National Instruments Corp (NATI) 2005 Q1 法說會逐字稿

Good day, everyone, and welcome to the National Instruments Corporation's first quarter 2005 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 and will end at midnight Central Time on May 4th, 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. And now for opening remarks, I'd like to turn the conference over to Mr. David Hugley, Corporate Counsel.

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, reduced budgeted spending plans 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, 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.

Good afternoon, and thank you for joining us. Our key points today are revenue of $130 million, up 4% year-over-year; highest quarterly gross margins in four years at 75%; and reduced budget in spending and hiring plans for the rest of 2005.

With a softening economy during Q1, we saw a sequential reduction in our system level sales, as well as a decline in our instrument control business year-over-year on very tough compares. We are pleased though with the continued strong sales of our core virtual instrumentation platform, including software, PXI and modular instrumentation.

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?

Good afternoon and thank you for joining us today. Revenues for the quarter were $130 million, up 4% over Q1 2004, and our diluted earnings per share was $0.14 per share. Our revenue for Q1 was down $7 million, or 5% from Q4. In our conference call on January 27th we had anticipated that our revenues would be flat sequentially with Q4.

While our revenues were below our expectations, we are pleased to deliver our 11th consecutive quarter of year-over-year revenue growth in Q1. We will see easier compares in the second half of the year. While we anticipated that Q1 would be a tough year-over-year compare, due to our strong revenue growth in Q1 2004, we are disappointed with our revenue performance.

In Q1 2004, our revenues were up sequentially with Q4 2003 on the [sake] of record highs and a JP Morgan Global Purchasing Managers Index. In hindsight, it was optimistic to expect to see a similar sequential performance this year, on a Global PMI number that has been driven lower by high oil prices and increased interest rates.

As a percentage of our revenues coming from system sales for more than $20,000 has increased over the last few years, we have become more susceptible to seeing revenue fall in Q1, as customers finished their fiscal year-end spending.

One key reason the shortfall in our revenue occurred was due to a reduction in our average order size. As companies restricted their capital spending in Q1, and as we saw some continued erosion in the average selling price of our data acquisition products. Our average order size fell from $2,900 in Q4, to $2,700 in Q1, a 7% sequential reduction.

The vast majority of this reduction came in orders over $20,000, which were down by $7 million sequentially. Last year we saw the normal fiscal year-end budget spending of Q4 be replaced in Q1 by new orders, given by the record Global PMI. We did not see that strength this year.

In Q1 the M Series and our new USB data acquisition products had outstanding success and drove a double-digit increase in the number of data acquisition units shipped. However, with an ASP significantly below our average for data acquisition, they are also having the effect of reducing our average selling price. As a result, while unit volume was up double-digits from Q1 2004, our total data acquisition revenue was only up in the low single digits.

The addition of these new products has significantly strengthened NI's competitive position and the improved gross margins of our M Series products will help as they continue to scale.

Regionally, the biggest shortfall came in our Asian business, which was up 4% year-over-year, compared to the 29% year-over-year growth we saw in Q1 2004. The majority of this shortfall came in Japan, where we saw a 9% year-over-year reduction in Q1 sales, compared to our expectation of double-digit growth. We believe that this is as a result of a weakened Japanese economy and a reluctance of companies in Japan to commit to their normal March fiscal year-end spending. Sales in the rest of Asia were up 17% year-over-year.

On a regional basis, revenues for the quarter were flat in Europe, up 4% in Asia, and up 7% in the Americas, giving overall growth of 4%. On a product basis, we saw the impact of a weakened global economy on sales of our instrument control products, especially to test and measurement and semiconductor capital equipment suppliers. These products, which represent less than 15% of our revenues, were down 19% year-over-year. Due to the mature nature of these products and our strong market position, sales of these products are usually most sensitive to changes in the growth rate of the global economy.

Q1 2004 is our toughest compare for these products, and as we go through the rest of 2005 our compares will get easier.

As a group, our other products continued to grow, with 9% year-over-year growth, led by our software, PXI and modular instrument products. Our year-over-year growth compares for these products will get easier as we go through the second half of 2005.

Moving down the income statement, gross margins for the quarter increased to 75%, up from 73.5% in Q4. This represents our best quarterly gross margin in four years and was driven by the increase in software as a percentage of our revenue, the sale of our German system integration subsidiary and the improved gross margins of some of our newer products.

