National Instruments Corp (NATI) 2004 Q3 法說會逐字稿

Good day, everyone, and welcome to the National Instruments Corporation's third-quarter 2004 earnings release conference call. Today's call is being recorded. You may refer 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, until the end of midnight Central time on November 1st, 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 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 product announcements, and expected gain related to legal damages, 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 our Form 10-Q for the quarter ended June 30th. 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 20 percent year-over-year revenue growth in Q3, strong sales of software, PXI, and modular instruments, significant new product launches at NI Week, and disciplined expense management by our employees. We are pleased with our strong sales of our virtual instrumentation platform in Q3, our continued aggressive investment in R&D resulted in several major product introductions during the quarter that strengthened our leadership position in key areas and expands our future opportunities. In our call today, Alec 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. Alec?

Good afternoon, and thank you for joining us today. Revenue for Q3 was $125.3 million, up 20 percent from Q3 last year. GAAP diluted earnings per share was 10 cents for the quarter, flat with 10 cents in Q3 last year. Pro forma diluted earnings per share excluding the impact of a $2.5 million charge for patent litigation, was 12 cents, up 20 percent from Q3 2003. Year-to-date, revenues were $377 million, up 24 percent from the same period last year. GAAP diluted earnings per share for the first 9 months was 39 cents, compared to 27 cents last year. Pro forma diluted earnings per share for the first 9 months was 42 cents, compared to 31 cents last year. We are pleased to deliver our 9th consecutive quarter of year-over-year revenue growth in Q3. On a regional basis, revenues for the quarter were up 15 percent in Europe, up 19 percent in Asia, and up 23 percent in the Americas, giving overall growth of 20 percent. On a product basis, we saw the impact of a slightly weakened global economy on sales of our instrument control products, especially to test and measurement and semiconductor capital equipment suppliers. These products, which now represent less than 16 percent of our revenue, were down $2 million sequentially. Normally, we would expect sales of these products to rise sequentially in Q3. Due to the mature nature of these products and our leadership position, sales of these products are usually the most sensitive to changes in the growth rate of the global economy. These instrument control products are used to control the operation of traditional GPIB and VXI instruments sold by other companies.

On a year-over-year basis, the growth rate of these products dropped from a strong growth rate of 24 percent in Q2, to a much more modest rate of 8 percent in Q3. Our newer products continue to perform well, led by a record revenue quarter for software. The strong growth of our newer products shows that our strategy of increasing our investment in R&D paid off as our order growth outpaced our peers. Moving down the income statement, gross margins for the were 73 percent. Gross margins were affected by lower revenue in Q3 and a decrease in inventory. Additionally in Q3, we increased our obsolescence charge by approximately $400,000 more than average. This increase was related to some of our older products and a decision to end-of-life several previous generation products. On the expense side, total expenses for the quarter were $81 million. This includes a $2.5 million charge to cover the additional cost expected as a result of the court's decision in our patent dispute with Software Inc., to delay the trial. Excluding this charge, total expenses would have been $79 million, below our guidance of $81 million in total expenses. I'm very pleased with the expense management across the company in Q3. On a pro forma basis, excluding this charge which was not factored into our guidance of EPS of 11 cents, our diluted earnings per share for Q3 would have been 12 cents, a 20 percent increase over Q3, 2003.

On another legal front, during Q3 the Federal Court of Appeals upheld a successful jury verdict we received last year in our patent dispute with The Math Works Inc. As a result, this month the U.S. District Court for the Eastern District of Texas has permanently enjoined The Math Works from manufacturing and shipping its Simulink products that were found to infringe 3 National Instruments patents. The Appeals Court has issued its mandate in the case, and we expect to receive payment of the escrow damages in November. Our accounting policy is to recognize these damages when we receive the cash, and so we currently expect to record a gain of approximately $6 million related to this in Q4. I must caution you that this is a forward-looking statement, and the nature of the legal process could result in this payment being delayed past Q4. As we said in our press release announcing the Federal Appeals Court's decision, we plan to invest some of the proceeds from this gain into our academic efforts. Currently we plan to invest approximately $2 million of this gain in cash and product donations to universities worldwide. Should these damages be received in Q4, we will therefore also incur an incremental marketing expense for these academic efforts in Q4. So net of the academic donations, we anticipate recording a gain of approximately $4 million in Q4. Our guidance for Q4 does not include this anticipated net gain. The Board of Directors has declared a cash dividend of 5 cents per common share, payable November 29, 2004, to shareholders of record on November 8th. Head count as of September 30th was 3,433, up from 3,299 on June 30th.

