National Instruments Corp (NATI) 2002 Q3 法說會逐字稿

Good day, everyone, and welcome to this National Instruments quarterly earnings release conference call. Today's call is being recorded. You may refer to your press release packet for the replay dial-in number and pass code. The replay will be available by 7:00 p.m. Central Time today and will end at midnight Central Time on Thursday, October 24. For opening remarks, I would like to turn the conference over to the General Counsel, Mr. David [Houghley]. Please go ahead, sir.

Good afternoon. During the course of this conference call, we shall make projections and forward-looking statements regarding the future financial performance of this company, including projections of future sales growth, expense levels and earnings during fourth quarter of 2002, and manufacturing inefficiencies. Such statements are based on management's current expectations or beliefs and are subject to uncertainties that could cause actual events or results to differ materially. Some of the risks that could cause our financial results to differ from forward-looking statements include fluctuations in customer demand for the company's products; expenses exceeding the company's budget targets, and delays in the introduction of new products. We refer you to the documents the company filed with the Securities and Exchange Commission, including the company's recent Form 10K and 10Q. These documents contain and identify other important risks.

This call is being made at 4:00 PM Central Time on October 17, 2002, and we undertake no duty to update any statements made herein. With that, I will turn it over to the President and CEO of National Instruments Corporation, Dr. James Truchard.

Thank you, David. Good afternoon, and thank you for joining us today. Our key points today are double-digit year over year growth in both revenue and earnings; dramatic year over year increase in operating income, and significant new products that continue to fulfill and expand our vision.

We were pleased with our strong performance in Q3. I believe we are well-positioned and are investing and executing effectively to strengthen our position and expand our future opportunities. In our call today, Alec Davern, our CFO, will review our financials; Ron Wolf, our Director of Strategic Marketing, will discuss our business, and I will close with a few comments before we open up for your questions. Alec?

Good afternoon. During Q3, NI delivered a very good performance and returned to strong year over year revenue and earnings growth. On a year over year basis, revenue was $96 million dollars, was up 13 percent. Operating income was up 32 percent and net income was up 18 percent. During the quarter, we incurred $1.2 million dollars in patent litigation expenses compared to a $1.2 million dollar credit that we booked in Q3 2001, when a previous case was settled. Excluding this change in patent litigation, operating income would have been up 87 percent.

Our ability to show good growth this quarter despite continuing problems for most of the industry reflects two major points. Number one: because our instrument control business has fallen from 27 percent of revenue in 2000 to 19 percent of revenue in 2002, we believe NI is now less susceptible to a downturn in the economy. Number two: during this downturn, we not only maintained our R&D investments, but we significantly increased them. This has resulted in a strong flow of new products, which has helped to fuel our growth. During Q3, we saw improvement in our year over year growth rates in all regions. In Europe, our revenue was flat year over year, a significant improvement over the 12 percent decline we saw in Q2. In the U.S., we returned to growth, with a 13 percent increase over Q3 last year. And in Asia, we improved our growth rate from last quarter, growing by 38 percent year over year.

Moving down the income statement, gross margins in Q3 were 73.8 percent, a significant improvement from the 71.5 percent we saw in Q2. The increase in gross margins was primarily driven by improved efficiency and the strengthening of the euro over Q2. Our operational performance in manufacturing improved significantly in Q3. We resolved the inventory planning issues we had with the IT implementation; we increased the efficiency of our U.S. operations to its highest level in three years; and after only 11 months of operation, we increased the efficiency of our Hungarian operations to the U.S. levels. This operational improvement allowed us to increase our finished goods by $2 million dollars and our raw materials by $5 million dollars. This, in turn, enabled us to increase our customer satisfaction and improved the linearity of our business.

This improved linearity enabled us to reduce accounts receivable by $4 million dollars, despite a $2.5 million dollar sequential increase in revenue. The increase in inventory puts us in a good position, going into what has historically been our strongest quarter of the year, and leaves us with inventory turns consistent with Q3 last year. We expect inventory to be relatively flat in Q4, but the mix will shift towards more finished goods and less raw materials, as we achieve the stocking levels needed to support our customers.

Now, total operating expenses were up 13 percent compared to Q3 2001, and operating income was up 32 percent. We continued our focused investments in R&D, increasing [both] our expenses and our head count by approximately 10 percent year over year.

NIWeek 2002 was a great success, with record attendance and major product introductions. We have aggressively promoted these new products in the marketplace, increasing our sales and marketing expenses by $3 million dollars sequentially and by 7 percent year over year.

Compared to Q3 last year, we saw a large variation in patent litigation. Last year we recorded a $1.2 million dollar gain from the settlement of a case, and this year we incurred a $1.2 million dollar expense related to our patent suit against [The Notworks]. This resulted in a $2.5 million dollar change in expenses, and increased our year over year expense goal from 8 percent to 13 percent.

