National Instruments Corp (NATI) 2004 Q4 法說會逐字稿

Good day, everyone, and welcome to the National Instruments Corporation's fourth quarter 2004 earnings release. Today's call is being recorded. You may refer to your press packet for the replay dial in number, and passcode. The replay will be available from 7 pm Central time today and will end at midnight Central time on February 2, 2005. 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 conference over to Mr. David Hugley. Mr. Hugley, 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, strong new product output in 2005, 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 September 30, 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 quarterly revenue, up 9 percent sequentially, record sales of LabVIEW, PXI, data acquisition and module instruments in Q4 and record annual revenue up 21 percent year-over-year with net income of 46 percent.

We are pleased with the strong sales of our Virtual Instrumentation Platform in Q4. Our strong investments in R&D, coupled with excellent sales and marketing execution, resulted in record revenue for the quarter and for 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 strong Q4 with review of $137 million, up 12 percent from Q4 2003 and up 9 percent sequentially. This represents the highest quarterly revenue in NI's history. The sequential growth in Q4 is in line with the average Q4 sequential increase we typically see. Our growth rate in Q4 is significant when compared to the unusually high 16 percent sequential revenue growth we saw in Q4 of 2003.

Revenue for the full year was $514 million, up 21 percent from 2003. This represents the highest annual revenue in NI's history. We are pleased to pass the milestone of $.5 billion in revenue. I feel that in 2004 we made good progress towards our goal of reaching $1 billion in revenue in 2008.

Fully diluted earnings per share for Q4 was 20 cents with net income of $16.5 million, up 47 percent from Q4 2003. This represents the highest quarterly net income in NI's history.

Net income for the full year was $49 million, a 46 percent increase over 2003. Fully diluted earnings per share was 59 cents per share. With a 21 percent increase in revenue and a 46 percent increase in net income we are pleased to have delivered on our goal of driving operating leverage in 2004.

Now looking at Q4 revenue in more detail. Sales of our Instrument Control Products were down 3 percent sequentially and down 4 percent year-over-year. And we are impacted by weak sales to test in measurement and semiconductor capital equipment companies. And by a decline in the Global PMI during Q4.

Sales of the rest of our product portfolio, i.e., our virtual instrumentation platforms were up 16 percent year-over-year compared to a very strong Q4 last year. During Q4 we saw growth in all regions. Revenue was up 11 percent in Europe and Asia and was up 15 percent in the Americas, giving overall growth of 12 percent. We believe that the slowdown in year-over-year growth in Europe is due to the weakening of the industrial economies in Europe during Q4.

In Asia, our growth rate was pulled down by a 16 (ph) percent decline in sales of our Instrument Control products, which make up a larger percentage of our Asian revenues. However, we continue to see good growth in our Virtual Instrumentation Products in Asia which had growth of over 20 percent.

Now we will look in more detail at the income statement for the quarter. Gross margins in Q4 were 73.5 percent up from 72.7 percent in Q3 on a 9 percent sequential increase in revenue. Total operating expenses were $79.3 million up 3 percent over Q4 2003. Total expenses included a $2.1 million net credit for patent litigation and an expense of approximately $2 million for educational donations.

Our R&D expenses were flat sequentially and were up 6 percent year-over-year. Software development expenses capitalized in the quarter amounted to $860,000. Also during the quarter, $1.9 million in previously capitalized software development costs were amortized to cost of goods sold.

Sales of marketing expenses were up by $2.2 million sequentially and by 12 percent year-over-year. This included approximately $2 million in donations, which we made to 100 educational institutions worldwide in Q4. Consistent with what we said in our October earnings call, we used 42 million of the award we received from the MathWorks (ph) case in Q4 to further engineering education, and to extend the adoption of LabVIEW and our Virtual Instrumentation Platforms in universities worldwide.

The net patent litigation credit of $2.1 million is made up of two elements. The first represents a net gain of approximately $6 million from damages related to the Court of Appeals affirmation of our victory against The MathWorks in our 2003 jury trial. This gain is offset by a $4 million charge we have taken in Q4 related to a new patent case concerning The MathWorks newly released version of Simulink.

This new version of SimuLink -- service pack 1 for release 14 -- was released by MathWorks in an effort to avoid the court's infringement injunction. While this release did remove some functionality from Simulink, we believe that this new version continues to infringe NI's LabVIEW patents. The Federal court for the Eastern district of Texas has ruled that a new trial is needed to decide the infringement issues presented by the newly released version of SimuLink.

This charge of $4 million represents the accrual for estimated legal costs to take this case through trial.

