National Instruments Corp (NATI) 2004 Q2 法說會逐字稿

Good day, everyone, and welcome to the National Instruments Corporation second quarter 2004 earnings release conference call. Today's call is being recorded. You may report to your press packet for the replay dial-in number and pass code.

The replay will be available from 7:00 p.m. central time today, and will end at midnight central time on August 3rd, 2004. With us today are Dr. James Truchard, President and Chief Executive Officer; Alex Davern, Chief Financial Officer, and John Graff, Vice President of Marketing. For opening remarks, I would now like to turn the call over to Mr. David Hugley, Corporate Counsel. Please go ahead, sir.

Good afternoon. During the course of this conference call, we shall make forward-looking statements regarding the future financial performance of the company, including statements regarding our expected revenue and earnings per share, future major product announcements, and expanding market opportunities.

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 annual report on Form 10-K for the year ended December 31, 2003, and on Form 10-Q for the quarter ended March 31, 2004. 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 President and CEO of National Instruments Corporation, Dr. James Truchard.

Thank you, David. Good afternoon, and thank you for joining us. Our key points today are: Record revenue at 27% year over year growth; quarterly operating income up 70% year over year; a record number of new products in Q2; and a clear focus on improving operating leverage in the second half of the year.

In our call today, Alex Davern, our CFO, will review our financials. John Graff, our Vice President of Marketing, will discuss our business, and I will close with a few comments before we open up for your questions. Alex?

Thank you for joining us today. We had a very strong Q2, with revenue of $127.1 million, up 27% from Q2, 2003. This represents the highest quarterly revenue in our history, leading the previous record of $124.6 million in Q1. Operating income was $15 million, up 70% from Q2, 2003, and fully diluted earnings per share was 14 cents on net income of $11.4 million, up 53% from Q2, 2003.

Our strong revenue growth is driven by the success of our new products and the strong global industrial economy. These new products that helped fuel our growth, the broad-based growth across our many products. The strength in Q2 drove a 14% year over year increase on our average order size to approximately $2800 dollars. During Q2, we saw year over year revenue growth of over 20% in all regions.

Year over year revenue was up 23% in Asia, up 30% in Europe, and up 27% in the Americas, giving overall growth of 27%. Moving down to income statements. gross margins in Q2 were 74%, up from 73% in Q2 last year. Total expenses dropped from 64% of revenue in Q2, 2003 to 62% this quarter. However, they were higher than our expectations coming in to Q2. Our R&D expenses increased by 4.5 million, or 26% year over year.

This reflects our continued committment to assigning our portfolio new products with a record number of new products being released in Q2. In Q2, we capitalized $1.4 million of internally-developed software costs, and expensed to cost of goods sold $1.8 million of previously capitalized cost. SG&A expenses were up by 22% year over year, and were over budget by $1.5 million in the quarter. While the money was well-spent, we were disappointed we did not deliver the full operating leverage expected in Q2.

We had a record number of new products released in Q2, incremental spending in sales and marketing occurred in areas related to new products introductions, such as demo equipment. In G$A, the incremental spending related to the new Sarbanes-Oxley [INAUDIBLE] full requirements. Traditionally, the company has had very good budget discipline, and we are focused on being within our budgeted spending levels for Q3. Our operating income increased by 70%, and our operating largely increased to 12% of revenue from 9% in Q2 last year.

Below the operating line, foreign currency saw a big swing from Q2, 2003 and sequentially. For Q2, 2004, we recorded a $743,000 foreign exchange loss equivalent to approximately one penny per share, due to the strengthening of the dollar in Q2. This contracts a more than $340,000 gain in Q2 last year. This was the main item which reduced our 70% year over year operating income increase to a 53% increase at the net income line.

Now turning to the balance sheet. Inventory increased by $9 million sequentially, including inventory related to products to be released [INAUDIBLE]. As I stated in our conference call in April, we decided to increase our inventory in Q2 to compensate for the surge in volume that we have seen recent quarters, as the positionals for the typical seasonal revenue increase in Q4.

We now feel that inventory is at the appropriate level, and intend to keep it effectively flat for the remainder of the year, which should reduce our inventory days by December 31. Day sales outstanding were 57 days, down from 60 in Q1. Net cash and short term investments were $192 million, with a net of $4 million of dividends paid in the quarter, and were also net of $7.4 million used to repurchase approximately 235,000 shares of the company's common stock in Q2.