Now, turning to the balance sheet. Inventory decreased by $1.2 million in Q3. 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 continue to reduce our inventory days by December 31. Days sales outstanding were 59 days. Net cash and short-term investments were $200 million, a new record, and were net of $3.9 million of dividends paid in the quarter, and were also net of $6.7 million used to repurchase approximately 251,000 shares of the Company's common stock in Q3. Now, looking out to Q4, we are expecting revenue to increase sequentially to a new quarterly revenue record. We expect to report fully diluted earnings per share of between 16 cents and 20 cents per share. As I stated earlier, this does not include the $4 million net gain we anticipate recording in Q4 related to the damages we expect to receive in The Math Works case. As these are forward-looking statements, I must caution you the actual revenue, earnings, and inventory balances for Q4 could be negatively affected by numerous factors such as any decline in the global economy, delays in new products releases, manufacturing inefficiencies, expense overruns, and foreign exchange fluctuations. So in summary, Q3 was a difficult quarter, with the slower global economy impacting our instrument control sales in Europe and Asia. We are committed to making the investments needed to sustain the long term growth of the Company. With that, I will turn it over to John Graff, Vice President of Marketing.

Thank you, Alec. As Alec just said, we turned in our 9th consecutive quarter of year-over-year revenue growth in Q3. The softening in the test and measurement, and semiconductor capital equipment sectors during Q3 resulted in a sequential drop in sales of our instrument control products. However, we were pleased with record sales of our software products and continued strong sales growth of our strategic PXI and modular instruments measurement platforms,with growth rates far exceeding the overall Company growth rate. Our strong investments in R&D led to the introduction of a significant number of new products in Q3, with major announcements made at our NI Week user conference this past August. Following on the excitement of the launch in Q2 of LabVIEW 7.1, our 10th annual NI Week conference was one of the most exciting yet. With record attendance and a record number of exhibitors, NI week was a testament to the growth and acceptance of virtual instrumentation. During NI Week we introduced several ground-breaking new products that strengthen our leadership position and significantly expand the opportunities for virtual instrumentation in new areas.

One of these product introductions was the new M Series family of data acquisition products, the next generation of multi-function measurement devices, which included 20 new hardware products for both PCI desk top PCs, as well as our industrial PXI platform. The M Series delivers more performance, more IO capabilities, and more value to our customers than previous generation data acquisition products. The cornerstone of this new family of data acquisition products is a revolutionary new architecture designed from the ground up, including the new NI FTC2 Custom A6 and NI PGI2 custom circuitry. These new technologies bring performance features never before available with plug-in data acquisition, including unprecedented timing and synchronization, and insuring accurate measurements at even the fastest scanning rates. With the new M Series family of data acquisition products, we believe we are uniquely positioned to continue our leadership position, while also expanding our ability to solve more applications in test, control, and design. For example, many tests that traditionally employed a variety of devices to provide the needed functionality, can now be solved with a single M Series device. One customer, a leading electronics contract manufacturer in Europe testing consumer electronics and cell phones, has integrated new M Series products into their automated test application, testing LEDs on cell phones. dIn the past, this customer used NI software with stand-alone instruments, but has now replaced these instruments with a single M Series device for their test application. We are pleased with early sales of M Series products which were well ahead of our Q3 forecast. We are committed to continuing our aggressive investment in R&D, and serving as the price performance leader in PC-based data acquisition. With these new features in the M Series, along with the continued enhancements to our NI-DAQmx driver software, our goal is to make data acquisition simple for even the novice user. If Q3 we continued to leverage new easy to use commercial technology, such as USB, by introducing 5 new USB data acquisition devices that make acquiring portable high quality measurements as easy as plugging a USB cable into a PC. And to further extend the capabilities of NI data acquisition, we introduced a new version of our NI-DAQmx driver software for use on LINUX operating systems.

In Q3, we saw continued strong growth of our PXI and modular instrument products. At NI Week last year, we introduced several new mixed signal modular instrument products, that delivered 100 mega-sample per second performance. By leveraging the increasing performance of commercial technologies, as well as our new SMC architecture, we doubled the available speed and memory depth of our previous instruments, by introducing 2 new PXI modular instruments that expand our measurement capabilities for test applications. These new products, which include a 12-bit 200 mega-sample per second digitizer, and a 16-bit 200 mega-sample per second arbitrary wave form generator, bring the advantages of PXI and modular instrumentation to a broader set of applications that we could not address before, in the areas of semiconductor, military avionics, scientific research, and consumer electronics. One consumer, In Sun Yung (ph), research engineer at Samsung Electronics in Korea, stated, "Before using LabVIEW, I used C, and Visual C++, which took on average 3 months to finish a project. I recently completed a VGA signal generator project in just 1 month using LabVIEW, PXI and NI's new 200 mega-sample per second modular instrumentation. " We are pleased with the continued adoption of LabVIEW, PXI and modular instruments as the platform for automated test applications, and we have many more new products in the pipeline that continue to grow the applications we can address.