On the expense side, total expenses for the quarter were $83 million, up 8% year-over-year. On a year-over-year basis, R&D expenses were up 2%. Software development costs, capitalized in the quarter were $3 million, and previously capitalized costs of $2 million were amortized to cost of goods sold during the quarter.

Sales and marketing expenses were up 10%, or $5 million, with 40% of the increase being driven by the weakness of the US dollar. G&A expenses were up 12%, driven by the weaker dollar and increased cost associated with the upgrade of our European ERP system in Q1.

Now turning to the balance sheet. Compared to Q4, inventory increased by $2 million and accounts receivable were flat sequentially. Net cash and short-term investments were $221 million, compared to $227 million on December 31st, 2004. This balance is net of $12 million paid for the acquisition of Electronics Workbench, Inc. during the quarter and $4 million paid in dividends during the quarter.

The Board of Directors has declared a cash dividend of $0.05 per common share, payable May 31st, 2005, to shareholders of record on May 9th. Additionally, the Company announced today that the Board of Directors has increased the amount of stock the Company can repurchase by 1.7 million shares, to 3 million common shares.

Now I would like to make some forward-looking statements concerning our expectations for Q2. The global industrial economy weakened during Q1, with JP Morgan's Global Manufacturing Index falling below 53 in March. While still indicating expansion, these levels are significantly below the record levels we saw in the first half of 2004.

In Q2 2005, we are currently budgeting revenue to be relatively flat sequentially and to report diluted earnings per share of between $0.12 and $0.16 per share. As a result of the lower than expected revenue growth, we have revised our spending plans for the rest of 2005, and we expect our year-over-year increase in expenses to moderate in Q2 and Q3.

Additionally, we have reduced our planned hiring for 2005 significantly. As a result of these actions, we believe we will see slower expense growth in coming quarters.

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.

So in summary, Q1 was a difficult quarter, with a slower global economy causing a reduction in our average order size and a decline in sales of our instrument control products. As we go through the second half of the year, our year-over-year revenue growth compares will get easier. We will spend carefully and will focus on leveraging our existing investments to drive the long-term growth of the Company.

With that, I'll turn it over to John Graff, Vice President of Marketing.

Thank you, Alex. While we delivered our 11th consecutive quarter of year-over-year revenue growth, we are disappointed in our quarterly revenue, even though we anticipated Q1 would be a very tough quarter, given the strong compare.

On a sequential basis, we saw a reduction in our larger system level orders, due to the cyclical nature of large capital equipment orders, as well as softness in Japan and Europe. Over the past several years, as we have expanded our system level sales of platforms such as PXI, modular instruments and Compact FieldPoint, our average order size has increased.

In the US and Europe, these larger orders tend to follow a calendar year cycle based on fiscal budgets, ramping up in Q4 and falling off in Q1. Further compounding the problem was weakness in large orders in Japan, which typically has a strong quarter due to the closing of their fiscal year in Q1, and in Europe, where we saw weakness in large orders at the end of the quarter.

With the completion of the upgrade of our ERP and CRM systems in Europe, we now have a global opportunity management system in place that gives us greater visibility into the pipeline of large orders and we are monitoring this closely to ensure more efficient sales and manufacturing execution.

Despite the sequential decrease in overall Company revenue, sales of our core virtual instrumentation products were solid. In Q1, we set a new quarterly record for total number of orders, driven in part by the strong demand for our M Series and USB data acquisition products. The transition to our latest data acquisition products has been faster than we anticipated and due to their lower average selling price, data acquisition revenue was lower than anticipated, despite double-digit unit growth.

Similar to the success we saw with LabVIEW 7 Express, our M Series and USB products are seeing growth in new users and new applications, especially among scientists, engineers and students who are just beginning to use data acquisition. As these customers use LabVIEW and these lower cost hardware products, we anticipate that they will recognize the benefits of virtual instrumentation and as we've seen in the past, adopt higher performance products such as PXI and modular instrumentation in the future.

While many of our initial M Series and USB products set new competitive price points in the marketplace, in the coming quarters we will introduce higher performance products for these families that should stabilize our ASPs. In addition, during the coming quarters, we will focus our sales and marketing efforts on leveraging the strong demand on M Series and USB to up-sell and cross-sell more of our virtual instrumentation platform.