Head count as of June 30th was 2,000 -- excuse me -- was 3,299, up from 3,207 on March 30th, and up from 3,108 on June 30th, 2003. The board of directors has declared a cash dividend of five cents per common share, payable August 30 of 2004 to shareholders of record on August 9th.

So looking at the rest of the year, we're expecting revenue in Q3 to increase sequentially to between $127 million to $131 million. This would represent an increase of between 21% and 25% year over year. In Q3, we expect to report total operating expenses of approximately $81 million and fully diluted earnings per share of between 13 and 16 cents, up significantly from 10 cents in Q3, 2003.

We are currently expecting to report record revenue for Q4 and fully diluted earnings per share of between 23 and 26 cents, up significantly from 14 cents in Q4, 2003. But these are forward-looking statements. I must caution you that actual revenue earnings for Q3 and Q4 could be negatively affected by numerous factors such as any [INAUDIBLE] in the global economy, the later new product releases for the [INAUDIBLE] efficiencies expense over loans, and inventory and product exchange fluctuations.

So in summary, Q2 was an outstanding revenue growth quarter, and while we delivered excellent operating income growth of 70%, we are disappointed we did not generate greater operating leverage. Our EPS for Q2 was 14 cents. It came in just below our guidance of 15 to 16 cents per share. The strengthening of the U.S. dollar during the quarter caused us to incur a $748,000 loss during the quarter, to produce the approximately one cent per share.

The second half of the year, we will be focused on continuing to grow the top line, while moderating the growth in our expenses, turning our operating margin in Q4 towards our goal of 18%. With that, I'll turn it over to John Graff, Vice President of Marketing.

Thank you, Alex. We turned in our third consecutive quarter of record revenue in Q2, delivering 27% year over year revenue growth. We were very pleased to see broad-based growth across all our many products in Q2. For our core products like software, PCP acquisitions, instrument control, machine vision and compact FieldPoint, and record revenue for PXI and modular instruments. Strong customer acceptance of our new products positions us well for record revenues in Q3 and Q4, as Alex just stated.

In Q2, we introduced a record number of new products, including the release LabVIEW 7.1, a significant upgrade that includes more new capabilities than in any previous dot one release of LabVIEW. In fact, one editor from Embedded Systems Programming magazine, while we're getting LabVIEW 7.1, asked why we had not called this version LabVIEW 8.0. Following just one year after the introduction of LabVIEW 7 Express, LabVIEW 7.0 expands its script technology to further improve ease of use and to store many more of our hardware products, including our latest modular instrument.

LabVIEW had another strong quarter of revenue growth, and early customer response to LabVIEW 7.1 has been very strong. The early LabVIEW 7.1 user is Adrian Riarda [PHONETIC], Control's Group Engineer at [INAUDIBLE] in Switzerland. He stated, quote, "LabVIEW combines powerful data analysis tools with excellent graphical representation. I estimate that this will shortens our [INAUDIBLE] time by a factor of three with respect to other software packages", end quote. LabVIEW 7.1 also marked the most significant upgrade of our highly-successful LabVIEW realtime products, which has been a key product for taking us into new application areas, including industrial control.

LabVIEW Realtime now includes many new advanced features for users programming determinate fixed mission-critical applications. Prior to this release LabVIEW targeted our own hardware platforms, including PXI, Compact FieldPoint, Compact Mission System, and Intelligent PCI Plug-in Boards. With this upgrade, LabVIEW upgrade can now also target any standard PC, which is obviously the most common continued platform for measurements in automation.

Customers can now use a low-cost desktop PC as a realtime target and leverage our very large portfolio of PCI plug-in hardware products for their application needs. We also further expanded LabVIEW Realtime to support more and more hardware and improve the integration with our new DAQ-MX [PHONETIC] driver software for faster code development and execution. We were pleased with the continued strong growth of sales of LabVIEW Realtime in Q2.

