margins and non-GAAP EPS was flat year over year.
Following a host of new product announcements at NIWeek last August, I've been encouraged by the application of these new technologies to solve our customers' most pressing challenges in automated test, F5 communication, the connected car and the industrial Internet of Things. Building on 30 years of innovation, NATI has enabled an ecosystem of engineers and scientists to improve their productivity and accelerate their pace of discovery.
With the recent technology preview at NIWeek, we demonstrated how our next evolution of software will help both new and experienced users with enhanced coverage of the engineering design flow from interactive measurements and automation to data visualization and web development. In Q4 we continued to build on our leadership within PXI module instrumentation, with the year-over-year growth in sales of semiconductor test systems.
With new instruments added to our portfolio at NIWeek, we further expanded the number of devices under test that can be addressed by our platform. Additionally we introduced a second-generation PXI vector signal transceiver which is being recognized by industry press as one of 2016's top RF and wireless products.
We believe the strength of our PXI portfolio and leadership from two decades of investment in PXI will serve us well as we continue to disrupt the traditional instrumentation model. Another area we continue to see success within software-defined radio products.
One example of the power and flexibility of the NI platform for RF prototyping comes from a collaboration with DARPA to simulate wireless environments. The Colosseum testbed housed at the Johns Hopkins University Applied Physics Laboratory uses many NI software-defined radio products to simulate wireless interactions between signals, essentially creating reproducible scenarios like neighborhoods or busy cities.
The Delpha Spectrum Challenge will use this testbed to provide a level playing field for a three-year competition, with winning teams demonstrating successful communication in crowded RF environments. In Q4 revenue from PC-based data acquisition products continued to be negatively impacted by the decline of PC sales, while our modular compact DAQ product saw a year-over-year growth, driven by applications focused on validation and characterization of smarter electromechanical systems in automotive, aerospace and power electronics design applications.
Turning to compactRIO, we believe these products will be a key component of the industrial IoT. Led by a demand for big analog data to drive operational efficiency, the industrial IoT has brought together companies from across the technology spectrum.
This convergence of information technology with operational technology has opened discussions and collaborations between companies with backgrounds in industrial machinery, power generation, power distribution, networking, cloud computing, automation and instrumentation. With the opening of the industrial IoT lab at NI's global headquarters in Austin, companies like Cisco, Hewlett Packard Enterprise, Analog Devices and PTC are partnering with NI to validate system architectures and create proven designs to shift the future of industry.
As I begin my tenure as CEO, I want to share some thoughts on my focus going forward. Growing our top-line revenue and achieving our operating model is my top priority.
Our interactions with customers and partners show the opportunity for us to grow our business and gain market share and I'm committed to doing what it takes for us to deliver on that opportunity. Strengthening these relationships with our customers is critical to achieving our financial growth goals.
For years we have invested in strong customer relationships that have kept us grounded in their challenges and focused on ensuring that our platform can meet and exceed their needs. Some of the long term drivers of NI's success and growth have been our ability to serve a large and diverse customer base, our dedication to customer success and the benefits of strong customer loyalty.
Our highly differentiated platform, powered by software, has driven the success of our system-level business which has generated the vast majority of our growth over the last 10 years. This platform has opened up new opportunities for us and large investments over the last few years are intended to drive long term growth for our Company.
Looking forward we will be focused on leveraging these investments to grow our business and achieve our operating targets. For the last few years we have stated our intent to deliver operating leverage based on our top-line revenue growth.
While we continue to focus on growing the top line in 2017, I intend to make progress towards our operating margin goal this year. As a result, we have budgeted for a low single-digit percent decline in headcount for 2017.
Given the significantly improving PMI, our strong gross margins and our differentiated platform, I believe that this will help us deliver on our leverage goals for 2017. Thank you and I will now turn it over to John Roiko, interim CFO, for a financial update.
John Roiko
Thanks, Alex. Today reported Q4 revenue of $329 million, down 1.7% over Q4 2015.
Core revenue which we define as GAAP revenue excluding the impact of our largest customer and the impact of foreign currency exchange, was up 3% year over year compared to our guidance of 5%. Deferred revenue increased by $3.5 million in the quarter.
For 2016 GAAP revenue was $1.23 billion, up slightly over 2015. Core revenue for the full year was up 3% year over year.