Excluding the effects of patent litigation, operating income would have been up 87 percent. This represents a dramatic improvement in our operating profitability over the last 12 months, and demonstrates the high quality of our business model and the high value we deliver to our customers.

Net income for the quarter was $6.7 million dollars or 7 percent of revenue. The bottom line is that we continued to deliver strong profitability and one of the highest net margins in the industry in Q3. We also had good cash flow in Q3, with $12 million dollars in cash flow from operations. This was offset by approximately $9 million dollars in capital spending related to the completion of our new R&D center and the installation of a second production line in our Hungarian manufacturing facility. This brings our capital expenditures for the first nine months of the year to $25 million dollars. We expect our capital expenditures to decline significantly to approximately $5 million dollars in Q4 and approximately $15 million dollars for all of 2003.

During the quarter, we also made our first significant repurchase of the company stocks since the IPO in 1995. We repurchased 813,000 shares, or approximately 2 percent of the outstanding stock during the quarter, at an average price of $24.00. This almost completes the 1 million share buy-back approved by the Board in 1998. In addition, at the Board meeting yesterday, the Board approved a new stock repurchase plan, allowing for the repurchase of up to 2 million additional shares of the company's stock.

Now, looking out to Q4. On the macroeconomic front, capital expenditures in the global economy continue to be under considerable pressure during the third quarter, and this is likely to continue during Q4. Another concerning factor is the Purchasing Manager's Index. This fell to 49.5 in September, its first time below the breakeven level of 50 since January. However, despite these macroeconomic issues, we believe that National Instruments will continue to see year over year revenue and earnings growth in Q4. We are currently expecting to see fully diluted earnings per share between 19 and 21 cents per share for Q4. As these are forward-looking statements, I must caution you that operating results for Q4 could be negatively affected by numerous factors, such as any further decline in the global economy, manufacturing inefficiencies, and foreign exchange fluctuations.

On another note, the tenant of our Millennium property has elected to buyout their lease obligations. As a result of this and some additional space consolidations, NI expects to recognize a pre-tax gain of approximately $4 million dollars in Q4. Given the nature of this gain, we intend to take advantage of this opportunity to further advance our strategy of bringing virtual instrumentation to universities around the world. To achieve this, we will establish a corporate foundation to continue our promotion of scientific and engineering research and education at higher education institutions worldwide. We intend to fund this in Q4 by donating the $4 million dollar one-time gain to the foundation. We believe that this donation will significantly advance our global position in academia, a key strategic area for NI.

With that, I'll turn it over to Ron.

Thank you, Alec. We turned in a solid performance in Q3, not only with our financial results, but especially in R&D, where we brought some very important new products to market. From a product mix standpoint, our computer-based measurement and automation products saw solid, double-digit revenue growth over Q3 2001. Our PXI platform for complete system solutions once again saw very strong growth and set another quarterly record for sales. Our FieldPoint platform for distributed data collection also saw double-digit revenue growth over Q3 last year and a record sales quarter. Software sales were also strong, with LabVIEW Real-Time and our DMM product for offline data analysis leading the way.

We were also pleased to see double-digit year over year growth in sales of our traditional instrument control products, which we believe is an indication that the market for traditional test instruments may be stabilizing.

The major highlight of Q3 was our annual NIWeek Conference. Attendance grew 20 percent from last year, setting a new all-time record. In his keynote. Dr. Truchard gave an update on our LabVIEW Everywhere strategy, as we reached another milestone with the introduction of LabVIEW FPGA. FPGA's, or Field Programmable [Gata] Rays, are hardware chips that ship with their internal silicone gauge unconfigured. We see FPGA as a fast-growing, exciting new computing platform that can expand the realm of applications we can pursue with virtual instrumentation. Our vision is to take I/O performance to even higher levels, using reconfigurable hardware products with onboard FPGA's that end users can program themselves using LabVIEW. Just as LabVIEW is revolutionizing the test industry with user-defined instruments, LabVIEW FPGA enables user-defined I/O hardware for systems that require high speed custom [logic] and tightly integrated Real-Time control, such as hardware [indiscernible] and industrial machine control applications.

At NIWeek, we also shared our expanding vision for LabVIEW, which we called LabVIEW Throughout The Design Flow. Increasingly, our customers are using LabVIEW not only to test completed products, but also to integrate real world measurement much earlier in the design process -- during the simulation and modeling phases of product design. From defining the first prototype to manufacturing the final product, we believe LabVIEW and virtual instrumentation can streamline the entire design process, and we're working to make that expanded vision a reality.