G&A expenses in Q4 were up 20 percent year-over-year and included approximately $1.4 million related to our efforts to comply with Section 404 of Sarbanes-Oxley. For 2004, we estimate this cost at approximately $2.5 million.

Now looking below the Operating Income line, Other Operating Expenses included a net charge of $2.3 million. Related to a $2.5 million write-off of an investment offset by a $242,000 gain on a sale of a subsidiary. The $2.5 million write-off related to a 10 percent minority position NI owns in a small start up.

This investment was made in 2001 and represents the only minority investment that NI has. As a result of a deterioration in the performance of this company and weakened prospects for future profitability we took this charge in Q4.

The $242,000 gain is related to the sale of our German systems integration company. This company had revenues of approximately $8 million in 2004. It represents the system integration arms of two German software companies we acquired in 1998 and 1999.

This business had gross margins significantly lower than the overall company. It will now operate independently as one of NI's global select integrators. This sale was effective December 31st.

On another non-operating item from Q4, the significant fall of the U.S. dollar resulted in a $2.1 million gain on foreign exchange. This is an unusually large gain and is unlikely to be repeated in future quarters.

Now turning to the balance sheet. Inventory declined by $5 million or 9 percent from Q3. Day sales outstanding were 55 days, down from 59 last quarter. Net cash and short-term investments increased by $26 million to a new record of $227 million. The board of directors has declared a cash dividend of 5 cents per common share payable February 28, 2005, to shareholders of record on February 7.

Now I would like to make some forward-looking statements concerning our expectations for 2005. The global industrial economy weakened during Q4 with J.P. Morgan's Global Manufacturing Index falling from 56 in Q3 to 53.6 in Q4.

However after falling for four months to a low of 53 in November it showed some modest improvement in December, led by a post-election recovery in the United States. While still indicating expansion, these levels are significantly below the record levels we saw in the first half of 2004.

For the full year of 2005 we are budgeting for record revenue and double-digit revenue growth, with fully diluted earnings per share of between 80 cents and 90 cents per share. This corresponds to an EPS increase of between 35 percent and 50 percent in 2005. This budget assumes midteen operating margins for the year and a tax rate of 24 percent.

In Q1 2005, we are currently budgeting revenue to be relatively flat sequentially and to report fully diluted earnings per share of between 16 cents and 20 cents. As these are forward-looking statements, I must caution you that actual revenues and earnings could be negatively affected by numerous factors, such as any decline in the global economy, delays in new product releases, expense overruns, manufacturing inefficiencies, and foreign exchange fluctuations.

In summary, 2004 was a very good year with revenue growth of 21 percent and net income growth of 46 percent. Our discipline and (technical difficulty) continued to increase our investments in R&D and our field sales for slowing the downturn have clearly paid off. With that I will turn it over to John Graff, Vice President of Marketing.

Thank you, Alex. We turned in a strong performance in Q4 delivering our 10th consecutive quarter of year-over-year revenue growth and a new quarterly revenue record. Our strong sales were driven by record revenues for LabVIEW, data acquisition, PXI, machine vision, distributed I/O and modular instrumentation products as well as record contribution to revenue from (technical difficulty) by a very strong fourth quarter of 2003 and a softening in the test and measurement in semiconductor capital equipment sectors.

2004 marked a record year for revenue with 21 percent year-over-year revenue growth. Our strong investment in R&D continued to pay off with the introduction of a record number of new products in 2004. Several significant products released in 2004 included LabVIEW 7.1 -- an upgrade to our flagship software program -- M Series, the next generation of plug-in data acquisitions, several new modular instruments that further fill out our platform for automated tests, Compact Rio -- a new embedded industrial control platform and SignalExpress, a new interactive software package that leads to tighter integration of design and tests.

For nearly 20 years virtual instrumentation has combined modular hardware, graphical system designed software, and PT technologies to create user-defined measurement and automation systems. This software-defined approach affords greater flexibility and because it is built on PC technologies has advanced in capability at a much faster rate than traditional approaches. We continue to see Virtual Instrumentation being adopted by thousands of companies.

In manufacturing tests alone, industry leaders such as Kodak, Lexmark, Motorola, Delphi, ABB and Phillips all use Virtual Instrumetation hardware and software for mission-critical high-volume production test applications. Recently Visteon (ph) needed to replace in the blind test system and shows LabVIEW, PXI, and Modular Instrumentation for the new system. For Julio Salazar, test engineer at Visteon, stated, "we standardized on NI software and replaced traditional rack-and-stack hardware with NI modular hardware including PXI, data acquisition, switching, image acquisition and modular instruments. With this new standardized test system, we save more than $13 million in reduced before space by more than 1300 square feet".