The LabVIEW 7.1 upgrade included the new versions of our LabVIEW PDA module for portable applications, and the LabVIEW SPGA ,which allows customers to define customer measurements on a chip. Most of these new LabVIEW software modules continued to show strong sales in Q2. Last year, NI lead an industry-wide initiative called Sensor's Plug & Play to bring the leading sensor vendors and new technologies together to simplify the integration of sensors and measurement systems. Up to 25% of the total cost of a measurement system is attributed to the time spent in system configuration.

In Q2, we added new functionality in LabVIEW 7.1, in our DAQ-MX driver software, that delivers the benefits of the Sensors Plug & Play to users, making our LabVIEW data acquisitions and signal conditioning products more attractive. Harden Armston [PHONETIC], Director of Sales and Marketing for Honeywell Sensors Deck [PHONETIC], a leading provider of measurement sensors, stated, quote, " Sensors Plug & Play software and hardware make configuring a smart sensor as easy as plugging a map into a PC", end quote.

In addition to very strong LabVIEW sales growth, we were also very pleased with solid year over year sales growth in Q2 for our PXI, PC Data Acquisition, Machin Vision, Compact FieldPoint and modular instruments products. In Q2, our modular instruments hit a new record revenue level, growing more than 70% year over year. One modular instrument success from Q2 is Juan Raez [PHONETIC], Engineer for Sony Audio Division, who uses the NI modular instrumentation, PXI and LabVIEW for audio tests.

He stated, quote, "we chose the NI dynamic signal acquisition module as the cornerstone of our audio test platform because of its rich feature set and outstanding accuracy. It enables us to perform audio tests faster and with greater accuracy then any other audio test products available", end quote.

In building complex test systems, users must organize the routing of many different signals among many different instruments. This is done through a technology called switching, which is at the heart of many large test systems and often represents up to half of the overall test system cost. In Q2, we announced NI Switch Executive 2.0 software and we significantly expanded our switching hardware with the introduction of the highest density PXI switch module in the industry, quadrupling the capabilities of our previous product.

These new products can greatly reduce customer assistant costs and time to market, while expanding our opportunities for PXI and modular instruments to applications we could not address before. PXI also had a record quarter for revenue, and continues to have great success in a variety of applications, from from automated tests to imbedded machine control, to alter complex military test systems. One PXI success from Q2 is Cocular [PHONETIC] in Australia, a world leader in the technology of implantable hearing aids.

They are using PXI, along with our modular instruments hardware and testing and LabVIEW software, to create a suite of automated test systems. These systems include an NIPXI Jastine [PHONETIC] Controller, as well as several of our modular instruments. These next-generation test systems took 30% less development time and are significantly smaller, saving valuable space in the production floor. We're also pleased with the continued adoption of PXI in military and aerospace applications.

In the June issue of Military and Aerospace Electronics, editor Ben Ames wrote, quote, "test and measurement equipment is pushed to its limits trying to keep up with the latest, smallest circuits. At the same time, Pentagon planners are trying to cut costs by buying generic flexible test equipment instead of the 400 different types of military and aeronotic test equipment used today. Trying to meet both goals at once, test equipment manufacturers are trained in techniques like the PXI Form Factor," end quote.

Leveraging the strong momentum of our software modular instruments and PXI platforms, in Q2, we partnered with six leading instruments and test service providers, including Techtronics and Flextronics, to host a series of highly-publicized automated test [INAUDIBLE] in 12 cities in North America. We're doing similar multivendor activities in Asia to further our opportunity there, including the first ever PXI Technology and Applications conference, which was held in Taiwan and China. Customer response to these events has been very strong.

In industrial applications, we continue to expand our product offering to handle more roust, demanding control applications, from process control, to machine condition monitoring, to discrete manufacturing. In Q2, we introduced six new digital IM products that further expand the high reliability feature set for industrial application. Together with LabVIEW Realtime, PXI, Contact FieldPoint and our many other industrial data acquisition products, we continue to have success penetrating new industrial control applications.

Next month at NI Week, you will learn more about our strategy and future initiatives, as well as see significant new product introductions that continue to further our opportunity in this area. Virtual instrumentation continues to make inroads as a productivity tool in the design process. This is highlighted by separate announcements between NI in MTS, and NI in Texas instruments.