For example, we announced plans to integrate LabVIEW with Texas Instruments' Code Composer Studio development tool, to help customers identify design flaws during the modeling phase of TI-based DSP systems. This can vastly reduce the time to develop DSB-based products such as digital media players, wireless LAN systems, optical networking systems, household appliances, and more.

Another example was our joint press conference with Techtronics at NIWeek, where we announced that their new Open Windows Oscilloscopes will include ready to run LabVIEW applications embedded inside the instrument, as well as an evaluation version of LabVIEW that the customer can use to customize functionality. Colin Shepherd, Vice President of Oscilloscope Products with Techtronics stated, quote, "Through this initiative, National Instruments and Techtronics deliver an unmatched solution for design engineers. By aligning ourselves with the industry leaders such as NI, we help engineers perform sophisticated analysis of their design and develop custom applications using LabVIEW software in our Open Windows Oscilloscopes."

We also announced a number of other new products at NIWeek. We released a major upgrade of our DMM software that integrates seamlessly with LabVIEW. Using DMM, engineers and scientists can perform offline data warehousing, data reduction, data mining, and data analysis on large data sets with more than 1 billion data points like those produced during car crash safety tests or load tests.

By leveraging the latest analog and digital converter chips, we lowered our costs and passed our savings onto customers through a new family of low-cost data acquisition boards. We also announced a new high-speed PXI digitizer module, our fastest ever 16 bit PXI analog output module, and a new LabVIEW based lock-in amplifier virtual instrument that can isolate hidden signals from noise as much as 30 times faster than traditional box instruments.

The two most exciting new hardware products announced at NIWeek are the most sophisticated measurement products we have ever produced: our new PXI 4070 Flex DMM, and our new PXI 5660 RF Signal analyzer. Most of you are probably familiar with our chart that shows our virtual instrument hardware capabilities versus traditional boxed instruments. With virtual instruments, all measurements boil down to two simple questions: What's the frequency of the signal, and how accurately do you need to measure it? If our hardware can acquire this signal in raw digital form, then our software tools and the power of the PC enable customers to build any instrument they want. With our new products in Q3, we have proved virtually every point on our frequency resolution curve.

Our new Flex DMM delivers 6½ digits to measurement accuracy in a single PXI slot. It is ten times more accurate than our previous product, and it is important for several reasons. The traditional DMM, or Digital Multi Meter, is the highest unit volume instrument sold. One easy way to understand why, is that DMM's are often used in testing anything with a battery or power supply. We estimate that at least 60 percent of our large GPIB customer base uses DMM's, and our new Flex DMM expands our served/ available market by $110 million dollars. More importantly, the DMM often serves as a system reference for measurement accuracy. As such, when a customer is evaluating whether to use GPIB, VXI, or PXI for this system, the quality of DMM available for that platform is a major factor. The choice of DMM often determines the choice of platform and therefore pulls a lot of other measurement hardware along behind it. We estimate that at least $2.5 billion dollars are spent annually on automated systems that include a DMM.

Most test and measurement systems require 6½ digit DMM accuracy, so this has essentially been a lock-out specification for PXI in many applications. Now, with our new Flex DMM, we compete very favorably with the best traditional DMM's on the market. In fact, because our Flex DMM is a virtual instrument with a revolutionary digital architecture, it is unlike any other DMM. It is the fastest 6½ digit DMM on the market, bar none, in any platform. It has many features found in traditional DMM's that cost four times the price and also has a built-in 1.8 mega sample per second isolated digitizer to boot.

We were very pleased with sales during this first month on the market. One example is an automotive supplier, who about two years ago replaced GPIB-based systems for testing engine control units with modular systems that use both VXI and PXI together. PXI could perform many other measurements, but they also needed VXI, because a precision DMM and a high speed digitizer were not available in PXI. In their current budget environment, the high cost of VXI has been a stumbling block for their original plan to broadly deploy these systems. They replaced the VXI digitizer with one of our high speed PXI digitizers, and have been anxiously awaiting our new Flex DMM so they could remove VXI completely and broadly deploy lower cost PXI-based systems. Needless to say, they were one of the first customers to order our new Flex DMM.

Another major new product is our PXI 5660 RF Analyzer, which extends our frequency range by a factor of 27, from 100 MHz before, up to 2.7 GHz now. Like our Flex DMM, this RF Analyzer is truly a revolutionary product in terms of architecture, throughput, and size. It leverages the latest technologies, such as GHz speed Pentium processors, digital downconversion [Asyx], and ultraminiature acoustic filters and oscillators. It measures signals between 9 KHz and 2.7 GHz with up to 20 MHz real-time bandwidth; features a spurious-free dynamic range of greater than 80DB and squeezes all this functionality into a compact 3-UPXI model. It delivers a full range of standard RF power, frequency, spectral, and vectral measurements, with throughput up to 200 times faster than traditional boxed instruments. In addition, because it is a virtual instrument, it also gives direct access to raw measurement data and includes comprehensive spectral measurement software tools that empower customers to customize its functionality far beyond traditional box analyzers.