Virtual Instrumentation has also seen tremendous success in defense and aerospace application. As we have stated in past calls, PXI has seen strong adoption in many Mill Arrow applications. The U.S. military and contractors for example are adopting Virtual Instrumentation widely. The U.S. Department of Defense, the world's largest single consumer of automated test equipment, has adopted the concept of software-based instrumentation.

Another example is Honeywell's Engine Systems and Services division, which recently developed a system that tests aircraft components such as turbines and generators, subjecting them to extreme pressures, temperatures, and other conditions similar to those encountered in real-life operating modes.

LabVIEW real-time, PXI and data acquisition were used to design the system that collects temperature and pressure data from over 2000 channels. By using Virtual Instrumentations instead of traditional methods, the system was finished in 40 percent less time.

The cornerstone of Virtual Instrumentation is software. We continue to see strong adoption of our software platforms and recognition from both customers and industry. LabVIEW sales reached a quarterly revenue record with very strong growth as a large number of new users adopted Virtual Instrumentation and graphical programming. In Q4, LabVIEW 7.1 continued the award-winning tradition of the LabVIEW software platform by winning the 2004 Reed Electronics Group European Product of the Year award.

In Q4, we continued to execute on our strategy of opening up the LabVIEW platform to new and exciting application areas by releasing two new LabVIEW control design tools, further pushing NI software and hardware into the control design space. These tools have been especially successful in academia, where some of the cutting-edge control research is conducted.

For example, leading engineering schools -- such as Texas A&M University and the Georgia Institute of Technology -- are using the LabVIEW control and simulation tools to design, implement and test advanced control processes.

Another key part of our software platform is to test and -- test management software product which has been adopted rapidly as customers are seeing the benefits of using an off-the-shelf automated test executive instead of designing one in-house. Q4 was a record quarter for TestStand (ph).

One customer -- Texas Instruments -- deployed TestStand in their fourth-generation IC characterization process. TI was able to develop a common test management and automation framework for developing modular and reusable device tests that engineers deployed across four design centers spanning three continents.

One of the newest members of the NI software family, SignalExpress received a Best in Test award from Test and Measurement World -- a leading industry magazine. We are encouraged by the initial interest in SignalExpress by both current and new customers who are using it with both modular instruments and traditional instruments and electronics design application.

Bob Pease (ph), staff scientist at National Semiconductors said, "With SignalExpress, an engineer can quickly do a reality check on design using real-time measurement data. I wouldn't build a production board based on spice alone but I will trust real-world bench measurements taken with NI hardware."

A key component of Virtual Instrumentation is flexible modular measurement hardware. At NI Week, the next generation of data acquisition, the M (ph) Series was released. The M Series has ramped up faster than anticipated as customers have seen the increased value of more performance and lower costs. We continue to leverage this hardware platform by releasing four new higher performance products this month, expanding the M Series to a total of 24 devices.

Another key measurement hardware platform is PXI Modular Instrumentation which has become -- by some accounts -- the most successful industry standard platform for measurement and automation since GPIB.

In Q4, NI released new PXI products at a rate averaging 1 per week. Including new PXI real-time controllers using the latest Pentium 4 technology, new switching hardware -- connecting NI hardware to thousands of channels easily -- and a new dynamic signal analyzer module increasing our portfolio of high-end audio test equipment.

Along with multivendor support, leveraging generally available technologies like the PCI hub has helped fuel the extraordinary PXI adoption rate. In the future evolution of PXI, based on PCI Express technology, we'll further expand the platform to serve more applications in areas such as telecom, consumer electronics, and aerospace.

A significant new hardware platform for Virtual Instrumentation is the Compact Rio Embedded Industrial Control System. Based on LabVIEW FPGA, the Compact Rio platform has seen strong early acceptance by customers in embedded design, machine control, and in-vehicle data logging applications. And has exceeded forecast in its first four months.

Further opening up new areas for the Compact Rio platform, we recently introduced several new modules that allow it to be used in a larger range of applications, including noise and vibration monitoring, and high channel count applications.

In Q4, Compact Rio was chosen as an EDN Innovation of the Year finalist -- one of only a dozen products that were selected from thousands of new products released in 2004.

In summary, we built on the successful launch of significant new products throughout 2004 and saw strong growth and adoption of these new products. We are pleased with the strong sales of our core Virtual Instrumentation software and hardware products. We believe Virtual Instrumentation is becoming a mainstream approach in automated tests. And we are very excited about the strong growth in the industrial control and other exciting application areas.

We look forward to leveraging the success of 2004 into 2005. With that, I will turn it over to Dr. T.