MTS is a world leader in mechanical test solutions for noise and vibration testing in automotive and aerospace industries. MTS is spearheading the development of a new noise and vibration framework that will use LabVIEW as the cornerstone in a new cost-effective platform that will let engineers and technicians more quickly define and deploy standardized tests in both product development and manufacturing.

Working with Texas Instruments, we announced the new power measurement tool that is based on LabVIEW and our PCV [PHONETIC] acquisition products, and lets the design engineers quickly and easily evaluate power consumption when designing products or subsystems that integrate new low-power DSP chips from TI. Our work with TI is part of our ongoing commitment providing graphical development tools for DSP design and test engineers.

With the diversity of our business across industries, customer interaction is a key component of our direct business model. And we continue to see strong activity levels in Q2. We had a record quarter for our NI.com website, including record sales at our on-line store, and a record 3.6 million visits to the site, a nearly 50% increase over visits in the same period last year.

In Q2, NI.com was named one of the ten best support sites by the Association of Support Professionals for the third time. And Test Engineers named NI.com the most useful vendor website in an annual web study conducted by Reed [PHONETIC] Research Group and Test and Measurement World magazine. We have also seen great results with interactions on the web in emerging markets such as China, where our web traffic in Q2 more than tripled over the same quarter last year.

In summary, we are pleased with our revenue performance in Q2, delivering a third consecutive quarter of record revenue, and we believe we are well positioned for the second half of the year. We want to remind you that our 10th annual NI Week conference is only three weeks away.

NI Week is a key event for launching new products and meeting with our customers and strategic partners. Please note that we have changed the date of our investor conference to be Tuesday, August 17th, which is the first day of NI Week, when we will introduce and demonstrate major new products that expand our market opportunity and strengthen our core.

The event will kick off by a key note address by Tim Dehne, Senior Vice-President of Research and Development. Dr. Truchard and other senior management will then discuss the opportunities created by our new product announcements and our expanding vision for virtual instrumentation. We're very pleased that early registration is at record levels, with nearly 30% growth over last year, and we have a sold-out exhibition. We look forward to seeing you there. With that, I'll turn it over to Dr. T.

Thank you, John. We are pleased with our performance in the second quarter, turning in record revenue at 27% year over year growth. We continued strong investments in R&D, we introduced a record number of new products in Q2, including LabVIEW 7.1, and the demand for our new products has reached record-levels in Q2.

While our expanses ran over plan, we are investing well and we will be focused on improving our operating leverage the rest of the year. I am confident and personally committed to meeting our goal, for the rest of this year. The record number of new products introduced over the past 12 months, as well as those we will introduce at NI Week next month, demonstrates how to wrap the technological evolution of virtual instrumentation and making it the approach of choice for engineers and scientists.

Today, virtual instrumentation has achieved mainstream acceptance in tests, and is penetrating deeper into new applications areas such as industrial control and design. In automated tests, we have taken the leadership roll with success -- the successful penetration and adoption of PXI by modular instruments and our strong software position. We continue to introduce new products that greatly expand our capability in this area and allow us to address significant large test system opportunities that were not available to us before.

At NI Week, you will see us continue to fill out our platform and strengthen our value proposition in automated tests. With the introduction of LabVIEW 7.1 Realtime, and new industrial data acquisition hardware in Q2, we continue to expand our opportunities in the area of industrial control. I believe these same technologies which have driven our vision of virtual instrumentation, bring significant value to to a wider range of applications in the industrial automation.

LabVIEW, LabVIEW Realtime and LabVIEW FPGA [PHONETIC] gave us the capability to enter a new arena known as programmable automation controller, that is bringing new levels of flexibility and performance to industrial control. Programmable automation controllers are the next generation technology for industrial control, and the market opportunity is significant. We believe that we have a strong base to work from, and we have some significant announcements planned at NI Week next month that we look forward to sharing with you.

Virtual instrumentation has also helped reduce the complexities of bringing products to market by providing measurement that is tightly integrated into the intricate process of designing and verifying new product prototypes. Our work with MTS and TI, as well as new features in LabVIEW 7.1 are just a start. We will continue our quest to bring ease of use to benchtop measurements, where we can give the design engineers the option to perform the measurements interactively, providing a common platform for design and test.