We estimate our new RF Analyzer expands our [served/available] market by $150 million dollars. We can now address [frequency-demand] applications such as spectral analysis, electromagnetic compliance testing, surveillance and defense applications, broadband satellite applications, RF component testing, and more. In addition, we believe our timing for this new product is especially good, given that RF technology, which was once primarily used in military and aerospace, is becoming a very broad-based technology, used in wireless consumer devices such as mobile phones, two-way radios, wireless LAN systems, satellite receivers, analog and digital television systems, remote control key fobs for automobiles, remote control toys, and more.

In addition to new consumer electronic applications, we can also now compete in advanced military and aerospace systems that require integrating RF signal analysis with other functions, such as DMM's, signal sources, digitizers, motion control, and digital imaging. One example is the U.S. Marine Corp measuring ballistics and flight characteristics of artillery from tanks and other launch vehicles. Their previous system used a traditional box spectrum analyzer to capture two samples per second of ballistic flight trajectory. Our new PXI-based RF Analyzer, hooked up to the same antenna, can collect 100 samples per second. That's fifty times as much data in the same amount of time, which can obviously help improve their accuracy.

As you can tell, we are very excited to release these two products, which were under development for several years. The customers and editors at NIWeek were excited as well, as those of you who attended saw first-hand. Fred [Body], publisher of The VXI and PXI Newsletter, covered NIWeek in detail in his August issue. Reviewing our new Flex DMM, he wrote, "When I first heard that NI was introducing a 6½ digit DMM, I wondered what the big deal was about. However, after I saw the product, and began to think about the implications, I came to a much different conclusion. People will begin to consider PXI for their toughest ATE systems. It's a big change in perception, and I believe will make a fundamental difference in how PXI is viewed from here on."

Reviewing our new RF Analyzer, he wrote, "By expanding PXI into RF testing, NI has made an important statement in where they want to go. For the first time, I'm beginning to believe that PXI will provide a significant challenge to VXI in large ATE systems."

In closing, we are pleased with our performance in Q3. Our new products were well received, and we have more exciting and revolutionary products in the pipeline. We stepped up our sales and marketing events in Q3 to back the launch of our many new products, and in the coming months, we will continue to be aggressive as we levy the success of NIWeek and our new products around the world with NIDay conferences in more than thirty-five countries. With that, I'll turn it back over to Dr. Truchard.

Thank you, Ron. I am pleased with our return to double-digit growth in both revenue and earnings. I am also very pleased with our solid execution throughout the company, especially in R&D and manufacturing. I want to thank those of you who attended NIWeek. We promised some revolutionary new products, and as you saw, we delivered. We expanded the visionary role LabVIEW plays in the industry with the introduction of LabVIEW SPGA, which has the potential to truly revolutionize the I/O hardware industry. And we expanded the visionary role LabVIEW and National Instruments can play in the future, with our LabVIEW Throughout The Design Flow initiative. In addition, we significantly expanded our measurement hardware capability with revolutionary new products that represent a huge step forward for our PXI platform and opened up exciting new application areas for the future.

The two most important factors in our long-term growth have been our level of investment in R&D, and our success in identifying new growth areas that leverage our core strengths. We delivered double-digit revenue growth for twenty-four consecutive years; then in 2001, we faced the most severe industrial downturn in our history. We fared much better than our peers, maintaining solid profitability while continuing to increase our investment in strategic initiatives. In fact, our profitable business model allowed us to use the economy as a strategic opportunity. We increased our investment in new product R&D, and expanded our sales force to position ourselves for the recovery. And those investments are now paying off. The new hardware products we introduced in Q3 are the most sophisticated measurement products in our history, and we have more on the way.

Fundamentally, our long-term goal is for National Instruments to grow at least 20 percent per year. Our return to double-digit growth in Q3 proved that R&D investments and effective execution can drive strong growth, even in a stagnant economy. Our strategic newer platforms, such as LabVIEW Real-Time and PXI, delivered strong growth throughout the downturn, and are key growth drivers for the future. I believe we are well positioned, and we have plenty of opportunity before us.

Let me conclude our call today by summarizing my view of the current state of National Instruments. Our vision is sound, our investments have been wise, our execution has been solid; our new products are on the mark; our timing is good, and our expanded sales force is ready.

Thank you for taking the time to join us today. We will now take your questions.