Thank you, John. As John said we are pleased to turn in our tenth consecutive quarter of revenue growth in Q4 with record sales of LabVIEW, PXI, data acquisition, machine vision, distributor IO and modular instrument run products. We continue our strong output of new products in 2004, introducing key new platforms such as the new M Series and the Compact Rio data acquisition embedded control platform.

Furthermore, 2004 was a watershed year with our modular instruments products achieving strong industry acceptance.

Additionally, our next generation M Series data acquisitions products demonstrated outstanding customer acceptance. Our industrial strength Compact Rio shows the differentiations that our LabVIEW real-time and LabVIEW FPGA products offer. Builders of machine control and monitoring systems can now use LabVIEW to build very high-performance industrial systems.

Overall, 2004 was a record year for new product output and early demand for our new products helped deliver 21 percent year-over-year revenue growth.

LabVIEW's Virtual Instrumentation approach was revolutionary when it was developed 20 years ago; and LabVIEW's dataflow approach has proven to be the ideal way to build measurement systems. We are now demonstrating that the dataflow approach is proving superior to alternatives of programming embedded systems.

Our 2004 investment in R&D continued to build its strength at the LabVIEW platform with which we added simulation and control design to LabVIEW to further extend its applicability to embedded design. We are now in the process of completing LabVIEW as a system design platform. This means that design engineers will not only be able to test their designs, they will also the able to rapidly design and prototype their hardware and software with LabVIEW.

Our Compact FieldPoint, Compact Rio and PXI platforms will be ideal for prototyping new systems. The introduction of instrumentation control products represented our first decade of success. LabVIEW and Virtual Instrumentation, our second decade, automation with machine vision and motion control, our third, and now we are preparing for National Instruments fourth decade with LabVIEW as a design tool.

Each decade we've built on the previous decades. Our success and our high level of innovation have helped us create a loyal customer following and an outstanding work environment. I am extremely pleased with the execution by our global R&D staff in 2004.

Many of the new platforms and architectures released in 2004 required many years to develop and I know our engineers and developers are very proud of the early success of their product. I look forward to further innovations and strong new product output in 2005.

The innovative spirits at NI is one that I am very proud of and one that I invest very much of my time fostering. I believe this innovative spirit is the key reason that earlier this month Fortune Magazine named National Instruments as one of the 100 Best Companies to Work For marketing their sixth consecutive year the Company has appeared on the prestigious list.

We are pleased that our employees recognized the Company's fun and engaging environment, opened Companywide communications, and consistent commitment to innovation and continuous improvement. Thank you for taking your time to join us today. We will now take your questions.

(OPERATOR INSTRUCTIONS)

Richard Eastman, Robert W. Baird.

A question regarding the growth rate here. As we look back in the third quarter and now are getting here in the fourth quarter and potentially in the first quarter, given your guidance, there used to be an opportunity to look at industrial production and put a multiplier on that and generally derive a sales number that was reasonable for NI. I know you look at the PMI which is more of a sentiment indicator but it would seem to me that if we look at industrial production which really has been quite good -- certainly domestically -- that we should be delivering a bit more on the sales line. What's your take on that?

Couple of things. Obviously first of all, we are going to have sold the company that represents about a $2 million run rate so you have got to factor that into the equation. The other thing I would factor in is that, obviously, NI is a very global company -- well over 50 percent of our revenue comes from outside the United States. And the global PMI, obviously, gives a pretty good picture of the global industrial economy. I think that is a much better barometer to use to evaluate our business than just the U.S. domestic industrial production.

Certainly, our U.S. business continues to guard (ph) it heavily with the U.S. industrial production but with more than half our business coming from outside the United States, then that is a key element to be factored into the equation.

Then, secondly, I was wondering if John could just expand a little bit on the military adopting this software-based instrumentation approach. What exactly does that mean? And does that trigger their suppliers so to speak or as well to look in that direction?

Yes, Rick, this is John. Absolutely. As the largest consumer of ATE, as the U.S. Dept. of Defense looks at specifying future test systems, it has big implications on all the contractors. So a decade ago, that was the big push -- over a decade ago -- of commercial off the shelf technology which led to PXI and the use of GPIB and that was really where we started to make some strong software inroads. Now the military has really identified that software is key to longevity of these test systems -- many of which need to last 10 to 20 years; and so they've started doing corporate debt more specifically in specing future test systems. So we are very encouraged to that, just really adds kind of momentum accretive to our software-based approach for tests.

Richard Hsu with S. G. Cowen.