In addition to introducing higher performance modular instruments, we also continued to enhance many of our other products used in automated test applications, including the industry's first GPIB device for the new PCI Express, allowing test engineers to take advantage of the latest PC technology to control traditional instruments, as well as 4 new VXI controllers that provide greater productivity and speed execution for test applications in the military and aerospace industry. All of these new products make our customers more productive, give them greater flexibility, and continue to lower the cost of tests, ultimately making virtual instrumentation more attractive for a wider range of automated test applications. To address the demand for highly rugged, ultra-high performance embedded control in a compact form factor, we further expanded our product offering in Q3 with the introduction of a significant new hardware platform, Compact RIO. By combining Compact RIO with LabVIEW with FPGA, engineers can leverage the intuitive graphical programming of LabVIEW to quickly reconfigure their hardware, and speed time required to rapidly prototype their new designs. With the ease of use of LabVIEW FPGA, combined with Compact RIO, now a broader set of engineers can reap the benefits of the greater performance, flexibility, and lower costs of this system. Process Automation Inc., an early customer of Compact RIO, needed a platform that was robust, low weight, industrial grade, and that provided deterministic, reliable performance in a small footprint. Greg Sessman (ph), automation systems consultant with Process Automation said, "The Compact RIO platform emerged as the most cost effective solution for our application. The largest benefit we have seen with Compact RIO is its ability to acquire and process data from system sensors at speeds normally reserved for very high-cost, custom hardware solutions."

Other early Compact Rio customers are using the platform in a wide variety of industries and applications, including in-vehicle data acquisition and control, acoustics and vibration analysis, and electric motor drive characterization. Venture Development Corporation named the new Compact RIO platform as best in show at the Embedded Systems Conference in September. We are pleased with the early acceptance of this new platform and believe that with Compact RIO and LabVIEW graphical programming, we greatly increased our ability to handle these robust, deterministic control applications. Virtual instrumentation continues to bring productivity gains to design engineers, during the new product design process. With Signal Express Software unveiled at NI Week in August, engineers can now interactively design, debug, characterize and validate their new product designs. Previously, design engineers spent hours acquiring and analyzing measurements manually with traditional bench top instruments. This process was very tedious and inefficient, especially given the increasing complexity of today's electronic devices and the growing number of tests needed to verify a design. Now with Signal Express, engineers can easily combine design simulation data with measurements throughout -- through an easy to use exploratory environment. Mike Burn, application engineering manager at Analog Devices stated, "Signal Express is a unique measurement tool because it is interactive and has the ability to import and compare design signals with measurement data. These features allow designers to quickly and easily make common measurements to characterize and validate their laboratory prototypes, eliminating a time consuming programming step." Since Signal Express is built on express technology, first introduced with LabVIEW 7 Express last year, design and test engineers can convert their Signal Express projects to LabVIEW block diagrams, for applications such as automated system validation and manufacturing tests. Thus shortening the time from design to verification to manufacturing tests. In addition to Signal Express, we also released upgrades to several other software products, including Measurement Studio 7.1 for Microsoft Visual Studio.net, LabWindows/CVI 7.1 for ANSI C development, and DIAdem 9.1 for large scale data management.

And we continued our nearly 20 year history of providing industry standard instrument drivers, which is software that makes it easier for users to communicate with and automate traditional instruments. Today, we provide drivers for over 4,000 instrument models for a wide range of computer interfaces, including GPIB, Ethernet, USB, and serial. And we continue to expand the number and types of instruments we support. In Q3, NI and Agilent Technologies announced the joint initiative to create native LabVIEW instrument drivers for several of Agilent's most popular life science instruments, giving customers more software development options and the flexibility of a full programming language to meet a wider range of lab and production application requirements. In Q3, we introduced a significant number of new products, and we're pleased with the excitement throughout NI Week. To continue this momentum into Q4 and early 2005, we are holding these series of user events and technical symposiums in 91 cities around the world, to demonstrate the power and growing capabilities of of virtual instrumentation, and we're pleased with early attendance. In summary, we are pleased with the early success of our major new product launches in Q3. We saw strong growth of our virtual instrumentation products, including record software sales. We delivered the 9th consecutive quarter of year-over-year revenue growth, and we are focused on our execution in sales and marketing to bring these new products to market. With that, I'll turn it over to Dr. T.