We believe the strong unit growth of M Series and USB products has strengthened NI's virtual instrumentation position and built a strong foundation for our measurement business in the long-term.

PXI and modular instruments have been two of our strongest performing product areas and their strong growth continued in Q1. During the quarter we introduced several new modular instruments, including two revolutionary instrument products that further increase the capabilities of PXI-based modular instrumentation. Our new Flex DMM digital multimeter is the most accurate 7.5 digit multimeter on the market available in any form factor and offers the additional functionality of a high resolution digitizer, making it an excellent fit for use in automated tests on both the production floor and in an R&D environment.

The second revolutionary instrument is our new Flexible Resolution Digitizer. A universal instrument having the most flexible combination of resolution accuracy and frequency sampling rate available from any instrument on the market. With this one device, design and test engineers can now use a single modular instrument to make a wide range of dynamic measurements, replacing many traditional instruments such as A/C volt meters, audio analyzers, frequency counters and spectrum analyzers at a fraction of the cost and footprint.

In addition, in Q1, we also introduced two new RF modular instruments and a new version of the modulation toolkit for LabVIEW. With these products, engineers have access to customizable functionality, unavailable with traditional RF instrumentation. Applications that benefit from this increased functionality include radio frequency identification, or RFID, wireless sensors, wireless telemetry and wireless standards-based testing. Together, these products continue to expand our capabilities for communications tests.

Further showing the penetration of modular instrumentation in the testing applications, Boeing selected an NI LabVIEW and PXI-based solution to remotely acquire, analyze and view complex data sets for its ground-based missile defense system. Boeing remotely accesses the PXI system over Ethernet to control and observe the data prior to, during and after test completion. By using virtual instrumentation, Boeing realized a cost savings of greater than 30% compared to their previous system.

On the software front, we continue to invest in LabVIEW as a graphical system design platform that more tightly integrates measurements into the design process. As time to market demands continue to increase, design engineers need to be able to shorten design cycles and conduct simulation and tests in parallel. In Q1, we released two new LabVIEW toolkits that let design engineers prototype, design and test their applications easily on diverse hardware targets.

The first product, the LabVIEW Filter Design Toolkit, is tightly integrated with our re-configurable FPGA hardware, so design engineers can design a digital filter and quickly validate it by downloading it to an NI FPGA hardware. This approach saves time and money for electronic design engineers by allowing quick validation of digital filter strategies, often employed in communications and consumer electronic devices.

The second toolkit is the analogue devices Blackfin test integration toolkit for LabVIEW, which provides a high level tool to easily build test systems and utilities for Blackfin processes system. By integrating testing, engineers can iteratively prototype and verify designs without the design cycle, identifying quals early in the process and reducing overall development time.

To further the integration of design, simulation and test tools, in Q1, NI acquired Electronics Workbench, a leading supplier of electronics design automation software. The Electronics Workbench flagship product, Multisim circuit simulation software, is widely used for electrical engineering training programs by academic institutions, including MIT and DeVry, and for electronics circuit design and board layouts by companies such as Boeing and Sony.

For several years, Electronics Workbench and National Instruments have collaborated to integrate Multisim with the NI LabVIEW graphical development environment. The Electronics Workbench acquisition adds graphical design and simulation software to the National Instruments platform of graphical development tools.

NI continues to see success in the industrial control space, as more companies are recognizing the benefits of LabVIEW Real-Time and our programmable automation controller platforms, as a reliable and deterministic solution for developing mission critical automation and control systems.

For example, [Katel] Engineering, a contract machine builder for manufacturers, used LabVIEW Real-Time in a compact closed lid control system to automate a cold steel rolling process. The NI PXI hardware and software monitored and controlled the steel making process with faster response times than traditional PLCs and ensured continuous operation, 24-hours a day, 7 days a week.

For industrial inspection and motion control applications, we released new versions of our Machine Vision and Motion Control software in Q1. Engineers and technicians can now use the more powerful pattern matching algorithms in our LabVIEW Vision module to identify and sort parts faster and with more accuracy. The NI Soft Motion software for LabVIEW received the Control Engineering Reader's Choice award. This software allows engineers to use any of NI's hardware platforms as a dedicated motion controller.