Just wanted to follow-up on the whole divestiture of the German system integrations, in fact. When you talk about 2 million run rate, was that what it was recently running at? Or had it decayed to levels under that? And related to that, I assume gross margins are -- could still be lower at, I will say 30 percent, 25, 35 percent? Was the operation actually bleeding beyond that? Can you give us a sense of the -- ?

Sure, Richard, it's Alex.

-- since it will be shed as you exit?

Sure. It's Alex here. The German system integration company really is as I said in the call is a legacy former acquisition of two software companies in Germany where we had some patents issues related to the LabVIEW patents in the late 1990s. We had very successfully integrated the software portions of the business into our overall business model and they certainly fit our business model and our sales force.

On the systems integration side, we put those two pieces together as one company a few years ago, with the intent of building it up with the potential to survive independently as a successful global systems integrator for National Instruments.

Their revenues in 2004 were approximately $8 million. That is about a $2 million quarterly run rate as we went through 2004. The margins of the (indiscernible) were much lower than the company overall and are in the range you talked about. From a profit point of view, net net, it has been basically a breakeven operation now for several years. And just in terms of our business model we wanted to focus our investments much more on standard products business and the integration business and it just made sense for them to be independent going forward as a select integrator, using NI products in their system integration tasks going forward.

We really wanted them to be successful once they were on their own feet.

If I can follow on with a second question and I'll go back. Can you give us a sense of where headcount is, excluding -- or including if you will -- the operation to be divested? However you want to characterize that. What is your posture right now, after having gone through roughly a year where you chose to be relatively aggressive in building up the field and R&D programs. Are you -- how would you characterize your current earnings posture?

Good question Richard. We are at 3,465 people right now. That includes the system integration division. Excluding that, we are at about 3400 people even. Including them, so on an apples to apples basis our total headcount in 2004 was up 12 percent. So a 12 percent increase in people on a 21 percent increase in revenue and about a third, a third or 40 percent of that increase is coming from the more emerging countries. So increasing our investment in those territories.

As we look into next year, as we have said in our conference call in October and here again today, our intent is to grow our revenues faster than our expenses in 2005. That is our budget plan. So we will be increasing our investments in R&D; but we expect that increase in headcount to be less than revenue. And we will be increasing our investments in the field but that will be mainly focused towards the emerging countries and in, also, North America where we are seeing good growth in the last 18 months.

Obviously, we have got the normal risks that I talked about earlier on in the call. But our plan is to -- we are postured towards increasing our revenues faster than our headcount in 2005. As I said on the call we are looking at double-digit revenue growth in '05 as our guidance; and we are looking for earnings growth somewhere -- net income growth -- between 35 and 50 percent. So we are planning to have operating leverage as we go into next year.

On an interesting note in our operating margin here in Q4 was about 15.5 percent which is the highest quarterly operating margin we have had since Q4 of 2001. We definitely delivered on improving our operating leverage for -- with revenue growth, our earnings growth obviously more than double revenue growth and we are certainly going to try to increase our operating leverage as we go into '05.

Ajay Hai, Thomas Weisel Partners.

Congratulations on a strong quarter. Couple of quick questions. The first one would be about the (technical difficulty) donation that you provided to the (technical difficulty). On your income statement balance sheet do we assume that it just reduced the inventory so it is equal to cost of goods sold, it was breakeven from that point (technical difficulty) call as the 2 million?

The donation was at a cost of $2 million to the Company. $1 million of it was product which was -- this was also expensed in our sales and marketing. It is on our sales and marketing line in the quarter. There's $2 million included in that for the donations. $1 million of that was products that we donated and $1 million was cash. This was over to 150 educational institutions worldwide. Obviously we want to take advantage of the benefit of the award we got from The MathWorks as part of this patent litigation; and also want to use that as a method by which we are going to expand the penetration of our Virtual Instrumentation platforms into these institutions globally. So the full $2 million shows up in sales and marketing in Q4.

Any follow-up question? Or did we lose Ajay?

The follow-up question with the -- when you are looking at the new competitor of dynamics with the introduction of LXI could you give us some color as to how much progress that is making? And whether that is mainly for complementary application or directly competes with PXI?

This is John. The introduction announcement of LXI, I think, lends credibility to the whole approach of modular instrumentation which, as you know, is the approach we have been talking about with Virtual Instrumentation now for almost 20 years. In terms of it compared to PXI, I don't think that is really the comparison. PXI, as we have stated on this call and many others, continues to really have some broad-based adoption and significant growth. A lot of that driven by the fact that it is a multivendor standard. Today there is over 60 companies in the PXI System Alliance and over 1,000 PXI modules.