Total value of orders for the quarter was flat year over year in U.S. dollars, while our order growth excluding the impact of foreign exchange and our large customer was up 5%.
Our revenue was negatively impacted by the strengthening of the dollar which hit a 14-year high during Q4 and our orders from our largest customers were down year over year. As Alec mentioned, the trend of our business varied significantly during the quarter, as the total order excluding foreign exchange and our largest customer were up 11% year over year in October, flat year over year in November and rebounded up 4% year over year in December.
The strong start of the quarter was very encouraging. While the weakness in November was a surprise given the improving global PMI, we were pleased to see improvement in our orders in December.
Non-GAAP gross margin in Q4 was 75.8%, up 60 basis points year over year. Total non-GAAP operating expenses were up $190 million, flat year over year.
And our non-GAAP operating margin was 18.2%. And our non-GAAP earnings per share were flat year over year.
For the full year our non-GAAP gross margin was 75.5%, up 30 basis points. And our non-GAAP operating expenses were up 3% year over year.
For Q4 net income was $34 million, with fully diluted earnings per share of $0.26. Non-GAAP net income for Q4 was $44 million, with non-GAAP fully diluted earnings per share of $0.34.
Our earnings were negatively impacted by a $3.2 million or $0.02 per share loss on foreign exchange as a result of the volatility of the currency market in Q4. This loss had not been anticipated in our guidance.
A reconciliation of our GAAP and non-GAAP results is included in our earnings press release. Now, taking a look at our order trends more detail.
For Q4 the value of our total orders was flat year over year in U.S. dollars.
Included in that is $2 million in orders received from our largest customer compared to $9 million in Q4 2015. Revenue from the largest customer was $3 million in Q4 compared to $10 million in Q4 2015.
For the full year revenue from our largest customer was $34 million, up 16% compared to 2015. Now breaking down the Q4 order values, excluding our largest customer.
We saw a 2% year-over-year decline in our orders with a value below $20,000. On the system side, our orders with a value between $20,000 and $100,000 were up 4% year over year.
And orders with a value over $100,000 were up 8% year over year. Now, turning to cash management.
During the quarter we paid $26 million in dividends. We ended the quarter with cash and short term investments of $358 million as of December 31, 2016.
Our effective non-GAAP corporate tax rate for 2016 was 21.6%, down from 28% in 2015. Today we announced the Board of Directors increased our quarterly dividend by 5% to $0.21 per share.
Now I would like to make some forward-looking statements. While we're encouraged with the improvement in the Global Purchasing Managers Index during Q4, given the weakness we found in November, we're choosing to be cautious in our guidance.
As a result we currently expect total revenue in Q1 to be in the range of $285 million to $315 million, up 5% year over year at the midpoint. We currently expect GAAP fully diluted earnings per share to be in the range of $0.05 to $0.19 for Q1, with non-GAAP fully diluted earnings per share expected to be in the range of $0.11 to $0.25.
As we increase our focus on improving our operating margin in 2017 we're budgeting for a year-over-year reduction in headcount for the first time since 2014. Another housekeeping items, we estimate that given the current exchange rate, the drag on a revenue from currency headwinds will be approximately 1% year over year in Q1.
In addition, as NIWeek moves from August to May there will be a shift of operating expenses of approximately $2 million from Q3 to Q2. Assuming the current tax legislation stay in place we currently estimate that our non-GAAP effective tax rate for 2017 will be approximately 21%.
In summary, while we're disappointed with our revenue performance in Q4, we're encouraged with the improving trends in the industrial economy. As we enter 2017 we're focused on growing revenue, leveraging our investments and improving our operating margin.
As these are forward-looking statements, I must caution you that actual revenue and earnings could be negatively affected by numerous factors such as the weakness in global economies, fluctuations in revenue from our largest customer, foreign exchange fluctuation, expense and headcount overruns, manufacturing inefficiencies, adverse effects on price changes and effective tax rates. We will be at the Morgan Stanley Technology Conference in San Francisco on March 2.
We look forward to seeing you there. With that, I'll turn it back over to Alex.
Alex Davern
Thanks, John. Before we open it up for questions I just wanted to mention that our Investor Conference and NIWeek are both coming up in May.