Thank you, John. While we saw a softening in the global economy in Q3, we were pleased with record sales of software and continued strong growth of our strategic PXI and modular instrument products. In Q3 we continued our strong output of products that are aligned with our vision and introduced several key new platforms at NI Week that strengthened the foundation of virtual instrumentation and tests, expand our visions to solve a broader set of applications in industrial control, and bring the benefits of greater productivity and integration to design. With new product introductions, including over 20 new M Series data acquisition products, we continue to lower the cost of tests by delivering greater functionality, productivity, and scalability. In addition, our new modular instruments, which double the performance of their previous versions in just 1 year, strengthened our value proposition in automated tests. With unprecedented time to market demands, combined with the growing complexity of today's devices, our core products, including LabVIEW, data acquisition, PXI, and modular instruments, are giving test engineers a competitive advantage in their industries. And we were pleased to see strong sales of these products in Q3.

We continue to broaden our product offering to address the demanding applications in industrial automation. As users add more advanced measurements and greater flexibility in their industrial control applications, there is a growing trend toward the use of programmable automation controllers, or PACs. To further address users' needs, at NI Week we introduced a revolutionary new PAC platform, Compact RIO. I am particularly excited about Compact RIO because it combines the deterministic control of real time LabVIEW, with the reconfigurability of LabVIEW FPGA, with a compact, ultra-high performance platform to deliver a highly rugged, reliable solution that provides the flexibility and advanced control users need. While the ramp up of this new platform will take time, I believe it allows us to have a very differentiated position in this area in the long term. And I'm very pleased with the success we've had working with our early adopters. In addition, since Compact RIO is based on LabVIEW FPGA, and is a reconfigurable platform, it is ideal for design engineers who need to quickly prototype new product designs. With Compact RIO, design engineers now have a platform for rapid prototyping that provides a path to their final production unit. Another challenge design engineers face is having to use disparate tools and separate environments to verify their electronic designs. With the launch of Signal Express, design engineers can now quickly compare physical signals with expected results, thus lowering their costs and reducing the time required to verify their designs. In summary, we introduced significant new products that strengthen the foundation of virtual instrumentation, and expand the opportunities for the future. We are pleased with strong sales of software, PXI, and modular instruments, and are focused on executing in sales and marketing to bring these products to market and make our customers successful. Thank you for taking the time to join us today. We will now take your questions.

Thank you, gentlemen. (OPERATOR INSTRUCTIONS) Richard Chu, SG Cowen.

Alec, I wonder whether you could talk a little bit about the revenue picture for Q4. You didn't give specific guidance there. In the last 9 years, your sequential Q3, Q4 has been around 11 percent. Last year was quite a bit higher than that, excluding that, maybe it's about 10 percent. Can you comment whether the EPS guidance that you're providing contemplates something like a typical top line quarter, or something more or less.

Richard, yeah, you're right. Our average sequential increase has been around 10 percent since the IPO, excluding last year, which was a particularly strong Q4 for us. We're obviously happy with the growth of our new products, but we are cautious about the year-over-year growth prospects for our instrument control business in Q4. We do have, as you said earlier on, a much tougher compare in Q4. And however, we do expect sequential growth in Q4, we do expect a record revenue quarter. Personally, my stance right now is conservative, given the high oil prices and some uncertainty as to how long it might take to resolve the presidential election. We'll have greater visibility to this as we go through Q4. Specifically, in terms of our earnings guidance, it does contemplate a range of a slightly weaker than normal Q4, with a normal Q4 sequential increase.

And then if I can follow on, you have for some time targeted approximately 18 percent operating margins as a normalized goal. Not too long ago, that seemed like a realistically attainable target for Q4, if not certainly for 2005 and '06. What do you feel about your ability to achieve that goal for 2005, and what would it take to get there? Is it strictly a function of top line, or are there costs and expense dynamics that we should be conscious of?

Good question. The primary issue I think, that's going to drive that, is going to be the top line. We are in the process of completing our plans for 2005, and our goal is to grow our revenues faster than expenses next year, and to increase our operating margins in 2005 towards the mid-teens. Obviously, Q4 in each year tends to be the stronger quarter of the year, so that should open up the possibility for us to have above average for the year margins in Q4 of '05. Obviously, that's a a forward-looking statement, so the key will be that we see a normal economy. And if we see a weaker economy next year, that will be the challenge for that. But we will certainly be very focused next year on increasing revenues faster than expenses. We've made a lot of, I think, very wise investments over the last 4 or 5 years, and we're going to be looking to get leverage out of those investments as we go into 2005. And that intent is very much shared across the whole management team.