Meanwhile, our approach from a software perspective has always been to support all the various instrumentation buses, including GPIB, PXI, USB and also Ethernet. In fact, today if you look, we have drivers for our software environments for over 140 Ethernet instruments. We work with a lot of those vendors of those instruments.

Another point. We ourselves have quite a portfolio of Ethernet-based measurement devices. FieldPoint, Compact FieldPoint, and others.

So from a software perspective I think it is just emphasizing that the future approach to test in measurement is modular instrumentation, with software defining the capabilities by the user. And that obviously is exactly what we call Virtual Instrumentation.

John Harmon with Needham & Company.

I have one question. I would like to sneak another one in quickly. Everyone is asking about synthetic instrumentation. That is more my question. What it centers on. How do you see your products fitting the military's requirements? My understanding is, they are really looking for a box with a screen and a keyboard and probably some pre-developed modules that perform the functions they need. Would you ship a blackbox PC with that kind of arrangement just for them?

This is John Graff. As I mentioned to the earlier question, as the military evolved from commercial off-the-shelf to realizing the importance of software, that has also really driven the military to this modular approach to the hardware. If you have seen pictures of military test systems they're in these bays that are six feet tall and 6 to 10 feet across. And the issue of front panels and interfaces is not an issue. I mean this is equipment being deployed to Iraq and Afghanistan.

So they are trying to downsize this equipment, make it flexible, make it modular. And as we mentioned in the call, the success of PXI and our software approach has been really significant. The concept of synthetic instrumentation is just exactly an acknowledgment of that. That the future of these high-end military test systems is going to be one of software-defined modular instrumentation. And so we are very encouraged. We see that as a significant acknowledgment of Virtual Instrumentation that the Department of Defense is talking about -- synthetic instrumentation. I'll turn it to Dr. T for a few (MULTIPLE SPEAKERS).

Sure. Our software basically is redefined to why instrumentation is being done. Typically one of our products like LabVIEW or LabVIEW Windows (ph) is used in two different ways. One is a system level software tool where we can build a test and measurement system that can control traditional instruments, that can control virtual instruments and it can control synthetic instruments. And then it is used in the second way in which LabVIEW can literally build the instrument, the software that would go on the instrument. And so that we can create an instrument with our PXI modules that would go in one of the systems. So with our personal software, we work both at the virtual instrument, synthetic instrument and then the system level design tools to create the whole solution.

We have continued to see very good success, John, in the government and military area (ph) and I really think the success of PXI and its future with PCI Express and its adoption by the military is really shifting and moving the whole (technical difficulty) industry toward the areas where we are strongest. That is an opportunity for us as we go forward.

Thank you. Then my second quick question was about, Alex, you mentioned at our conference about taking R&D spending down as a percentage of sales in '05 to I think 15 percent. Is that a requirement to get your operating margin to the midteens? Or does that make them slightly nicer midteens?

Our plan as we talked on the last couple of conference calls and obviously at your conference in January is to grow our revenues in 2005, faster than our expenses. So we do expect to see our R&D and our sales and marketing and our G&A as a percentage of revenue all fall in 2005. Obviously there's risk factors associated with that as I talked in the call; but when we look at this in terms of getting to 15, I wouldn't want to be too exactly specific with R&D per se. But we do expect to see if all is a percentage of revenue and move down towards 16 or slightly below as we go into '05. That is part of our plan to get to midteens operating margin.

David Yuschak with Sanders Morris Harris.

Alex, for you. The quarter on the marketing side was basically flat on expenses relative to the third quarter. I think you ended up producing revenue pretty much within the band of your guidance, I think, from the third quarter. Question is, was there -- in that kind of productivity, did you do some cost controls there or were you just getting more productivity off of that and didn't really put much more investment in there to get the productivity up? And as you look into 2005, you did indicate somewhat where you might be looking for productivity there. What kind of thing -- where would you see the productivity come in the most in that if we are to start seeing some of these midteens operating margins in 2005, as far as getting the sales ramped up? It may be better than maybe low teens whatever the target might be for sales.

Where would the pleasant surprises come in in getting the productivity?

I think that is a very good observation, David. As you said in the call or said on your question we were up $2 million sequentially but that was all driven by this donation. You take that out of the equation and we were flat sequentially. And really it is driving leverage and John is going to talk here for a second about that. But in terms of our business strategy, that was exactly our plan coming into 2005 and the sales and marketing guys have delivered and that is one of the key elements that allowed us to drive such strong operating leverage in '04. And we'll also look to that as part of our plan for 2005 as we said in the call.

John, I think can give you more specifics on some of the cool things they have been doing to achieve that.

