Oct 26, 2017
Executives
David Hugley - VP, General Counsel Alex Davern - President & CEO Karen Rapp - CFO Eric Starkloff - EVP, Global Sales and Marketing
Analysts
Vijay Bhagavath - Deutsche Bank Patrick Newton - Stifel Richard Eastman - Robert W Baird
Operator
Good day, everyone and welcome to the National Instruments Third Quarter 2017 Earnings Conference Call. Today's call is being recorded.
You may refer to your press packet for the replay dial-in numbers and passcode. With us today are David Hugley, Vice President, General Counsel; Alex Davern, President and CEO; Eric Starkloff, Executive Vice President, Global Sales and Marketing and Karen Rapp, CFO.
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 future growth and profitability, future restructuring charges, and our guidance for revenue and earnings per share for the fourth quarter 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 to the company files regularly with the Securities and Exchange Commission, including the company's Annual Report on Form 10-K filed on February 16, 2017 and our quarterly report on Form 10-Q filed on August 1, 2017.
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 today. My key messages today are; record revenue and operating income for third quarter.
Non-GAAP operating expenses flat year-over-year for the first nine months and then 28% year-over-year increase in non-GAAP net income for the first nine months. I'm pleased with our performance this year.
We've delivered record revenue and record profits through Q3. With non-GAAP net income of 28% year-over-year and we've made significant progress towards our target business model.
With strong alignment throughout our organization. Within continued success and the key focused areas of semiconductor test, 5G, electric and connected vehicles and the industrial Internet of Things.
Within semiconductor, we continued to see strong performance from our PXI platform and or PXI based semiconductor test system. With consumer demand driving higher performance from connected devices, the associated complexity puts demands on device manufacturers to look outside of traditional test methods to address increasing test times and cost.
By leveraging our software centric platform, semiconductor manufacturers like Analog Devices, IDT, Search Logic and Panasonic have using NI platform to simplify system design reduced their cost of test and bring new devices to market faster. As 5G technology transitions from research and prototyping to semiconductor characterization.
We're excited about the strong relationships we've built since the initial investment of our 5G lead user team in 2010, key researchers from leading organization such as Intel, Lund University, AT&T, Nokia and many more have built their IP on our software defined radio platform to showcase key 5G milestones that will now inform the characterization, validation and test phases of 5G. This year we've seen acceleration in the shift of vehicles from internal combustion to electric drive and from human control to autonomous control.
The pressures of new features time to market and safety have introduced new test challenges for OEM and tier-1 suppliers, by tightly integrating physical, electrical and RF measurements with LabVIEW programmable FPGAs. Our platform has enabled an ecosystem of application experts to address these emerging test challenges.
Coupled with our long-term relationships within these accounts, we believe we have an opportunity to drive growth within new test applications from advanced driver assistance, active safety and electrification. Turning to the industrial IoT, we believe the convergence of business process and technologies opening new opportunity for the NI platform to supply the operations data of the industrial IoT.
Helping our customers achieve their business outcomes in design, manufacturing and test. In Q4, we are launching a global seminar co-developed and co-marketed with Intel, HP enterprise, PTC and others to demonstrate to our respective customers, the technology and best practices require to implement the industrial IoT.
I'll now turn it over to Eric Starkloff to talk more about our products and the success we're seeing from aligning our product development, marketing and sales teams around key applications where we provide differentiated value for our customers.
Eric Starkloff
Thank you, Alex and good afternoon. I'd like to share results from our products and our regions as well as results from market areas we're focusing on to drive growth.
To begin, let's review our performance by product areas. In application software, following the LabVIEW 2017 and LabVIEW NXP releases at NI week.
We talked growth in LabVIEW seeks and continued excitement from our customers about our new capabilities. Our focus on driving it option at our largest accounts through enterprise agreements, product enhancements to increase usability for new users and new capability to address larger distributed deployments, continue to increase both the number of users and the value of LabVIEW to our existing users.
In our PXI product, strong revenue growth across many different applications. With new product releases at NI week and over 20 years of product in ecosystem development, PXI continues to be a major disruptor of traditional, automated test and automated measurement systems.
By providing software continuity, investments made by our customers and partners - be used to address new and emerging market opportunities. In particular, RF and wireless has been an area of innovation and growth for PXI.
At Broadcom for example, an engineer in new product introduction said, “we were able to reduce manufacturing test time of power amplifiers by five times compared to existing test systems by using NI vector signal transceiver to implement power servering [ph] on FPGAs.” By combining RF measurement in generation with an open FPGA our customers have been able to increase test coverage and decrease test time to help bring new chipsets and standards to market faster.
In our data acquisitions products, PC plugin products were flat year-over-year, due impart to continued flat to declining PC sales. While our modular data acquisition systems including CompactDAQ saw a strong year-over-year revenue growth.