Mark Roberts of Wachovia Securities.

I'll ask my one question and then follow up. They're not all that related. Alex, can you give us a break-down by segment of the revenue this quarter, you know, like between telecom and semis and automotive, et cetera?

I'll let John address the industry type mix.

On the industry perspective, as we kind of mentioned in the call, on the semiconductor, capital equipment, and instrument ATE, we saw a softening on a sequential basis. On the positive side, we continued to see growth in electronics, biomedical, and automotive, provided some uplift, especially around some of our newer products and the virtual instrumentation products. As we mentioned in the call, some of the sequential drop in our instrument control business was due to the weakening in semiconductor and ATE.

Are you able to give us, though, like a percentage breakdown of the revenue mix in the quarter?

We don't break it out, Mark, by product category. Can tell you that none of our industry segments is greater than than 10 percent. But we've not traditionally broken that out by category. We're a very, very diverse company, as you're aware, with the tens of thousands of customers we sell to, that is a very, very difficult exercise to conduct.

Okay. My follow-up question, you did some stock buy-back in the quarter, as well as the dividend is relatively new. Can you talk a little bit about -- you've done this on previous calls -- but can you talk a little bit about where the Board is thinking going forward. Are you intending to continue grow the dividend, or buy back stock, or both?

We introduced dividend last year, obviously in the spring, following the change in tax law, and we have this year increased that dividend by 50 percent back in the spring. So, our intent when we introduced the dividend, was that this would be a long term plan. It was obviously, driven by change in the tax law. And so we'll be continuing to review this, and I don't know exactly how the Board will react to any potential future changes we may take, or we may see in the tax law. I do think, absent any change in tax law, it's likely that we will continue the dividend strategy.

Richard Eastman, Robert W. Baird.

Alec, could you just walk us back through this gross profit margin number? The way I calculated it, it looks like with an incremental margin of 73 percent, which is where it's been running, that we're perhaps 2 million light on the gross profit margin line. I think you identified about 400K of that in obsolescence charges. Can you zero us in on maybe the balance from that type of metric?

Sure. A couple of things happened during the quarter. Obviously, our margin dropped about a point from Q2. And the biggest change there, sequentially, is I did talk in the call, is we increased our obsolescence expense this quarter quite a bit more than normal, because of decision to end-of-life some older generation products. Also, as we have been building up inventory in the first couple of quarter of the year, we did see better utilization than we saw here in Q3 when we saw inventories reduced slightly. Another issue that played a factor in this quarter was, we did a lot of introductions of a lot of new products this is quarter. And that brought with it a fair degree of cost related to low yields and scrap and prototype expenses in the quarter. Looking forward into Q4, our current expectation is that we will see our gross margins rebound to about 74 percent in the fourth quarter. So that's currently what we expect to see for our next quarter.

Okay. And then as a follow-up, could you just give us a better flavor for the traditional instrument business? Understanding that you don't talk to mix, it's fairly obvious that the mix is pretty heavy on the semicap equipment side and obviously the ATE. But the ATE side I guess, itself is influenced by the semicap equipment. I'm surprised that some of the traditional test companies really have had pretty good, very good year-over-year growth in the third quarter. I'm a little bit surprised that you're either budgeting very high, or that that business fell off as much as it did. Is that business very sensitive to the semicap equipment?

Certainly semi -- if you look at the overall mix of business, semi, capital equipment, and ATE is a much larger portion of our instrument control business than it is of our business overall, a significantly larger portion. There's a lot more OEM business, as I said on the call last time. Significantly higher percentage of our instrument control business is OEM related than our general business. This tends to make it much more sensitive to changes in those companies overall. I think when you look at the order growth, not only for the ATE companies like Teradyne and others, but other companies that play in the semiconductor, capital equipment space, like Cognex, pretty dramatic changes in their orders sequentially from Q2 to Q3. And then the order growth I've seen from some of the larger T&M companies that I watch, in terms of year-over-year order growth, has also been definitely affected here in Q3.

So your shipping cycle is shorter? Is that kind of what you're implying?

Absolutely. Our shipping cycle is 1 day. I mean, that's a very good point. Our backlog is typically, we don't ship out of backlog these products. Our shipping cycle is daily.

Is there any impact on that business from the growth in the USB?