Yes. The most significant thing that jumps right out is giving us leverage in our market investment is, obviously, the Web. And in past calls we've highlighted the success we have had and that continued in Q4. We once again had record business to our website. I think for the year we had nearly 15 million visits to NI.com. So kind of shows you the magnitude and volume of the engineers and scientists from around the globe that are hitting our site.

A lot of what drives that growth in traffic is again, back to this R&D investment and exciting new products. One other thing that is giving us leverage is that investment in our field sales force and as an example of that we just, last week, came off of our worldwide sales conference where we brought our field back here to Austin; and I think the summary of that has been is we sense a lot of excitement from our field again around these new products and the early success they are seeing in the market.

Just a follow-up question then. As far as getting to your 15 percent operating margin, is it going to be a combination of the operating expenses plus maybe another nice contribution out of gross margin or are we getting on gross margin where you think that should be long-term and it is a matter more just getting sales ramped up to get that gross margin sustained at 74 and we're going to have to do more things on an operating expense line as far as productivity is concerned. So I'm just kind of curious how we get there as you look at that?

That is a good question. I would expect to see improvements in our leverage as we talked in the call(indiscernible) across the whole income segment. We would expect to see some improvement in gross margin next year. Also the fact that we have now sold off the system integration company with a much lower gross margin. We will naturally call that sort of upward move in gross margin in '05. We are very focused on leverage and the investments we have made over the last five years have been a pretty sizable chunk of forward investment into the future of the business. And as you and I have talked many times in the past our goal there was to set up the Company for future growth in the second half of this decade. We believe we're pretty well-positioned for that. Our target is to get to $1 billion in revenue in 2008. We made a lot of progress in '04. Getting over the $.5 billion mark and we are also going to try to now return leverage to the bottom line and take advantage of those investments as part of our plan to get to $1 billion by 2008.

Richard Hsu, S. G. Cowen.

Couple of clarifications here. The revenue guidance that you provide. You are talking double digit but you did re-deduct 18s (ph).

We are looking at double-digit growth as our guidance for next year and operating margin in the midteens.

Okay but you did not say teens in terms of revenue growth.

That might have slipped out, Richard, but that was -- if it was, it was an accident on my part. What I should've said was is double-digit. With our earnings release.

I guess -- I would like to just go back to the discussion about marketing and sales expenses in Q4. Normally you would think that while most of your payroll is dollar-based, that currency probably caused some upward pressure there. You have back end loaded commissions.

All of those factors taken into account, it seems remarkable that on an (indiscernible) derivation (ph) that spending was all flat. I wonder whether you have benefited in any way from the way you accrued spending earlier in the year?

Richard no. Not at all. If you look at our spending model as we go through the year we had some reasonable hedges on our European business and our Japanese exchange rates. Our European and Japanese exchange rates through '04, those roll out at the end of this year. So we will -- we had the same basic effective rate against our European business in '04 and Q4 as we did in Q3. So there will be no real impact there.

We also ramped up our marketing expensing midyear because of LabVIEW 7 1 launch back in May.

As we look out to '05, we will see some increase in spending and in our revenue, sequentially, as a result of improved foreign exchange rates in the first quarter. That is factored into our guidance for Q1.

Does that help you understand?

Yes. Do operating expenses fill the marketing list sequentially in Q1?

We would expect our sales and our expenses across the board to go up in Q1 as we move to a more market-related exchange rate in the first quarter.

But, historically, from a constant dollar point of view, we typically see sales to marketing to be flat to slightly up in the first quarter.

There are a lot of trade shows in Q1 all over the world.

The very large, the exchange gain that you posted at the other income line. Was that with the dollar weaker? Was that a result of substantial monetary asset exposure that you had in local currencies? And if so have you just -- a dollar appears to be between January and March to be down a little bit. Would you expect that a further gain there at the other FX line?

We try to hedge as best we can. We had significant foreign currency exposures and receivables and inventory and those are exposures we try to hedge as best we can; but you can't really predict these things with exactitude. So, this represents the movement on the dollar in Q4 against the unhedged portion of our exposure. The dollar so far in this year, obviously, has strengthened a little bit against the euro and declined a little bit against the yen.

So depending on what happens the rest of the quarter, we will try that number. But certainly a $2.1 million gain is unusual for us to see that size of a gain but the movement of the dollar in Q4 was also quite unusual.

It will scale, depending on how the dollar moves for the rest of the quarter.

And I apologize. While I have you I would like to ask just one more thing about OEM. OEM business which took a big hit in Q3. You characterize it as being weak in fourth quarter. Did you see that stabilize or did you see it fall off further?