In summary, I believe our strategic investments with R&D, sales and marketing have significantly strengthened the foundation of our company, and expanded our opportunities for the next decade. I believe we are in the strongest position in our history for virtual instrumentation, and we are focused on meeting our objectives for the rest of the year. Thank you for taking your time to join us today. We will now take your questions.

Thank you, at this time if you would like to ask a question, please press the star key followed by the digit 1 on your touch-tone telephone. If you are using the speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We'll proceed in the order that you signal us, and we'll take as many questions as time permits. Once again, please press star 1 on your touch tone telephone now. And our first question comes from Richard Chu.

Yes. Good afternoon. I've got a couple of questions. First of all, on the FX loss, on the surface, it would not appear as if the U.S. dollar made dramatic movements in the quarter. Was there significant changes in your exposure asset liability position -- monitoring liability position -- that propagated the loss, and how reversible is that likely to be, assuming rates stay where they are?

Well -- this is Alex here -- we did have, you know, recently significant move from March 31 to the end of June on the balance sheet rate on the dollar versus the Euro. We were slightly less hedged than I would have liked to be at the end of March, and that left us a little bit more exposed. We've firmed up on that quite a bit during the course of Q2. So I think our exposure to that in Q3 is less than it was coming into Q2.

So -- I'm sorry. So at this point, if the dollar were to remain flat --

We would expect that number to be close to zero --

Great, okay.

-- as it was in Q1.

Okay, that's fine. And then, was there a legal expense accrual in the quarter as well?

No, we had the -- about $400,000 worth of costs related to the preparation for the [INAUDIBLE] appeal -- this is the Federal Court's appeal of the successful jury verdict that we won in January of last year. And that was heard in the first week of July. So that cost in Q3 will drop down to a very low level and should be zero there for that in Q4.

Okay. Just with respect to the full business and total demand, you had record revenues. Throughout the quarter there has been, certainly, despite the continuing recovery, concern about the state of industrial recovery, I wonder if you can characterize some of the cross trend that you're seeing in your end-markets, if you extract some from the new product impacts out of it in terms of the underlying demand picture. Are there some pluses and minuses that perhaps you could review?

Well, first of all, I'll take it [INAUDIBLE] and hand it over to John for by industry. In terms of the demand during the course of the quarter, we saw strong demand throughout the whole quarter, and that certainly is very encouraging. The macroeconomics metrics we track, such as the JP Morgan, Global PMI, and other industrial metrics, some were very strong throughout the quarter, including for the month of June. And so, they continued to indicate the likelihood of a continuing industrial expansion in the second half of the year. And in terms of the industry, I'll hand it over to John.

From a vertical industry standpoint, in the quarter, we saw broad growth across all the various industries we serve. As a reminder, we've always pointed out that no one vertical industry is more than 10% of our revenue. Highlighting a few from the quarter, Mill Aerospace, we saw some significant growth year over year and subsequently. And the same with Telecom. Automotive, electronics, consumer electronics and industrial markets all saw growth. So, again, it was pretty broad-based demand across products and across industries that helped fuel the record top-line revenue.

Certainly new products was a key element to that, as well.

Altitudes -- this is the final point on the gross margin -- in the absence of leveraging, could you -- can explain what contributed to the relatively higher operating cost expansion relative to field, was component costs an issue at all?

-- Start off, et cetera.

Certainly at this point, we haven't seen any pressure on the component prices. We typically have a seasonal pattern related to gross margin, which is very much driven by our geographical mix, so if you look at the last number of years, you'll see gross margin tends to develop subsequently from Q1 to Q2. And that's how they did in -- matter of fact, in Asia. Internationally, our margins are typically higher than domestically. And Asia tends to be very strong in the first quarter with the fiscal year end in Japan at the end of March. And then Asia revenues tend to drop sequentially from Q1 to Q2, and the U.S. tends to take on a much bigger percentage of the total total revenue pool as we go into the second quarter. And that's really the issue we're facing here in Q2. So component pricing, we certainly saw some stretching out in lead time this is year from last year. We have seen a little bit of component pricing pressure, but nothing significant at this point.

Okay, thank you very much.

Thank you, Richard.

Our next question comes from Rajiv Pike.

Yeah, good evening, gentlemen.

Hey, Rajiv.

Just a few quick questions. The first one is, you know, just sequentially, your gross margin impact by 1.8 million of that was, you know, from your expensing software to cost?