USB, GPIB is a very successful product for us. We have launched USB, GPIB some years ago and we've seen quite a lot of growth out of the GPIB to USB converter. So we do see that as a real good market opportunity and we've certainly leveraged these new technologies as they come to market. John, perhaps could add some color to that.

Yeah, one other comment I might add, Rick, is that when you look at a typical test system you have multiple instruments, and as long as there's one instrument with a GPIB interface on it, then we'll still sell that interface. As Alec mentioned, that led to more popularity of our USB to GPIB converter, so you can bring all these different types of instruments in. So all new instrument standards continue to evolve, as they have over the last 20 years, we're able to seamlessly support those with our software. But I don't think it's had a real material impact on the overall GPIB business.

Companies like Teradyne saw a significant drop in their overall orders, some 48 percent I believe, sequentially, so those sectors were hit pretty hard.

Ajit Pai, Thomas Weisel Partners.

The first question is about your gross margins again. And just looking at it, the third consecutive quarter, or the second consecutive quarter of a decline in gross margins, and year-over-year on 20 percent revenue growth, you have a lower gross margin. Now, this is a quarter of record software sales for you, as a percentage of the mix also, I would assume. Does that mean that some of your new products are actually lower than your Company average margin?

Hi, Ajit. That's a good question. Obviously, we've had a couple of things affect us, as I talked in the quarter here. I think the majority of the sequential impact we saw in gross margin is more specific issue related, and as I said earlier on to Rick, I anticipate that our margin for Q4 will return to about 74 percent, which will put us back, and pull up the average for the year closer to 74 percent. That's obviously a forward-looking statement based on our expectations for revenue growth. But, overall we don't see any major change -- any shift in the mix causing a challenge for us on gross margins. We just have some operational issues as we go through these particular quarters and we expect to be back at 74 percent in Q4.

And the target is still 76 percent for gross margins?

Long term target is still to get to 76 percent, that's correct.

Okay. And then the follow-on question is about the average order size.

Okay.

Did it rise during the quarter, and what is it for this quarter, relative to last quarter?

Yeah, this is John. The average order size in Q3 was a little over $2,700. That compares to $2,800 in Q2.

Is it the first time that your average order size has fallen in the past 8 quarters?

I don't have that in front of me. No. It's --

Q3 tends to be slightly weaker. Last year in Q3, we saw 8 percent GDP growth in the United States, so we had a good lift from that. Year-over-year, our average order size is up 5 percent. We definitely did see some impact here to the large OEM business in the ATE space. Those tend to be quite large orders, because they buy in bulk, and that did have marginal impact on the average order size.

But the pricing environment is still intact?

From a discount point of view, there's no change. If that's your question.

Yeah, the discount point of view and what you've got to price (indiscernible) ?

No, there's no change.

No change.

David Yuschak, Sanders Morris Harris.

Just a follow-up to the one comment you made, Alec, about that 400,000. Is that over and above your normalized obsolescence charge?

Right, David.

As far as your comment about record software sales, could you give us some view as to when your last record was, how much may have it exceeded that, and what does the software sales look like at this record, compared to your previous records? Is there any kind of shift in mixes from LabVIEW to other things you're doing?

This is John. The last record was just the previous quarter. As you have heard us say in the last few quarters, we continue to have strong momentum in our software driven primarily by the ongoing success of LabVIEW 7 Express, which was followed by the introduction in Q2 of LabVIEW 7.1. Now, the software growth we're seeing isn't just exclusive to LabVIEW. As we also mentioned in the call, we've come out with updated versions of basically our whole software platform. And we've seen strong growth across the board. So, overall, we're continuing to see momentum. Our goals as we set out, was to continue to get greater penetration in existing accounts, and to grow our software sales in new accounts. And that momentum continued in Q3.

Going back to the previous cycle though. How would you -- have you seen a good shift in the way things are showing up on software sales for your other initiatives other than LabVIEW?

Nothing that I could comment that's any different than past. We continue the investment in R&D and the new features in a lot of our software. LabVIEW and our whole family of software has continued to meet a lot of market needs.

The other way to look at it, too, LabVIEW is not just one product, but a family of products. A lot of our new initiatives are LabVIEW-related products that tie very tightly to that LabVIEW core.

Obviously software is very strategic for us, and products like LabVIEW Real-Time have enjoyed very good success. LabVIEW FPGA, LabVIEW PDA, they all extend the base of LabVIEW to new platforms, new opportunities for us.

One follow-up here. On your sales and marketing. Down a bit from your second quarter. Usually your third quarter is pretty robust just because of NI Week. Were you able to cut back sales and marketing expenses as the quarter progressed, in light of seeing maybe the soft sales trends that developed as the quarter progressed?