Thank you. The question and answer session will be conducted electronically today. If you'd like to ask a question, please signal us by pressing the star key followed by the number 1 on your touchtone telephone. We will take as many questions as time permits, and will respond in the order that you signal us. Once again, please press star, 1, if you'd like to ask a question.

Our first question today comes from Richard Eastman with Robert W. Baird.

Yes, a couple things. Alec or Ron, would you be able to maybe disclose the percentage of sales that now comes from the automation side of the business, software automation side?

It's Alec here. As we've talked before, it's pretty hard for us to quantify that. We feel very positive and very enthusiastic by the performance we've seen from LabVIEW Real-Time and PXI. Obviously, those have good application on a factory floor. But trying to quantify exactly what percentage of it goes into lab or monitoring or manufacturing is really too difficult for us to speculate on. But certainly we've seen very good success with those products, with record quarterly sales this quarter. On the new products we brought out at NIWeek are going to help to fulfill that vision of increasing our market share in that area.

Let me ask you -- in Asia, could you just maybe walk through where you saw the growth year over year?

Certainly. We have continued to invest in Asia in the sales side, and marketing side, throughout last year, and we saw very good response to that in the Asian tiger countries. So I would say in non-Japan Asia, we saw very good results pretty much across the board. And we're going to continue our strategy of investing there. As we've talked in previous calls, our revenue from Asia as a percentage of total, is probably light compared to most test and measurement companies. Most TM companies would get a bigger percentage of their revenue from Asia; we got started with our direct sales force there a little late in the early 90's. And so we're continuing to invest in there to increase our market share and get it back up to the levels we believe it can attain, going forward.

Is there an end market or two that is obvious to you that's growing, or is it really just the penetration story here that we should focus on?

It's a penetration story. I mean, we're such a broad-based company that it's no particular end market that's going to drive revenues for the company or in any one region. So it's broad-based adoption of low cost, highly productive tools where people are swapping out more expensive alternatives and looking for lower cost, more productive ways to get their job done.

Okay, very good. Thank you.

Next we'll go to [John Hegrenis] with Baldwin Anthony.

Good afternoon, nice quarter. Let's see, last conference call we talked about how discounts and pricing pressures were trending kind of flat. Is that still the case?

Yes. No real change in discounting.

And just a question about the share repurchase. I assume you got pretty aggressive here in the last quarter. Is that why you increased it and do you plan to kind of stay aggressive in the near term?

Well, on the first question, we should start by [indiscernible]. We've had no change in our discounting policy either sequentially or year over year, and haven't seen any pressure on pricing from that point, just so that's clear. On the stock repurchase plan, obviously, this plan has been in place since 1998, and we really haven't taken advantage of it over the last four and odd years. In the current time frame, we have much clearer visibility into our capital expenditures going forward for the next couple of years. We expecting them to really start to drop dramatically starting in Q4 and be at a much lower level next year, and probably for 2004 also. So we don't have much demand on our cash currently and certainly it'd be at the price that we bought it back at an average of $24.00 in Q3, the acquisition of the shares or repurchase shares is clearly accretive. And so those will be the key factors that led to our actions in Q3. What we chose to do in Q4, we'll wait and see.

Okay, thanks.

Moving on to Paul [Knight], with Thomas Wiesel Partners.

How long has PXI been in the marketplace now?

We started shipping our first real products in the spring of '98. So a little over four years. We had a pretty small portfolio of products when we started off, and obviously the portfolio has been expanding, as has the number of companies in the PXI systems alliance, and the number of products provided by other vendors. And obviously here in Q3, at NIWeek, we made some significant steps forward, really not only for NI's PXI platform, but for PXI as a standard, with the new 6½ digit DMM and our first RF product. So, it's been steadily building momentum.

What is that business growing at right now, Alec or Dr. T?

Well, we believe it's probably not in our shareholders' best interest to share the specific data, but it has grown very strong throughout this whole downturn from the last eighteen months. We had record revenue for the quarter in Q3, and we're very pleased with the market share that we're gaining with PXI.

Now, VXI is - isn't that really a military application, and isn't PXI much more broad-based than that?

This is Ron. VXI was developed in the late 1980's. It is a modular instrumentation platform based on the VME bus, which was an early 80's computer bus. Originally, it was targeted at mil-aerospace, but in the early 90's the military budgets weren't spending a lot of money, and it also penetrated into commercial applications. So you see VXI embedded in a lot of high-end ATE systems. It's used in a lot of large channel account data acquisition applications, such as physics research and wind tunnel applications and things like that. But certainly our role in VXI -- we're the leading supplier of controllers is really the position we play. Much like GPIB. And we've got a very, very strong software position. So when you look at PXI, it's a much – in addition to being lower cost – it's a much broader-based platform in terms of functionality, because it leverages the PC so heavily. For example, VXI doesn't really have machine vision products and motion and some of the things that we're able to do in the PXI platform. So it never penetrated much into industrial applications, for example.