Look forward to seeing you and celebrating our customer success along with the new and innovative products that we will be releasing to the market at NIWeek. To close, I want to reiterate our focus on revenue growth and our commitment to achieving our operating model by leveraging the long term investments in our platform, focusing on system-level sales and strengthening our relationships with our customers, we believe we can provide for all our stakeholders.
Thank you. And now John, Eric and I will take be happy to take your questions.
Operator
[Operator Instructions]. Our first question comes from the line of Richard Eastman from Robert W.
Baird. Your line is open.
Richard Eastman
Alex, could you kind of just speak to the slowdown in order growth? We came out of the Q3 with 8% growth in orders.
We were pretty excited about that, core orders. We obviously decelerated to 2% here.
You did comment on November, but again it suggests no real momentum leaving or exiting 2016. I mean, how do you reconcile that?
Alex Davern
Sure. We were pretty pleased, quite obviously, with the improvement we saw in Q3.
And just correct the data point core orders for Q4 were up 5% in total. So we did see a slowdown.
And when we were talking to you this time three months ago, frankly on the back of a strong double-digit start to Q4, we were feeling pretty optimistic. We did see a real definitive pause from our customers and it was interesting that we saw all three regions, Americas, Europe and EMEA all went from positive to a significant slowdown in November and then a recovery in December.
But that is honestly a bit of a mystery. We have our own internal speculation as to what might've been the impact there but don't have any definitive answers.
As I look into 2017, I'm really encouraged by the significant acceleration we have seen in the global PMI. You have Europe very strong, the Americas very strong, most places in Asia very strong.
And honestly I'm also pretty encouraged by what I see from the silicon companies that are at earlier stage in the supply chain than we're, companies like Intel and TI that are seeing an improvement in their business. So I'm looking at those signs to give me optimism as we enter 2017.
We did definitely see a slowdown in November with a few sales bounced back in December. And we will see how things play out here in Q1.
But I would like to believe we will see the impact of the positive PMIs flowing in our business in 2017.
Richard Eastman
And yet, just as a follow-up, the guidance for the first quarter is very definite midpoint is kind of seasonal in terms of a seasonal slowdown from fourth to first which is typical. But that revenue number at the midpoint really doesn't anticipate anything other than seasonality off of a little bit softer fourth quarter.
And in that is also the large customer, apparently again we're not getting off to a big start there. But how do you feel about where we entered the year, kind of the seasonal comment and then also any sense of what this large customer, our largest customer, could do here in 2017?
Alex Davern
It's a little early to -- let me answer the second question first, a little early to give a specific for the year. We had a good year in 2016 with the largest customer, we were up 16%.
We do expect to start Q1, we'll be somewhere in the $2 million, $3 million, $4 million range. And I'll be in a much better position in April to answer and address the question about how the rest of the year looks.
We've been very pleased with certainly the broadening of our footprint within that account and that's what really drove the growth we saw in 2016. But many of their major purchase decisions will be made between now and the call in April.
So it's a little too early to make a commentary on that. And in terms of our revenue and expectation for Q1, I will make the observation, John and I are both new in our new roles and so we want to make sure we get off to a good start.
Operator
Our next question comes from the line of Patrick Newton from Stifel. Your line is open.
Patrick Newton
A couple of housekeeping, is first on the tax guidance of 21%. John, does that exclude any positive impact from renewals, the R&D tax credit?
John Roiko
Yes, it does. It assumes that it carries forward.
So it's basically the same regulations that we're dealing with in 2016 for our guidance for 2017 currently.
Patrick Newton
Okay. And if that was renewed then that 21% would look more like 19%?
John Roiko
No, we're saying that's already baked into the 21%.
Patrick Newton
I'm sorry. I misunderstood, okay.
And then if I could get your employee headcount and then also average orders list?
John Roiko
Sure the ending headcount is 7,550. It is down about 1% sequentially and up about 1% year over year.
The average order size is $5,444. Again, flat sequentially and down about 3% year over year, as some of that reduction that we saw in our largest customer is baked into that number.
Patrick Newton
Great. I guess, Alex, pertaining to the budgeting for a low single-digit reduction in headcount.
Is this just not backfilling natural attrition or are you truly reducing and optimizing certain areas of the organization?
Alex Davern
It will be a mix as we look at this, Patrick. We're looking to optimize the cost of Company.
We have made some pretty significant forward investments over the last number of years. Last time we had a headcount reduction was back in 2014.