That's correct.

So could you give us some color as to what software exactly it was that you started to expense in capitalizing in this particular quarter?

Well, this quarter we capitalized about $1.4 million of software development costs related to new projects being completed in Q3. And then we amortized $1.4 million of previously calculated costs. So [INAUDIBLE], it comes out to about a $400,000 hit. The policy we've been following [INAUDIBLE] for a long time is we capitalize the cost of our software development projects as they come into data, and then we'll amortize that cost over a 3-year period. So what's being amortized now is the accumulation of costs that have been capitalized over the course of the previous three years. Now obviously, there was a spike in that last year because of the release of LabVIEW 7.0 and we're paying for that this year.

Okay, LabVIEW 7.1 that was just released, the impact of that has already been experienced in Q2 --?

That's been experienced in Q2 and that was a much less extensive project; and therefore, the capitalized numbers are much smaller.

Much smaller. So going into the September quarter and December, we wouldn't expect an uptick because of any further expensing of software capital?

No. No. I think the numbers are fairly normal now. They'll move around a little bit each quarter, but don't expect any significant moves in either of those numbers for the rest of the year.

Okay, [INAUDIBLE] related expenses, how much of that is going to be, you know, impacting the next quarter, and is it going to be ongoing?

These costs will continue from here towards the end of the year. So for Q3 and Q4, you know, this is not a small project and it's a significant cost-contributor. I do expect in 2005, that the absolute cost level will be less than 2004, as we move past the start-up phase of this and more into more of a maintenance mode. But I do expect these costs in Q2 to continue in Q3 and and Q4. And that's factored into my guidance.

It's factored. So you'd expect the G&A portion of the guidance also to step up going into the next two quarters.

Well, we obviously indicated an increase in expenses in Q3 to $81 million. And part of that will be, obviously, G&A.

Okay, and part of that -- what would it be driving that increase in expenses? Part of that is the R&D trend, or is it primarily sales and marketing or would it primarily G&A?

We'll see some increase in R&D. Also, sales and and marketing with NI Week will be a contributor. So these things are all factored in. And I'm confident that we can hit that $81 million level in the third quarter. We also had new employees. We tend to take in a lot of engineering talent, much of which started in June. This goes into sales marketing and R&D. And then we tend to take in quite a number of interns during the summer months, which is a very, very effective recruiting tool for us, which we stepped up this year.

And what is the change of head count between the end of last quarter this quarter? I think you hired a hundred people last quarter. How many was it -- what was the number?

Close to 100 again. I can give you exact number if you can bear with me for just a second. Head count at the end of June was 3,299 as compared to 3,207 at the end of March, so a little over 90 people.

Okay. And then, one last question would be about the PXI platform. You know, right now, the total number of modules available on the market based on most counts in magazines is about 850 or so. How many of those is national instruments manufacturing itself?

This is John. Our current PXI product family is a little over 160 modules.

160 modules. And last year at the same time would it have been about half that -- prior to NI Week last year?

Off the top of my head, we'd have to check. I recall it being around 100. So significant increase there, and as we talked on the call, we've seeing very strong revenue growth in in PXI and also, especially -- greater then 70% growth in our modular instrument. So we -- [INAUDIBLE] Suite platform that we released last year has had tremendous success, and we'll be talking more about the future of that as we get to NI Week here in three week's time.

And with all these new product introductions are you facing supply constraints in the number of modules you can provide because of like high numbers of SKU's that have introduced?

No, I mean, the management of this is not a problem for us. Certainly, trying to get the demo portion of this into the field, we expense demo equipment as soon as we give it to our field people. Some companies hold it in inventory. Some capitalize and depreciate it. We expense it. And we spent almost 800,000 in Q2 on demo equipment. So, you know, it does create a little bubble in that type of area. But in terms of managing additional products, we're very scalable in manufacturing it. I don't see that being an issue for us at all.

Okay, and one last question, which is the the average order size. You know, you typically provide us with the way it's scaled over time. Is it higher now than it's ever been in the past?

We had 2800 in Q2, which is up 14% from Q2 last year.

And sequentially?