With multiple new modules and TSM or time sensitive network based distributed synchronization. CompactDAQ enables customers and industry such as automotive, aerospace and research to more easily build accurate, distributed measurements systems and reduce the time spent on expensive low-value activity like wiring and system set up.
Our CompactRIO product also saw year-over-year revenue growth in Q3 by providing high performance measurement FPGA processing and intelligent networking at the edge. CompactRIO helps our customers bring the industrial IoT to life.
By flipping industrial assets with sensing, processing and network communication our customers gain access to critical data that drives outcomes like efficiency, safety and reliability. Now looking at order side, we had strong year-over-year growth in revenue from orders over $20,000.
Demonstrating our focus and alignment on driving systems business and more opportunity in our larger accounts, orders under $20,000 also saw modest growth. From a regional perspective we saw year-over-year revenue growth in all three regions led by double-digit growth in our APAC region.
We're also pleased to see continued strong growth in our revenues with alliance partners. we believe the NI platform is incredibly well suited to enabling capitalize on the market disruption created by demanding new semi-sector technology, 5G prototyping and test, connected and electric vehicles and the industrial IoT.
Key to our success for decades has been our strong grasp of customer challenges, gains through direct selling and a strong connection between our sales teams and our product and company strategy. Building on that, we've been evolving our sales organization to address the opportunity in these key applications areas.
By applying a more deliberate approach to sales coverage of our large customer base, deploying our highest value resources to customers and geographies where we expect the greatest return and decreasing our cost of sales on our high volume transactions, we believe we can deepen our relationships with our customers and increase our share within these target areas. I want to conclude by recognizing the hard work of our R&D sales and marketing teams to both deliver on the near term success of our customers and our business while also evolving and focusing their effort to align around our future growth opportunities.
I will now turn it over to Karen Rapp for the financial update.
Karen Rapp
Thank you, Eric. Today we reported Q3 revenue of $321 million, a record for the third quarter.
In Q3, revenue was up 5% year-over-year and we believe this represents a share gain in the test and measurement market. Core revenue, which we define as GAAP revenue excluding the impact of our largest customer and the impact of foreign currency exchange results were up 5% year-over-year.
The impact of foreign currency was minimal in third quarter and the revenue from our largest customer was flat year-over-year. Looking at our operational results, non-GAAP gross margin in Q3 was 75%, total non-GAAP operating expenses were $190 million down 2% year-over-year.
Our non-GAAP operating margin increased by 290 basis points year-over-year to 15.4% demonstrating continued commitment to our new operating model and disciplined expense management. We reported net income of $33 million with fully diluted earnings per share of $0.25.
Non-GAAP net income was $42 million or $0.32 per share, which represents a 30% year-over-year increase. Included in our GAAP net income is $1 million of restructuring charges.
Year-to-date non-GAAP net income is $104 million of 28% with operating expenses flat year-over-year. A reconciliation of our GAAP and non-GAAP results is included in our earnings press release.
Now taking a look at order trends in more detail. For Q3, the value of our total orders was up 5% year-over-year in US Dollars included in that total is $8 million in orders received from our largest customer as compared to $5 million in Q3, 2016.
Now breaking down our Q3 order values, orders with the value below $20,000 were up 1% in the third quarter. As an indicator of the strength of our systems business, we saw all orders over $20,000 up 8% year-over-year.
Orders with the value between $20,000 and $100,000 were up 8% year-over-year and orders with value over $100,000 were up 9% year-over-year. We believe the continued systems order growth is indicative of the value our customers see in our innovative platform.
As Eric mentioned the catalyst to our sales transformation has been the evolution of our business and to more system sales opportunities. This deliberate sales channel investment will help to optimize our direct customer relationships to support our growth goals.
Moving to the balance sheet and capital management. During the quarter, we paid $27 million in dividends continuing our history of returning value to shareholders.
We ended the quarter with cash and short-term investments of $385 million at September 30, 2017. And the NI Board of Directors have approved the quarterly dividend of $0.21 per share.
Now I would like to make some forward-looking statements. Included in our guidance for Q4, 2017 is approximately $4 million in revenue from our largest customer.
Given our historic seasonality trends, we currently expect total revenue in Q4 to be in the range $331 million to $361 million. The midpoint of this range represents a new record revenue for our fourth quarter.
We expect GAAP fully diluted earnings per share will be in the range of $0.27 to $0.41 for Q4, with non-GAAP fully diluted earnings per share expected to be in the range of $0.34 to $0.48. Included in our Q4, 2017 GAAP earnings per share guidance is approximately $1 million of restructuring charges.
I'm proud of the progress we've made in improving our operating performance this year, with the midpoint of guidance providing for 31% year-over-year increase in non-GAAP fully diluted earnings per share. We remain committed to our operating leverage plan for 2018.