As I said in the call for our instrument control business, which is the biggest part of our OEM business, we were down 3 percent sequentially so we did see some sequential weakening, but nothing compared to the fall off and I would say correction we saw in Q3. So I think my characterization would be that correction really happened in Q3, stabilizing mildly weaker in Q4. We had some tough compares on the OEM and the ATE side and control side in the first quarter of 2005 because it was very strong in '04. So we will see what happens sequentially but our compares are certainly tougher in first quarter.

Bruce Harrop with M Funds (ph).

Nice year and quarter and whatnot. I just have a question on your long-term revenue targets. If I use your $1 billion compare that with, say, the 500 million that you just did in '04 that gives you an 18 percent full year growth rate out to 2008. Similarly if I compare that with 2003, if there's 18 percent growth rate over five years which is just tremendous. Would be all that I could -- that would be in my mind a very satisfactory outcome as a shareholder. But I just want to compare that with the guidance you gave in your analyst conference in New York a year or so ago where you said your long-term revenue targets were 20 to 40 percent and just wanted to try to reconcile those two numbers.

Certainly that is a good question, Bruce. Our long-term target is to do consistently over 20 percent a year and that is our goal and that is what we strive for. In terms of putting in a number and a date in place we certainly we put a number with a specific day, we'd like to do try to do our best to hit it. So that is kind of the philosophy behind that.

We make the investments that we made over the last number of years to try and achieve our goals of greater than 20 percent growth per year but in trying to put a stake in the ground? We probably were a little bit more conservative than that. Just to try to do our best to try and hit that target by 2008.

So our philosophy and all of our compensation plans, internally, are still driven by 20 to 40 percent revenue growth. 18 percent of operating income and that, certainly, I can tell you is how Dr. T thinks and how we try to run the business internally. Does that answer your question, Bruce?

Yes. It does and that makes sense to me, I guess some people -- and maybe I'm simplistic -- but some people might say, "Well, the midpoint of that is 30 percent so that is your long-term revenue target." To me, it's just hard for any company to grow at that rate over long periods of time and so I just don't want to be confused or have other shareholders confused by that or correct me, is that really truly your long-term target to gross 30 percent on average?

Our target is to be between 20 and 40 percent. That is our goal and like I said, as you said, that is not an easy thing to do. As we set our goal for 2008, we want to set a goal we felt was achievable. But our compensation plans are built on that model of 20 to 40 percent growth.

Okay. I think even if you do the 20 or 18 you're targeting, that would be tremendous.

Okay. Do you have a follow-up, Bruce?

Yes, I do. In terms of trying to understand how the industrial automation business is going and maybe can you give us a sense how big -- what size of your sales that would be today as a percentage and also, what do you think that could be in 2008 (inaudible)?

Two of our platforms that really go in that direction hardware wise are FieldPoint and Compact Rio. As we've mentioned in the call the Compact Rio got off to a really good start this last quarter. It was announced at NI Week and it targets machine builders and both sets need a very high performance control and applications; it's built around some of our strongest technology, LabVIEW and real-time and LabVIEW FPGA. And we are really excited about where it is going. Certainly that has been a growth area this year for us and we are looking forward to seeing that continue to grow.

And that is still a relatively small percentage of your overall scale?

It is smaller but it is growing and it is growing quite fast. We expect to see that to increase as we do through the next number of years.

And in 2008 again do you think that could be half of your sales or is that too aggressive?

It is hard to predict with precision that far out but we would expect it to be substantial.

Richard Eastman of Robert W. Baird.

Couple of thoughts. One is, Alex, you had talked at one point about moving your distribution in Europe from Amsterdam to Hungary. Has that been done and has that been done smoothly?

That is a project we are still examining, Rick, and one we will be looking at for '05 or '06.

Is there any price contribution in your '05 expectations?

Price contribution meaning from foreign exchange or from increased prices in general or -- ?

Prices in general.

We certainly are expecting to see improved margins in our data acquisition business from the improved margins in our M Series products as we see that transition continue. It has been very successful; and as we see that continue on into 2005, beyond that, we don't expect any material changes in prices for the Company overall.

And then is my math right. Did FX add about 4.5 million at the topline?

I'll have to sit down and do the math. It is the difference in 8 percent growth and 12 percent growth. But that is about right. But as you know we decreased our prices in Europe twice last year, in order to reflect the change in the exchange rates. So from a volume point of view, the dollar number is a much closer approximation of our volume increase than the local currency growth number.

Thank you very much. We will be presenting at Thomas Weisel Partners conference in San Francisco on February 7th. We hope to see there.

Thank you very much for joining us today.

That does conclude today's teleconference. We would like to thank everyone for their participation and wish everyone a good day and now at this time, you may disconnect.