I think it was slightly flat or maybe slightly up. I don't have the exact number. There wasn't much change sequentially. Obviously, we typically see fourth quarter is our peek for average order size, so being up 14% year over year in Q2 would indicate that we're likely to have -- this year being our highest average order size in the history of the company. And that's certainly an indication of the success of our ability to sell system-level platforms.

Okay, and the industrial production numbers that recently came out showed a slight softening in June. There's nothing that you see in your markets that would make you concerned about that?

Certainly, you know, you see numbers at the PMI come off their record levels from May to June. But that's exactly what I would expect, given the very high levels of the PMI in May. That, and the fact we obviously have a slightly harder compares in Q2 -- sorry, in Q3 and Q4 -- those are both factored into our guidance of 21 to 25% revenue growth in Q3 and record revenue for Q4.

Okay, thank you so much.

No problem, Rajiv. Thanks.

In the interest of time, we do ask that all participants please limit yourself to one question and one follow-up question. We now go to Richard Eastman.

Yes, just a question on -- I want to circle back to Alex. I think, John, you had mentioned this too. Could you give the growth rate of PXI? And then also in terms of your modular instruments being up 70%, is that largely a function of the mixed suite product that you introduced?

The -- Well first off, this is John. I'll start with the PXI numbers. We didn't explicitly give the growth rate, but I can tell you it was approximately double the company's growth rate. In terms of the modular instruments, we talked about it being approximately 70% growth -- and,yes, the primary driver of that is the mix signal suite of modular instruments that we introduced at NI Week last year.

Huh, okay.

So we've had very strong response. The acceptance of those new modular instruments is helping to create the pool for the whole PXI platform. A continuation of that, that we mentioned in the call, was our new PXI switch, which also just opened up more opportunity to sell the PXI platform in some of those same modular instruments that we introduced last year.

So each new product, you know, as it adds capability, increases our ability to sell what we already have as well.

And Alex, does any of those hardware growth rates that you're talking to PXI modular instruments, does any of that play into this slight gross margin? Depression, maybe?

Product mix wasn't an issue on margin, sequentially.

Was not. Thank you.

We also had, as we talked, very strong software growth as well, which is the other main other variable. Software's percentage of revenue is consistent from Q1 Q1 to Q2.

Okay, all right. Thank you.

Thanks, Richard..

Our next question comes from David Ushak.

Thank you. I think most of my questions have been addressed, but let me just try a couple of them here on you guys. The million and a half dollars over budget on marketing, you indicated that a lot of that was demos that were sent out, is that right?

David, to be fair to John, it was sales and marketing, and demo equipment was one of the elements. You know, when you have growth as we've had for the first six months of 26% after a few lean years, you're going to have a lot of different demand for different things to do, and one of the areas was in product MO's, as we're seeing the success of the sales force -- once they put the modular instruments into the hands of our customers, we're having good success with sales. We wanted to put some increasing momentum behind that. There were some other areas related to new products as well, such as in advertising and trade shows, which also drove a little bit ahead of our expectations. And again, I want to put it in perspective. You know, really, I view this as somewhat limiting to upside. We had a higher revenue number that we budgeted. We had a higher expense number that we budgeted. We're focused on that, and we want to hit our spending target for Q3, which I'm very confident that we will. And this positions us well to deliver close to 18% operating income in Q4, which I think will put us in a good position relative to our long-term margin target in 2005.

Now, the -- it's not common, though, that you've had a lot to do with test products, is it? Would this kind of suggest maybe there's a more robust nature to some of the things you're trying to put out there in the test area?

I think what you can say is we see a lot of opportunities in getting these instruments into the hands of our customers, because our success rate of selling is real high. So that's creating demand and it takes a little while for the revenue to come from that. So it's really driven by a clear opportunity in front of us.

Is that -- Is that more robust performance, though? That's what I'm driving at. Is it --

I'm not sure I understand the question.

Okay. Is some of the things being done more robust? In other words, in the request for demos.

More complex perhaps.

Right. That's what I mean. I mean.

Right.

Okay. So the potential revenue off of those boards can be significant as those demos get demonstrated? [INAUDIBLE],

Absolutely. As we build a reputation in this market space, having people touch and feel and prove that it works is a key tool.

So on your share buy-back, what was the the average price?

A little over $31 a share, David.

Okay. That's all I have for right now, thanks.