In summary, we're encouraged by the continued strong order in Q3 and the value we offer our customers through our innovate platforms. I also continue to be impressed with our employees as we deepen our customer intimacy and remain focused on our growth and profitability goals this year and into 2018.
As these are forward-looking statements I must caution you that our actual revenues, expenses and earnings could be negatively affected by numerous factors. Such as any weakness in global economies, fluctuation in revenue from our largest customer, foreign exchange fluctuations, expense overruns, manufacturing inefficiencies, adverse effective price changes and effective tax rates.
We will be participating at the Baird Industrial Conference and Stifel Growth Conference in Chicago as well as the Credit Suisse Conference in Scottsdale in November. We look forward to seeing you there.
With that I'll turn it back over to Alex for some closing comments.
Alex Davern
Thank you, Karen. In this year of change for NI.
I'm proud of our execution for [indiscernible] profitability goals. In 2017, we've expanded our platform of highly differentiated products, we've built deeper customer relationships with our most important customers and partners and we've optimized our sales channel to more efficiently serve our broad based.
These efforts have yielded record revenue and record profits through the first three quarters. I'll finish by expressing my appreciation for the focus and dedication of our employees.
Through your efforts, we're well positioned to drive impact in our target applications areas and achieve the growth and profit that will provide the investment for our future. Thank you and we will now open up for your questions.
Operator
[Operator Instructions] our first question comes from the line of Vijay Bhagavath from Deutsche Bank. Your question please.
Vijay Bhagavath
What are the key catalyst [indiscernible] Alex and Karen in your view that could drive upside to your own internal targets on the top line and how I mean is, if you could call out any specific test used case or a product theme, that we could kind of follow and think about in terms of potential drivers to upside to your own targets as we head into fiscal 2018? Thanks, and I have a follow-on.
Alex Davern
Sure, looking at 2018, Vijay I appreciate the question. Obviously, we're only giving guidance for Q4, 2017 but when we look at into next year.
I'm very pleased that we've had tremendous success and delivered record revenue profitability this year and have closed significant portion of the gap between our target profitability and where we have been historically. We're going to be very focused on executing against our committed leverage model next year.
And you know obviously well we're not giving any guidance for 2018, there are some things that are shaping up favorably both from the broad macro dynamic from a currency point of view and then product traction as well. Both across our software platform, our PXI data acquisition products, our CompactRIO products and then, with the focus in the sales channel on ensuring, we continue to drive market share gains in our systems business.
So, I think there is a number of factors that are quite positive as we look into next year and we'll be in a position, we'll talk more about that in January.
Vijay Bhagavath
Perfect a quick follow-on for Karen. As we head towards year end, helpful for us to get any modeling guidelines for the New Year.
How should we think of margin metrics for fiscal 2018? Thanks.
Karen Rapp
Vijay, thanks for the question. For margin you can take a look at our historic gross margin trends and project that into the future at similar types of rates.
Always staying within the operating model that we've committed to in public, so that should give you some guidance for that.
Vijay Bhagavath
Okay, thank you.
Operator
Thank you. Our next question comes from the line of Patrick Newton from Stifel.
Your question please.
Patrick Newton
I guess first my traditional housekeeping, if I could get you where - headcount in the quarter and also your average order size.
Karen Rapp
This is Karen, that's for me. Headcount ended at just over 7,400 people.
We're flat sequentially and from an average order size looking at around $5,900 again flat to last quarter.
Patrick Newton
Perfect then I guess that it seems like you're well on pace to hit that previous metric of low single-digit declines and headcount for the full year. I guess as we think about that translating to OpEx, would it be reasonable similar - in the third quarter year-over-year to think that the fourth quarter year-over-year could see a decline in absolute OpEx.
Karen Rapp
We're looking at number Patrick that is probably less than 1% year-over-year for the fourth quarter.
Patrick Newton
And that's 1% decline over of?
Karen Rapp
Growth.
Patrick Newton
Okay. And then.
Alex Davern
I know, you know this, but in Q3 we also had shift of NI week. Last year it was in Q3 and this year it was in Q2, so that had some impact in the third quarter.
Obviously, we talked about that in Q2 as well, so.
Patrick Newton
Yes, okay and then I guess either for Alex or Eric, if we think about the early drop of the 3GPP standards next thing this year, does that pull forward any type of timeframe for us to see meaningful [indiscernible] revenue maybe out of research and characterization or should we think of an inflection for NATI in 5G around the full release 15 in mid-2018 or perhaps even think about an inflection differently, just trying to get an idea.
Eric Starkloff
Sure, I'll take that one, it's Eric. Hi, Patrick.