Our revenue opportunity with PXI, Paul, will be a lot greater than our revenue opportunity with VXI.

Alex, another question and the last one. The PMI index has been at 50 or a little better seven months in a row, and while not a robust economy, a bottoming one, suggested by the PMI. Do you sense that in your business?

Certainly. Normally we're pretty flat sequentially in Q3, and we saw better performance than that, but we remain a little bit cautious on the overall economy, maybe because we can't control it. The PMI is a little under 50, which indicates, according to the ISM, about a GDP growth of around 2.5 percent or so. Industrial production down a little bit in September, although it's up 1.5 percent year over year, which is the best year over year showing in a long time. So we remain a little bit cautious on that. I think Europe continues to struggle economically. Our real focus is on driving forward our own product lines and, as we said in the call, in the instrument control, which has been – the [product line] for us which is most sensitive to the economy is now below 20 percent as a percentage of revenue, and that's going to be less of an issue for us in a tougher economy. So we're glad to return to growth, and it's really all about new products, and it's about fulfilling our vision of delivering more productive, less expensive tools for our customers.

Okay. Thank you.

Moving on to David [Jeshack], with Sander Morris Harris.

Congratulations on the quarter, guys. [Indiscernible] to drill down a little more on the marketing expenses, and correct me if I'm wrong, but I think you were forecasting like a $61 million operating expenses for the third quarter on the last call?

We did exceed our forecast in operating expenses for the quarter, Dave, that's right. As we went through the quarter and got visibility to the strong performance we saw in the top line, and also the very strong performance we saw in gross margin, we opted to be a bit more aggressive. We also saw the tremendous response of our customers at NIWeek to the announcements that we made. You know, we see great opportunity for these products and we've taken that feedback into consideration in stepping forward more aggressively in promoting these products in the marketplace.

So you're kind of telling me you're very optimistic about some of the things you put on in the way of product introductions in the NIWeek to really beef that spending up.

That will come later in the quarter, just because of NIWeek being midway through the quarter. I think anybody who was at NIWeek would understand our enthusiasm for our customers' reaction to these new products.

And is there any kind of delay in which that kind of extra marketing expenses can then begin to realize [better] productivity going ahead?

Well, certainly these things take time to pay off, and these products are -- you know, we've never had a 6½ digit DMM that's ten times more accurate than we probably could have had before, so it's going to take time for our success in that kind of arena to ramp up from zero. Same in RF; we've never had anything beyond 100 MHz; this is – [the product is] 27 times beyond our previous product. So we'll take some time to ramp up in those areas but, you know, we're all about long-term success at NI. We've grown the company over 20 percent for 23 out of the last 25 years, and it's all about the long-term growth. So we're not afraid to invest in these initiatives that will take a little bit of time to pay off. We've already seen a significant benefit in terms of the P.R. we got from NIWeek. The press coverage on these products has been tremendously positive, and it's very, very good for the PXI platform.

One question about your spending. In the last 12 to 18 months you've added the second line in Hungary; you brought on the Hungary plant; have been aggressive on the R&D, hired engineers; you even brought in a new R&D facility. And then there's some marketing expense here. So you've been pretty aggressive in spending. The question I have for you is, looking forward, about scalability. Looking at your spending budget indicated you probably thought maybe capital spending would begin to back off in the next, say, five quarters or so. Could you maybe address a little bit about scalability and what your plans are for that right now as far as some of the key components – marketing and – [indiscernible] because I'd like to get a sense of when we can see getting you back to some of those operating margins [indiscernible] – certainly it looks like you're in the initial stages of a nice sales ramp up.

Certainly, David, that's a good question. On the capital expenditure side, we're obviously expecting cap ex to drop in half here in Q4 and then in 2003, about half the level it was in 2002. And I wouldn't see any significant increase in that in 2004, so capital expenditure will be – I think will be very scalable. We have a lot of infrastructure in place to support a bigger business. In terms of our head count additions this year, they've been fundamentally focused towards the sales organization, or, sorry, towards the R&D organization. In sales marketing and G&A, we had continued to invest last year, and I think we have a lot of capacity. So I think we have the capacity in the sales group to continue to grow the company from this level without having to add a lot of people. But we are very determined on the R&D side; we see a very good opportunity ahead of us, and we will be continuing to increase head count in R&D. So that would be the primary area of focus.

And one last question. The Siemens relationship you developed was about a year or so ago? How long was it? Fifteen months? You made that announcement you were going to work Siemens on some -- work with their automation equipment?

That's correct.

Could you give us an update on where you stand on that?