Thank you.

We go next to John Harman.

Hello, good afternoon.

Hey, John.

I think the good ones are taken, so I'll just ask what percentage of sales were traditional instrument control hardware?

The traditional instrument control part of our business continues to grow, you know, somewhat less than the overall, as you would expect. We had good growth there. They're now about 17% of revenue.

Okay, thank you. And looking at your operating expense guidance, and looking at, you know, last year, the operating expenses picked up about $3 million in the third quarter, that would imply you're probably not going to hire a hundred more people next quarter? Are you done with hiring for the time being, or what's your --?

We will be continuing to hire in Q3, but the rate of increase in stopping should be down from Q2.

Okay. That's all I have. Thank you.

Thank you very much, John. Your next question is from Robert Kingdom.

Thank you. Alex, just a quick question on the inventory. The -- could you just break down the raw whip and finished goods from Q1 to Q2? As we move, you know, from 51.5 to about 60.4, I guess, where was the main -- the delta there?

It was about $4 million in raw materials and about $5 million in finished goods. Our strategy with the release of new products now is, we've gotten somewhat burned by announcing products and not having them available. We've gotten much more disciplined about our timing of new product release. Our strategy is to have a couple of months to forecast on the shelf before we release new products. And that is one of the elements driving the increase sequentially as we put inventory in dollars on the shelf for products that we've not yet announced, that are not yet shipping, that we'll release in about three week's time.

Right. Right. Are you seeing from a raw standpoint -- I think you sort of commented on this in your earlier earlier remarks -- but just from your raw material balance and the components that you need, and the inventory balance, I think, among just about everybody in your space the last six or seven months. But are you, you know -- is it leveling out where now you feel like, okay, we have enough inventory to serve what we need for the next six months?

Sure. I mean, as I said on the call, I expect our inventory now level to be flat from here to the end of the year, so we anticipate sticking with this inventory level and having very similar level at December 31. We traditionally have had a significant spike up in revenue, really starting in September and into Q4, and the average over the last decade or so has been about 11%. And what I'm trying to do is make sure we smooth out our bill process so that we stay as efficient efficient as possible in manufacturing and avoid inefficiency in our sales channel by having a tightness of supply in Q4. So I'm very comfortable with our current inventory levels and expect to finish at a similar number in December.

So COGS -- you know, I guess -- So, COGS is probably a relative basis, could go to approve, I guess, if I had to read into this correctly.

I'm not sure I understand your question. I mean, the increase in long-term inventory is not an effective cost of goods sold.

The end of the year fourth quarter has better COGS.

Well yes, typically we have [INAUDIBLE] higher margins in the fourth quarter, and obviously the absolute level of our cost of good sold would be higher, because we'll have higher revenue. And that will drive down the days inventory on hand at the end of December.

Right, so I know the dollar value will go up, but as a percent, you COGS is --

Typically, it's the highest gross margin quarter.

Okay, great. Thanks, guys.

Okay, thanks, Robert.

We have a follow-up question from David Ushak

On the expense side, again, the R&D is about 16 days of sales. You've got a long-term objective of 16. Do you have any reason why -- when you may be able to get to that 16?

Well, as we typically see the new quarter tends to be a fairly significant sequential increase in revenue, and that tends to bring down -- bring up our operating margin and bring down each individual [INAUDIBLE] as a percentage of revenue. We would [INAUDIBLE] that had to be a gain in Q4. And so for the year, I would expect that the R&D as a percentage of revenue will come down from that 16 day level. That should position us very well. You know, our guidance of 23 to 26 cents a share for the fourth quarter relative to consensus' 24 obviously says that we're comfortable with the current Q4 guidance, and it should leave us closer in line as a percentage point of our 18 percent long-term target in Q4.

But most of those people you added in in R&D are a high percentage of the R&D as well, to boost that total for the quarter?

A significant number of R&D, but also a significant number for sales on marketing and agent.

Okay.

That will continue to be a focus.

Okay, thank you very much.

Thanks, David. And there are no further questions.

I'll turn it back over to you, Mr. Davern, for any closing remarks.

Well, thank you very much for joining us today. We look forward to seeing you at our Investor Day on August 17th, and our week here in Austin. Thank you.

And that concludes today's conference. Have a great day.