We are seeing customers use the software with a wide range of hardware platforms, including data acquisition and CompactRIO to control motors and actuators in diverse industrial applications.

Our early success with the new CompactRIO industrial platform continued in Q1, as end-users and OEMs integrated CompactRIO into many applications from machine control to vibration monitoring. EDN Magazine editors selected the NI CompactRIO reconfigurable control and acquisition system as a winner of Innovation of the Year award in the embedded systems category. The editors noted that the award recognizes how embedded system designers can increase productivity with CompactRIO and LabVIEW to quickly develop custom control and acquisition hardware. This new industrial control platform has seen strong customer acceptance and is meeting our early expectations.

In summary, while we are not satisfied with our revenue performance in Q1, we are still positive to the future opportunities of virtual instrumentation. We are pleased with the strong order volume of our core virtual instrumentation software and hardware products, driven by the strong new product output of the past few years. We are focused on our efforts throughout the Company, both short-term and long-term, on our operational executions to achieve our business growth goals.

With that, I'll turn it over to Dr. T.

Thank you, John. While we are pleased to turn in our 11th consecutive quarter of year-over-year growth, we are disappointed with our revenue performance in Q1. As Alex and John highlighted, we saw a sequential reduction in our average order size as the result of the drop-off in larger system level orders and when combined with the drop-off of a tough compare from mature instrument control business, resulted in our revenue shortfall in Q1.

Despite this revenue shortfall, we are pleased with the continued strong customer adoption of our many new products, especially our M Series and low-cost USB data acquisition products. These products have ramped up much faster than we anticipated, and while this impacted short-term revenue due to their lower price points, the strong unit volume was a good sign that the health and future prospects of virtual instrumentation.

Higher performance versions of the USB products which are scheduled to be released throughout the year should help [NI feed] data acquisitions product portfolio.

Over the past several years we expanded R&D, while we completed major developments of next generation architectures resulting in record new product output for 2004. This strong output of new products has generated significant revenue growth to offset the decline in our mature instrument control products.

We are now satisfied with our current R&D investment level and we will be selective in our hiring going forward, while we continue to release a significant number of new products. This should allow us to moderate our expense growth as we move toward our goal of becoming a $1 billion Company in 2008.

In summary, while the short-term poses a challenge, we believe our vision is clear, our new product output is strong and our business strategy sound. We have a number of actions that we're putting into place, including adjusting our budgeted spending and hiring plans and balancing our USB data acquisition portfolio that should show benefits in Q2 and in the second half of the year.

In the coming quarters we will be focused on increasing our revenue growth and managing our expenses, while positioning the Company for success over the long haul. Thank you for taking the time to join us today. We will now take your questions.

(OPERATOR INSTRUCTIONS.) Richard Chu, SG Cowen.

Good afternoon, thank you. Could you just clarify a couple of things and then I have a question? Give us an indication of what hiring was in Q1, the plans for the balance of the year. And then the Electronics Workbench design software acquisition, what was the impact of that acquisition? And then if you could talk generally about indications on April business trends in Japan and other industrial markets, what your new CRM system and pipelines are telling you?

Richard, I'll try and address those in order. Number one, we did add about 50 people during Q1. We had initially planned as we came into 2005, to add about 500 people in total. And we had to significantly reduce that by somewhere between 40 and 50% in terms of our plan for this year going forward. So we do see ourselves adding some incremental staff, but significantly less than we originally planned coming into the year.

In terms of Electronic Workbench, that contributed a little over $1 million in revenue during the quarter, and as you're aware, we also spun-off our German system integration subsidiary, which had a run rate of about, on average, about $2 million per quarter. So the net of both those events is about a sequential drop of about $1 million in revenue.

In terms of the market conditions so far this quarter, obviously, it's a little too early to call exactly how the quarter is going to end up, but in terms of our expectations, we've certainly factored in what we've seen so far into our guidance. And what I can say, obviously, is economically a lot of the news that's come out here so far in April has not been very positive, especially about Western Europe and Japan. So, we can color those as two regions that we continue to be concerned about in terms of the macroeconomics going into the next couple of quarters.

Ajit Pai, Thomas Weisel Partners.