That's going very, very well, especially in Germany. We're seeing very good effects from our relationship with the Siemens sales force. We continue to work on product collaboration and we're very pleased with the success we've seen from that. We're doing some joint seminars with Siemens and we see very good opportunities to leverage their brand in Germany, as they do see to leverage our brand.

I think you had some issues with having to do some compatibility with your software versus theirs?

It was a good opportunity for us to create an interoperable suite between our software and their software, so. We saw that as a good opportunity.

Has that been pretty much complete then at this point?

We're still working on that, but Version 1 is out, and we'll be continuing to invest in that going forward.

Okay, thanks.

Thanks, David.

From Solomon Smith Barney, Tim Anderson.

It's Tim Anderson. I just had a couple of questions for you. Congratulations on a great quarter, but I was hoping you could give us a little bit more detail on gross margins. I think you had mentioned it was impacted positively by the euro. I was wondering if you could give us a little bit more color on that, as well as it looks like your gross margins level have returned to where they were a little bit more than a year ago, which is encouraging. Where do you think they can go over the next quarter or two?

Good question, Tim. On the euro side first, the average effective exchange rate with the euro in Q3 is about 5 percent ahead of what we saw in Q2. Obviously, all of our sales in Europe are converted in euros, and so the increase in that provided about a million dollars in incremental revenue sequentially, without any increase in cost. So you're going to leverage on the gross margin there. Obviously, the euro had been at very, very low levels earlier in the year, so we're returning to a more normal situation.

In terms of the long term, obviously we've had gross margins in the 74 to 76 range for most of the last decade. We had operationally slipped a lot in the first half of this year, and manufacturing operations had gotten quite inefficient. So we've improved that a lot in Q3; we see more room for opportunity there to continue to improve that going forward. I wouldn't care to predict gross margins in Q4 or Q1; I think it's a little too short-term at this point. But long term, we remain determined to return to our corporate goal of 76 percent gross margin.

If I could ask two more quick questions. Regarding your guidance in your share buy-back. Have you factored in a timing elements associated with the share buy-back in your guidance, or should we be looking at the forward guidance exclusive of any share buy-backs at this point?

I would count it as exclusive of any share buy-back and it's on the assumption that that will be in cash, and any action we may take in a buy-back will depend on circumstances, obviously, as we go forward.

Questions for you, Ron. You had mentioned an automotive manufacturing case concerning industrial automation successes there. Is there anything else on the horizon that you could help characterize for us, to exemplify how you're penetrating that market space?

The automotive market space or the factory floor?

Factory floor.

Well, as we said, we're very excited about these two products, particularly the DMM and the RF Analyzer, because what they do for a platform is really make it complete for a lot of factory floor applications. So the automotive industry this quarter had a great quarter; we had very strong growth there, both year over year and sequentially. We also had a really good quarter in government and aerospace, as well as in consumer electronics. And those are all applications where our PXI platform and LabVIEW Real-Time are really helping us get on the factory floor. And we're starting to get the benefit from people who have been designing us in over the last year; we're starting to deploy systems. But it's broad-based in nature, just like our overall business. It's diverse across industries and I think we're moving forward in a very broad-based way.

Great, thank you.

Thanks, Tim.

Moving on to Pat [Sadukin] with [Globescan].

Yes, I have a couple or three quick questions. You know, October, we are about two and a half weeks into it, so, Alex, how is the feel of the business? It's a short period of time, but if you, you know, care to make some comments there?

I'd rather not. I think it's too short a period of time for us to comment on, I'm afraid.

Okay, next question is for Ron. You I, think, at one point mentioned machine vision product. Now, how that category of products doing? And there's a company called [Cognex]. Do you compete with Cognex as far as machine vision products' go?

Okay, well, we had a good quarter with machine vision. As you know, it's an area that we entered several years ago. It's a key component of our PXI platform. And the success we've had there has been driven by our ability to really integrate machine vision alongside motion control and measurement hardware, and really do integrated solutions. Cognex is a player in the machine vision market. Our goal is really to bring machine vision to the mainstream of users and make it a measurement technology that's just as easy to use as any of our other products. And so that's the real thing that's driving that growth, is making it accessible to the masses of engineers and scientists out there, and we continue to be pleased with that.

You don't compete with Cognex in that area; is that how I should --?

This is Alec here. I'm sure sometimes we do compete, but our primary focus is our own LabVIEW user base.

Okay. My other question is, the R&D. You are very, very committed to R&D with long-term strategy. At this time, what is the R&D expenditure as percent of sale? And do you plan to stay that way, I mean, in terms of the percentage of your sales [indiscernible]?