Obviously from a sales point of view, no. We still had a very good quarter at 20 percent year-over-year growth, and we have to put the investment behind that. So we did see an increase year-over-year in sales and marketing. But we were mindful of having overspent in Q2, and the organization did a very good job, very disciplined in terms of managing our expenses against our budget for Q3. So I was pleased to see us with our spending coming in below budget. But we've got to continue to make the investments as we deliver on this 20 percent top line growth in Q3.

We continue to see scale from our investments in the Internet. We've seen really a good growth and there are a number of visitors, and so that continues to improve our efficiency in marketing.

As I said earlier on, Dave, too, our intent as we go into next year is to grow our revenues faster than our expenses. So we hope to deliver some more leverage from that investment in '05.

So, next year, just a little more moderation getting your resources you're putting into play this year to become more productive next year?

That will be our goal.

John Harmon, Needham & Company.

I apologize if I ask something redundant, but I got in halfway through the call. Regarding the shortfall in traditional instrument control revenue, when you preannounced you said one of the causes was ATE. Historically you said no industry is greater than 10 percent of sales. Is ATE near or greater than 10 percent of instrument control sales?

Of the instrument control product line itself, specifically?

Yes.

Yes. I have to double-check, but I think probably. I haven't looked at it that way exactly, John.

Okay. The reason I'm asking --.

That's likely to be true.

What other industries are very large that could cause that revenue to vary?

As part of the instrument control business?

Uh-huh.

Semiconductor area, I'm not aware of any others outside of that. I'd have to sit down and look at it. So we can talk off line.

Okay. If you get the chance. Thank you. And secondly, did you give an update regarding your lawsuit against The Math Works, and specifically when do you think you might receive payment for the damages that have accrued?

On the damages side we gave an expectation that we expect to receive the damages in Q4, in November. We do intend -- we expect to record about a $6 million gain as a result of that. That is not factored into our guidance, John. We do anticipate spending $2 million of that $6 million on academic efforts, which will show up as sales and marketing expenses. And we'll make that decision when we receive the cash. If we do receive that payment in Q4, it will end up being a net gain, net of the academic donations, of about $4 million. That's obviously a forward-looking statement. We don't have any reason why that won't happen in Q4, but the legal process is as it is, so it is possible that may slip beyond Q4.

Thank you. And finally, previously when you've had litigation expenses, you haven't taken the pro forma route and excluded them, but you did this quarter. Is this something different? Or, and then you would probably exclude them next quarter as well?

It's really in response to, you know, a large gain and expense this quarter and the expectation of a large gain next quarter. And that's potentially causing a fair amount of confusion. So we wanted to try to clear that up. If this gain comes through in Q4, you'll see that our GAAP earnings will actually be higher than our pro forma earnings, if this gain does come through in the fourth quarter. So we wanted to just clear up the possible confusion related to these numbers moving in opposite directions.

Mike Whitfield, Wachovia Securities.

I wanted to ask you about, from an applications standpoint, are there places where you think you're gaining share, whether in production, whether in test related functions, or in product development?

Good question. Especially, and I think as you heard in the call, we feel very good about our position and a lot of production tests, manufacturing tests, applications, the momentum driven by our success with software, PXI, and modular instruments, which all had very strong growth in the quarter. As we have increased the measuring capability of our platform, which we did again in Q3 with the introduction of 2 new modular instruments, we're seeing continued success in penetrating into those applications. Now, a lot of these newer areas, driven by designing platforms like Compact RIO, Signal Express, new functionality in our M Series data acquisition, is opening up doors into new application areas. And there we're focusing on getting the beach head success in key application areas, where these initial products fit and then build the long-term success off of that. So, overall we feel good about market share gains and continued penetration of our new products.

Okay. Are there particular milestones that we can look for when you talk about the opportunities that Compact RIO, for example, are bringing to you?

In terms of technical milestones, we continue to bring our some key new products as we go forward. We now have a robust architecture there and we should be able to iterate on that with new products quite rapidly. In terms of application areas, this is an area that will be a little more heavily OEM focused than Compact RIO, and you may see us over the next year, 18 months, announce perhaps some OEM wins, and that would be a good way to track that as that may happen, as we go forward. This is a brand new product platform, obviously, just released. Good early success, but we have to to build on that as we over the next couple of years.

Richard Chu, SG Cowen.

Couple of unrelated things. I'm slightly puzzled by your comments about the European growth rates slowing down to 5 percent in constant currency terms. We hear (indiscernible) much better numbers elsewhere in broad sectors of technology and even in instrumentation. So wondering if you could expand on whether there are perhaps factors that are unique to you that you're seeing there?