Two quick questions. The first would be about just the software as a percentage of sales in this quarter. And then the second question would be your strategy in terms of penetrating the industrial automation market was to try and use the indirect channel integrators, etc. Could you give us some color as to what you experience over there has been?

Sure. I'll take the first one and then John is going to take the second one. So software as a percentage of revenue was about 20% this quarter, up from about 18% in Q1 2004. So we continue to see good success from our investments in software, which really we believe is a real key indicator for the strength of our strategy and our success in expanding our market opportunity for the future. I'll let John address the second question.

On the industrial automation front, we continue to see success and growth, driven by the success of software like LabVIEW Real-Time and the expansion of our hardware platforms, the PXI, Compact FieldPoint and more recently, CompactRIO. Some areas where we're seeing success is especially in machine control and with machine builders.

You asked about partner efforts and how we're going to market. We are able to leverage our direct sales force, but we are consciously building up a stronger partner network around us, especially to help offer more of a complete system solution for these types of industrial applications.

An example of that is actually right now we're in the midst of a series of events where actual instruments and approximately half a dozen partners are hosting a bunch of one-day seminars around the country and then eventually this will go around the world. And we're seeing great response in attendance.

So, overall we continue to be very pleased with the growth and success in the industrial automation.

And is there a mix that you have of how much is going directly and how much is going indirectly over there?

Well, it's still primarily a direct business model. The partners play a role in supplementing our platform, often known as the whole product solution. They might have pieces of the system solution that we don't have. We do have our system integrators in VAR, some of which were already in our alliance program, but we have been consciously adding others that have expertise in industrial and machine applications.

But it's not a material change in terms of how we sell or go to market.

Okay. Can you tell me the 500 people that you're planning to add, which you mentioned at the beginning of the year or that you're cutting by 40 to 50%, that would mean that this year you still expect to bring the total, as compared to the end of the year, to increase the headcount to about 200 to 250 people. Could you give us some color as to what geographies those people would be added in and what functions they would be added in?

Sure. A significant portion of the additions will come in the emerging countries, so we would expect our cost per headcount to go up by some number significantly less than the absolute increase in number of people.

In terms of functions, it will be both in R&D and sales and marketing. We continue to have good sales growth in the emerging countries, as we talked about Asia, excluding Japan, was up almost 20%. Eastern Europe continues to be very strong. So we'll continue to invest in those areas, both in the sales function.

Obviously we have our manufacturing operations in Eastern Europe, so that will be a point of investment as well. And we'll also be investing in R&D in the emerging countries as we go forward. So we will see some shift in our mix of geography of employee base as we go forward.

Richard Eastman, Robert W. Baird.

A couple of things. One is, Alex, did you mention that sales growth was 9% after you excluded the large systems downdraft and then also the traditional instrument sales? Everything else was up 9?

It was up 9% just excluding instrument control.

Okay. Because if I do the quick math with the large systems, I think you had said in the prerelease conference call, the large systems were about 25% of sales?

Yes, that's correct, in that ballpark, yes.

If I pull those out and kind of weight it, it looks to me like the balance of the product portfolio was up in the high teens.

Yes, you could certainly look at the math that way. Sequentially, almost the entire decline sequentially, or actually the whole decline sequentially, came in orders over $20,000. And the bulk of the business that's less economically sensitive was flat sequentially.

Let me ask you, John had mentioned earlier that PXI sales were strong in the quarter. Wouldn't PXI be the platform for most of these greater than $20,000 sales?

It certainly is a key platform. Obviously, instrument control and distributor IO also play a role there. And what we said was year-over-year PXI continued to show strong growth. But we did, across pretty much all of our product lines, see some decline sequentially.

So, when we're talking about the growth, I think John was referring to year-over-year growth in the first quarter.

Okay. And then just the last question here and I'll jump back as well. When I look at the geographic numbers, the one thing that steps out is that we talk about the European softness, we talk about Japan falling off, but the growth in the Americas has stayed quite flat for four straight quarters, in the $61-$62 million range. And I would have thought that, you know, the economy's been stronger here, new products, LabVIEW 7 Express, [unintelligible] here first. How do you explain that? Why haven't we seen growth in the Americas with the new product pool?