That allowed us to deliver a significant improvement in operating a profitability. Over the last number of years we've obviously been forward investing to deliver core elements on the platform.
We talked about [indiscernible] technology preview earlier in the call. You've seen some of the build-out yourself.
That really run into a tough profitability challenge from the significant surge we saw in the dollar in the last two years. So essentially we're going to be leveraging those investments we've already made, optimizing across the Company to bring headcount down in 2017 to make sure that we make forward progress on our operating goals in 2017.
Patrick Newton
And then I guess shifting gears, given a lot of the industry chatter about the opportunity in 5G. In your prepared remarks you talked about the second generation of EST putting you in a very good position.
I'm curious if you think that 2017 is the year that 5G and Flex for National Instruments or in the broader industry for solid growth or is it more realistic to think this could be 2018 or even later before it can be a meaningful contribution?
Eric Starkloff
So 5G, obviously we been involved. We've been really at the front end of that for a couple of years now and prototyping these system and in algorithm development.
That continues to be a really strong position for us. Alex mentioned some examples in the software-defined radio that's related to that area.
Speaking to your question about 2017, I think we will start to see some business in the semiconductor area with some new we semiconductor designs that will start to need early validation test. We're going to continue selling prototyping system throughout this year.
I think most people think that the volume production of devices is still a couple of years off. But I do want to emphasize one of the unique parts of our strategy in this area is that we're able to monetize that along that whole flow.
So in addition to putting us in a good position for the business that's going to come in 2018, 2019, we're selling systems into prototyping, building customer relationships. And I think we're going to have some of those to highlight in May when we see you here in Austin.
Patrick Newton
And just last one for me is looking at orders a little bit differently. You saw an acceleration in the larger size orders, I think the greater than $100,000 excluding your largest customer was up 8% year over year.
Could you walk through anything by end market or geography that is driving that uptick?
Eric Starkloff
Yes, I'll take that one as well. Certainly on the end market side, if I looked across the industries, most were pretty close to the Company's performance and flat, relatively flat, with a couple notable exceptions.
One of them is in the semiconductor industry, really in semiconductor test. That is largely in those large order categories and it goes from the validation labs through production.
That's been an area we focused on. So we've been really pleased that that's been a growth driver.
On the other side, some of the areas a little bit more weakness, energy continues to be weak for us. It has been for some time.
Academic is another area that there has been some weakness, particularly in emerging markets. I'm talking about places like [indiscernible] and Arabia and Russia where a disproportionate amount of our business is in academia.
And difficult economic situation has lowered government funding in those areas and that has had an impact on spending in academia. So that's been a little softer than typically.
It's still a very strategic part of our business, obviously. But semiconductor's an area that we expect to continue to be strong and as an area of investment and new product development.
Patrick Newton
And I know I said this is my last one. But John, just on the tax again.
I was looking back at some NIWeek notes and I think you previously guided to 2017 to be in a range of 18% to 20%. And then I think with the R&D tax credit, 16% to 18%.
I'm curious what's driving the 21% target for the year?
John Roiko
Yes. So it was in both numbers, Patrick, just to be clear.
And then what's different is those were expectations that we were putting together way before we had better clarity for the 2017 numbers.
Alex Davern
So I think it's a shift in the mix of regional profitability. And the overall profitability is impacting that estimate, Patrick.
Operator
Our next question comes from the line of Richard Eastman from Robert W. Baird.
Your line is open.
Richard Eastman
Sorry. As mentioned, back in the queue.
Can I just ask about EMEA. In local currency I think you commented it was kind of flat.
And I'm curious, what's the tone there and any kind of explanation? That had to underperform, I presume, at flat?
Or is that -- maybe you can put a little color on that.
Alex Davern
That's a very good question. EMEA's obviously has taken the biggest impact on the currency, as well and certainly for our portfolio of regions.
We're -- as I have seen certainly in the last few months a tremendous improvement in the PMIs in Europe. When we look at a flat performance, we're certainly expecting to see an improvement on that as we move into 2017.
The Europeans have had a tough go of it the last couple of years. It seems from the activity metrics that we look at that Europe should be well positioned for a much better 2017.
Richard Eastman
Alex, when you look at the geographic mix within the business and you think out through 2017, into and through 2017, is there any reason to assume that any geography should outperform the other?