That's a good question. We've had significant price decreases in Europe in our local currency as we've adjusted pricing, as the dollar has weakened against the Euro. So we dropped our local currency prices by about 10 percent on January 1st, and then about another 10 percent on the 1st of April. That obviously plays directly into the local currency year-over-year growth rate. So if you look at gross currency growth rate, it doesn't reflect unit volume growth. We try to keep our pricing in Europe within a band of the U.S. dollar price. And so as the U.S. dollar has weakened considerably, we have taken a position of corresponding the relative price decreases in Europe. And so we have had quite good unit growth in Europe throughout the year and in Q4, but you don't see that showing up in the Euro, in the local currency price, or revenue comparison.

Do you see trends continuing into October, in terms of some of the macro-weakening that you referred to?

I think it really, it doesn't make a lot of sense for to us comment too much on a few weeks of bookings numbers. I think what I said earlier on, in terms of guidance is the way to look at it. Obviously we do have concerns, as I said earlier on, for some continuing weakness in our instrument control business, based on macro economic factors. I guess we'll have to wait until we get further in the quarter to know about the rest of Q4.

You said in the past that the OEM business is normally about 8 percent. How much of that was in the third quarter?

The OEM business was down in Q3. I don't actually have an exact number for you right now. We can talk offline.

Then finally, I wonder if you could just go back to the software issue in LabVIEW 7. LabVIEW 7 made its way onto the scene in 2003. You talked about this being --

Hello? Richard?

Mark Roberts, Wachovia securities.

I did have one follow-up question.

Sure, Mark.

When you were talking about operating margin targets, I've noticed that you have a pretty consistent trend of increasing R&D spending as a percentage of revenues. And I know you've addressed this before, but are you still seeing that, you know, is that an opportunistic spend, where you have the discretion to lower that, you think, in the future? Or is it really the result of kind of an accelerating, competitive environment and shorter product life cycles?

I think it's an opportunistic trend. We've seen the opportunities that have come open to us from our strong market position in a number of areas, and have chosen to be aggressive in leveraging on that. In terms of where we're going with R&D as a percentage of revenue, our target is about 16 percent and we have been running ahead of that here in 2004, closer to 17 percent. Our goal as we head into next year will be to try to move that number back down towards our long term target of 16 percent. So I don't anticipate the trend we've seen of increasing R&D as a percentage of revenue to continue into 2005.

Richard Eastman, Robert W. Baird.

I just wanted to stay on the geographic topic for a second. When we look at Asia, our local local currency growth there has also been slowing really through the year. We noted it, kind of flagged it in the second quarter, and it dropped further in the third quarter. So, the impact there is presumably from the traditional instrument business? And then secondly, have you also dropped your prices there relative to the currency move?

Rick, good question. The traditional instrument business is stronger as a percentage of revenue in Asia than in other parts of the world, as a result of the aggressive move of a lot of industrial capacity to Asia. So that definitely is a factor in it. The other issue is that we had very, very good success in terms of ramping up our growth in Asia last year. So our compares get a little tougher as we go through. We also have responded, similar to the drop in Europe, to decreasing prices, we have also done that in Asia. Although the move of the dollar against the Asian currencies hasn't been nearly as extreme as the move of the dollar against the Euro.

At what point do we raise prices, given that currencies have basically flattened out, or are close to flattening out? Are we in a position in '05 to raise our prices?

Well, I mean, the dollar took another dive in the last days, about 4 or 5 percent against the Euro in the last 10 days. That's we look into next year. Against the yen and the other Asian currencies, like the Taiwanese dollar and so on, it has been pretty stable. But, you know, we sell a product that is consistent across the globe, you know, a GPIB board or a data acquisition board is the exact same in Germany, as it is in Japan, as it is in China. And so we deal in the global market with short lead times, and so we've always had a strategy of balancing our pricing to changes in exchange rates. The net economics on the business, certainly when the dollar weakens are positive, despite the reduction in pricing.

So we should look at the sales growth as probably the real number in terms of thinking absorption?

Yeah, the dollar revenue change is a much more accurate reflection of the change in unit volume. If that helps answer your question?

Yep, yep. Thanks again.

And ladies and gentlemen, that is all the time that we have for questions today. Gentlemen, I would like to turn the conference back over to you for any additional or closing remarks.

Thank you very much for joining us today, and we will talk to you next time.

That does concludes today's teleconference. Thank you for your participation, and have a nice day.