Well, you've got a couple of things going on there, Rick. First off, Q1 was real strong for us last year, as I think we had a pretty strong industrial economy in the United States and we saw the economy weaken as we went into Q2 and beyond. Also, we saw the absolute revenues from instrument control drop fairly considerably, a heavily amount, Richard, in the United States as we went through last year, once we got the peak of sales to AT and the instrument control and the CNM vendors in the first quarter.

So I think we took a good step up in Q1 last year and we tend to have a weaker Q1 in the United States and then strengthen as we go into Q2 and Q3, has been our historical pattern. And so if we do follow our historical pattern, we'd expect to see sales, in absolute terms in the US, increase here in the second quarter.

And typically that's offset by a sequential decline in Japanese sales. Japan, their fiscal year end is March and we usually see our peak revenue in Japan in Q1 and then it tends to fall sequentially from Q1 to Q2. So, it's not that dissimilar with the pattern we would normally expect to see.

John Harmon, Needham & Company.

I was wondering if you could elaborate a little more on your expense controls? You talked about growing expenses up more slowly than revenues and cuts to your original hiring budget, but can operating expenses stay flat throughout the rest of the remainder of the fiscal year? Generally they're up in the fourth quarter. Is there any way you can quantify the cuts you're making?

Last year we had a pretty steep sequential increase in our operating expenses from Q1 into Q2 and Q3. This year my expectations are we'll see operating expenses be flat in Q2 and Q3. Q4 is a little far out to predict at this point in time, but we do expect, with fairly flat sequential expenses, to see our growth rate of expense fall off in the next couple of quarters.

Okay. And then kind of a housekeeping question. In your preliminary results you were talking about $1 million foreign exchange loss. It turned out to be half of that. What led to the delta between your final results and your preliminary results?

Well, John, we put out our press release at 7:00 a.m. on the 1st of April, so it's obviously driven by the foreign exchange rates at the end of the previous day, coupled with all the activity that happens up to that point. So, it was an estimate and we were a little conservative.

Richard Chu.

A couple of things. Just on the comment that you made on operating expenses, with headcount going up, how would you manage flat Q2, Q3? Is it adjustment in discretionary spending programs? Is it capitalization accruals that will allow you to do that? Could you clarify that? And then I have a second question.

Sure, Richard. The increase in expenses in headcount, especially given the geographic mix that we're looking at this year, is actually not a tremendously significant amount of dollars, number one. Number two, we had some expenses that hit us here in Q1, such as a pretty significant expense related to our ERP implementation in Europe that won't repeat as we go on. So we'll see those things kind of balance out as we go through the next couple of quarters.

Do you have a rough sizing of the more or less one-time kind of expenses in Q1?

Well, for the ERP it's in the $500,000 to $600,000 range. It's hard to put an exact number on it.

Is there any unusual Sarbanes-Oxley accruals?

No, Sarbanes-Oxley, in terms of most of the costs were expenses we went through last year. Of course, we are accruing for the cost we expect to incur this year. So that, plus the staffing to support it is built into our numbers.

And then second question on the DAc M Series transition that you talked about at length, you indicated that was down year-over-year in dollar terms. Can you give us a sense of how the total DAc revenues are looking on a sequential basis? If you could actually go back a few quarters, that would give us a sense of the kind of shape that you are going through on that transition.

Sure. Let me first off correct a misnomer. In the call when I talked we said our unit volume in DAc was up in double-digits. And revenue was up in the low single digits. So revenue was up year-over-year in the low single digits.

In terms of DAc sales overall, they were relatively flat sequentially, Richard, from Q4. I don't have the data to hand on more specifically going back in history. So we can possibly talk about that offline. But just to make sure you did get that data acquisition revenue actually was up in Q1 year-over-year. But there was quite a gap between the unit volume increase and the revenue increase.

Okay. And are you assuming that--you alluded to some of the new higher-end introductions on the product side that will begin to bring up the--flush out the offering at the higher performance end. In your guidance right now, do you assume that that DAc product line will be sequentially flat to down pending that, or are you beginning to count on also that contribution?

Well, honestly, we're only giving guidance out into Q2 at this point, Richard, and we're almost a month into it. So, that is not really a factor in our equation for the next two months. John can talk a little bit more about our product lines then.

Data acquisition is one of our larger product lines and so there'll be a number of new products. Some of those have already started. For example, in the quarter just completed we introduced four new M Series boards that have 18-bit resolution. These are more accurate data acquisition boards. Actually the first 18-bit boards in the industry. So these are just ramping up.