Alex Davern
Yes, definitely our numbers get a little bit muddled because all the revenue for our largest customer gets recognized in APAC. So when you look at it by quarter you're going to see that.
If we exclude our largest customer here in Q4 and if you think about it over the course of the last several years, China has been a standout growth region for National Instruments, as it has been for many companies. So we had close to double-digit revenue growth in APAC excluding the largest customer.
So that is an area that I think I would expect to see continue to grow as a portion of our revenue. Obviously China now is the world's second largest economy.
That is the one I would call out in particular.
Richard Eastman
Okay. And then just two more things.
One is should we be concerned at all, LabVIEW 2016 which you more or less introduced last August at NIWeek. Thought process is that maybe that gets widespread distribution or availability around May NIWeek this year.
Is there any concern that we could see a bit of hold-up on sales here as we await the newest version of LabVIEW?
Alex Davern
So let me address that one directly, Rick. Obviously we released a tech preview.
In addition to LabVIEW 2016, we released a tech preview of a future version of LabVIEW and received very strong customer reaction. This is a way for us to get significant customer usage and feedback.
It is part of the staged release of a set of new products. So we're looking forward to the general release of the shipping version, if you like, of that product.
And it's going to deliver, we believe, a lot of value for our customers across the whole value chain of the engineering tool from web to big data to 5G. So I guess we would love to talk to you more a lot about that at NIWeek.
Richard Eastman
But you don't think it's influencing order patterns here or could in the spring here? Should we be aware that?
Eric Starkloff
Comment, Rick, from Eric. The software technology preview is available to any of our customers that buy the product or are on service.
So it actually creates really an incentive for them to buy the standard LabVIEW 2016 and the service that comes with it. So we don't anticipate that having an impact from that point of view.
Richard Eastman
I see, okay. And then just maybe the last open-ended question here little bit.
Alex, any concern here about this border tax adjustability that everybody is talking about here? Pretty much everything that you guys sell is kind of produced outside the U.S..
How do you -- any concerns there or any initial thoughts about that?
Alex Davern
I have been looking forward to the opportunity for there to be good tax reform in the United States in my 22 years at NI. And I've been frustrated many times and had lots of speculation.
So I think the safest thing to do with this is when we know what's going to happen, then we will address it at that point. Until then the number of scenarios we cut model are almost infinite.
Operator
Our next question comes from the line of Patrick Newton from Stifel. Your line is open.
Patrick Newton
Just two more follow-ups. I guess Eric and Alex, you alluded to the FTS being strong in the prepared remarks and then Eric I think you brought it up again as being kind of a growth driver for you in the quarter.
Can you help us understand relative size of that business at this point or at least relative growth rate?
Eric Starkloff
Yes and just to be clear, my remarks were about our semiconductor position in general. FTS is an important part of that for production.
We've been very pleased with the results of that. It's a relatively small portion of it, but growing very fast.
One of the compelling things is we actually sell across the design cycle of semiconductor components. Starting in labs, characterization labs is a very big part of our semiconductor test portfolio and that's really standard PSI products in LabVIEW and our RF portfolio.
And then that flows into FTS. So it is relatively significant part of our business when you look at all of it and it's all growing double digits.
And FTS is growing faster than that.
Patrick Newton
And just last one is, given the comments on academics still being relatively soft, I'm curious is that still your largest vertical?
Alex Davern
I believe the answer that question is yes, but not by as wide a margin as [Technical Difficulty].
Patrick Newton
I'm sorry. Somebody was over-talking.
I heard -- you kind of got cut off there, Alex.
Alex Davern
Sure. I believe it is still our largest market segment or industry segment, but not by the same margin that it was a couple of years ago.
Patrick Newton
And is wireless the one closing the gap?
Alex Davern
I think, as Eric talked about, aero defense is a big market for us, automotive, wireless certainly, semi tech. So there's a number of strong markets out there that would compete for the number one spot.
Operator
[Operator Instructions]. It looks like we have no other questioners in the queue at this time.
I would like to turn the call back over to management for closing comments.
Alex Davern
Thank you very much for joining us. We look forward to talking to you in April.
And please book your flights to beautiful Austin, Texas in May. We look forward to seeing you at the Investor Conference and NIWeek.
Thank you.
Operator
Ladies and gentlemen, thank you again for your participation in today's conference call. This now concludes the program and you all may disconnect at this time.
Everyone have a great day.