Yes, so regarding 5G as you know we've had a - at this point a fairly long history in the researching and prototyping side starting back in 2010, so we continue to serve that part of the market which has been a good business area and our software defined radio part of our business and now as you mentioned, we believe that puts us in a position to start to search some of the early testing capabilities and validation particularly of early semiconductors. Our timeline is still similar to what we've talked about before, we're already engaged with lead users doing early silicon and we expect that to continue through next year and then commercial rollout, we're still beyond that by in large into 2019, 2020 and beyond.
So really our focus at point is continuing our prototyping business and setting ourselves up with deep relationships on early testing opportunities and such [indiscernible] space.
Patrick Newton
Great appreciate the comment and I guess just one more if I may. Alex, you talked about automotive, you talked about IoT, you talked about 5G and you talked about some traction with substantial number of your product portfolios.
It seems like macro trends are very much in your favor and we started to see your competitors who you've consistently gained share from, start to see growth. So, if we step back and kind of take that all in, I'm curios why if I look at the 5% growth target at the midpoint for the December quarter, how come that growth rate is not accelerating more?
And especially if we think about an easy comp year-over-year, are there any key dynamics that we're missing or key inflections that are more of a calendar 2018 event.
Alex Davern
So not allowing question at all Patrick, but so good question Patrick, when we look at the broader market and we look into 2018. Reflect on our success in 2017 and executing [indiscernible] to deliver record revenue, to midpoint about 6% core revenue growth and over 30% increase in our non-GAAP net income.
As we look into 2018, our goal would be complete the job on executing against our business model, achieve our revenue target that's what we'll be pushing for. And as I said earlier on to Vijay's question, certainly the macro trends the currency in our product traction are setting up well for 2018.
For Q4, our approach to giving guidance, Karen's approach to giving guidance is the - make sure we're going to hit our goals and what we commit to so, we strictly use historical seasonality and to set the guidance expectation for Q4 and that's the logic behind the midpoint of revenue growth for the fourth quarter.
Patrick Newton
Great and thank you for the details. Good luck.
Operator
Thank you. [Operator Instructions] our next question comes from the line of Richard Eastman from Robert W Baird.
Your question please.
Richard Eastman
Just very quickly, Alex could you kind of speak or Karen, could you just speak a little bit to Europe and the 1% growth rate there. The comp was fairly easy and I'm curious what's lagging in Europe?
Eric Starkloff
Rick, its Eric. Let me take that one.
The 1% is on our [indiscernible] region and obviously there is a few different dynamics happening there. We have parts of that region that are performing very, very well.
So, Germany is one that stands out, [indiscernible] there, double-digit growth, its lot automotive business we highlighted that at one of the verticals, it's doing quite well. And then we have other parts of that region that are lagging.
So, Russia and Arabia have been challenged for probably [indiscernible]. The UK has been bit challenged and so that - that's net south to that.
Now we're encouraged as we look over the last couple of quarters on the strengthening PMI strengthening economy in that region, we do see opportunity in the business that we have across the EMEA region.
Richard Eastman
Okay and then, couple of the key markets government, academic [indiscernible]. Could you just toss a little bit of color around those?
The kind of key end markets for you. Have they stirred the perk up some?
Eric Starkloff
Yes, I can take that one as well Rick. So, let me start with the couple that we highlighted.
So, semi has been very strong, so that's a strong double-digit growth in semi. As a reminder, our semi business really consists of both footprint in the labs, where our software and PXI platform is been used for quite a long time, that continues to be strong and then as you've heard from us we're increasingly also serving the production area of semiconductor through our semiconductor test system, so strong growth in semiconductor.
The other strong growth area is in automotive and transportation that we highlighted. So, we see a lot of changes in that market place in terms of the needs of testing some of the new technologies that are coming in that space that are well aligned to the capabilities of our platform and we have long-term relationship with customers in automotive.
Those are the stronger ones. One the other side, some challenges we've mentioned before over the last couple of quarters, that our US Government business was softer and that's continued into Q3, so we saw softness in that space and some softness in the academic industry as well.
Richard Eastman
Okay and then maybe just one last question. Just when you look at the order growth by less than $20,000 order side, how do you feel about that 1%?
Does that kind of turn positive here? Is there any feel around inflecting there?
Again, PMI if that's indeed the driver probably doesn't get much stronger than it's been. And I'm just curios about that piece of the business.
Alex Davern
It's a very good question, Rick. Certainly, I think as we look forward the underlying metrics that we look to for that business or something emerging as we look forward.
Richard Eastman
Okay, awesome. Thank you.
Operator
Thank you. And this does conclude the question-and-answer session of today's program.
I'd like to hand the program back to Alex Davern for any further remarks.
Alex Davern
Thank you very much for joining us today and we look forward to seeing you in one of various investor conferences over the course of the next few months. Thank you very much.
Operator
Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program.
You may now disconnect.