I'll comment briefly and then I'll ask Dr. Truchard to comment on a longer term strategy. Right now it's at 17 percent revenue, which is a little above our normal model. But what we decided to do during this downturn was take advantage of our very strong profitability of our business model. And in a time when many of our competitors were laying staff off and really scaling back, we took the opportunity to step forward and be aggressive. We've increased the total engineering headcount in the company since the downturn started in Q3 of 2000, in the last two years by about 30 percent. So we have been quite aggressive. I think the level of – as a percentage of revenue, as been a little higher than what we wanted, because of the depressed economy, but we're going to stay the course here in terms of the absolute level. And I'd like Dr. Truchard perhaps to comment on our long-term strategy there.

From time to time, we've analyzed the effect of our R&D efforts and consistently we've seen that R&D was a key driver for our growth over the years. So on that basis, we have chosen to continue to invest. And I'm spending much of my time driving that process and making certain that the [definition] of products we have can be effective in this time frame. So we're putting a lot of energy into it; we've got clear opportunity that's well defined; our [franchises] for virtual instrumentation is very, very strong, and we haven't completed all the things we can do. So in this time frame, we're putting a lot of energy into it; I'm putting a lot of my time to make sure it goes the right way. And so we're really working hard to see that is a key driver for us.

Great, thanks. Thanks so much, Alec.

From Time Square Capital Management, Andrew [Gallagan].

Hi, guys. Congratulations on a fantastic quarter.

Thank you.

Really great execution. I have a couple quick questions for you. In the past, you've given us some data points. I was hoping to update those. First of all, your average order size in the quarter?

Sure. Average order size was up from Q2. It's right around $2,500 dollars per order right now, and so we're back close to the high points we saw at the end of 2000. [Indiscernible] key indication of our success with our platform products like PXI and [indiscernible].

Right, right. On your website, how many visitors did you get this quarter?

We had a little over 1.7 million in Q3. Continuing strong visit and traffic, and obviously we're using that as a way to control our sales and marketing expenses overall by leveraging the benefits we get from the web.

Can you talk about the daily order rate so far in this quarter?

Really, I'd rather not get into the specifics of Q4; we're very early on in the quarter. We have done that occasionally in the past, but we've opted in this circumstance to focus on the EPS guidance. And we'll continue to probably do that going forward.

Okay. And then maybe you can talk a bit about – some of the analysts have expectations out there for 2003. I don't think you've given any guidance yet, but I was wondering if you could sort of comment a bit on the numbers that are out there at this point in time.

Well, my intent at this point is to give guidance on 2003 in January at our conference call.

Okay.

Once we have a better feel for how things are panning out economically, etc. So I'd rather abstain on that point. As you said, I have not given any guidance on 2003 to date, and I will do that in January.

Okay, great. Thanks again, great quarter.

Thank you.

Richard Eastman has a follow-up question.

Just two quick things. One is, could you clarify, Alec, on the gross profit margin? A million dollars was the impact at the revenue line? Or at the gross margin line?

A million dollars is the impact at the revenue line [indiscernible] euro.

At the gross line, or [indiscernible] --

Well, you'd have to sit down and do the math. That's obviously going to be a few tenths of a point. It's not massive, but --

Okay. But it carries through at the same gross margin?

It'd be a million dollars in absolute gross margin.

[Indiscernible] exchange rate.

And then as a percentage it'll be a few tenths of a percent of total revenue.

And let me ask you this. As a legal expense, how would you envision that going forward? Does it stay up at this level for a while, or -- ?

Well, we're very committed to defending the investment our shareholders have made in intellectual property, and so we remain extremely committed. This particular case is due to go to trial in January. And so this thing, this particular case, should be wrapped up by the end of Q1. And obviously, our expectations on legal expenses are baked into our EPS number for Q4.

Okay, thanks.

All right? Any other questions?

Yes, we have one more follow-up question from Paul Knight.

Alex, it was regarding the lawsuit. You're saying you're going to trial in January?

That's correct. Yes, we're going to trial in January. Here in Texas.

So legal costs, I guess, will continue for the foreseeable future.

That's correct. And that's, as I said, baked into my Q4 EPS number, is that assumption.

What court level is that in Texas? Is that a U.S. District Court?

I'll turn it over to my legal counsel here.

David Houghley here. Yes, it's pending in the Eastern District of Texas, federal District Court.

What's the next step up from that?

The federal Circuit.

Okay. Thank you.

Is that our last question, operator?

Yes, there are no further questions at this time. I'll turn the conference back over to Mr. Davern for any closing comments.

Okay, thank you again for taking the time to join us today. I'll be presenting at the Thomas Weisel Partners Tests and Measurements Conference in New York City on December 11th. We hope to see you there. Thank you.

That concludes today's conference call. Thank you all for your participation today.