In addition, as Dr. T. Mentioned, in the coming quarters, which is kind of talking to the rest of the year, we'll fill out more of the M Series line and the USB line with products that have higher performance, thus higher selling prices. And we think overall that can lead to the stabilization in the average sales price for data acquisition.

Did you say that data acquisition gross margins are actually higher despite the reduction in ASPs?

That's correct, and that's one of the reasons why we're driving forward with this product transition, because I think it will, once we get through this transition, put is in a stronger competitive position in the marketplace and also in a stronger financial position. We want to leverage our scale, our ability to scale the development of custom ASICs that significantly reduce the cost to build these boards, while also adding unique differentiated performance. And I think as we move through 2005 and we lack the compares of this transition, we would expect as we move into 2006, that the gap between the increase in unit volume and increase in revenue will narrow significantly.

(OPERATOR INSTRUCTIONS.) Ajit Pai.

Looking at the Electronics Workbench acquisition, it was only a partial impactor in this quarter, but next quarter is the contribution going to be like closer to $2 million, that would completely offset the German business that you got rid of?

We had two months out of the quarter, Ajit, this time, so we had two-thirds, so it would be a little bigger, maybe 50% bigger if it works out, certainly on a linear basis. That would still be probably about $0.5 million less than the divestiture of the German business.

Okay. And then just shifting gears to looking at the operating margin right now. Right now you're watching some headwinds. More tailwinds starting the headwinds as oil prices go up, interest rates go up, and also you're watching the PMI sort of indicates that things are still growing, but at a much slower pace. Given that environment, the fact that you're increasing expenses, at what point do you think that the target, you know, you have your 76%, I'd love to sort of hear what the target is on the gross margin front? And then on the operating margin front, the target of 18%, at what revenue level do you think you'll be able to get it or is it the revenue level or is there a timeline to get there?

Well, it's probably some combination of both. Let me just qualify first, we expect to keep our expenses flat here in the next two quarters, so let me just qualify the comment with that.

In terms of our expectations on 76% gross margin, obviously we made a fairly significant amount of progress in this last quarter and have seen our best gross margin now in about four years. As we continue to scale the M Series and transition our production to Hungary, and as we hopefully continue to scale the business, if we see positive growth, I think that we are, in terms of my timeline, I think there's a possibility to see us get close to 76% by the end of 2006. And that's going to depend on continued revenue growth as we go through 2006.

That's a forward-looking statement and that depends on that actually happening, so there's risks associated with that. But that would be, if I had to hazard to guess, that would be the timeline, I would think of.

Our hope coming into this year is that we would be able to get close to our 18% target operating model by Q4 of 2005. And that was the hope we had and talked about in our conference call in January. Obviously, with the slowdown we've seen in our business in Q1, that's more difficult. I still do expect to see Q4 being our highest operating margin quarter of the year, and I think as we see things settle out here in the next three to six months we'll probably be able to recalibrate on that point in time in which we hope to get back to 18%.

But your current model is assuming that the sequential increase that you see normally in Q4 will be more muted this year than it was in past years?

Well, it's difficult to tell at this point in time. We've seen generally a 10% increase, pretty much consistently, even in years like 2001, when we were going through a major downturn. Or last year when we were dropping off a record high in the PMI in Q1, down to a much more modest level by Q4. So, that has tended to be a pretty steady indicator in the past. It's too early to predict that at this point. But I don't have any reason today to believe we won't see that kind of increase in Q4.

Right. And then just moving on to looking at your tax rate. You're at a 24% tax rate this year, relative to 25% last year, and as that mix changes in terms of your national versus domestic all the regions, can you expect the tax rate to come down further, or you think it's going to stabilize at current levels?

Well, we had a pretty rapid decline in tax rate from 32%-33% a few years ago, down to 28, and then 25, and now 24%. So, we're going to continue, obviously, to work on that, but there are a lot of variables in play. And so, we'll give guidance on a tax rate for '06 as we get further in the year. I wouldn't expect that any further declines in tax rate like we saw this year. It's a 1% decline versus a 3% decline in previous year, that they will start to flatten out as we go forward.

Okay. On your legal case that you have right now and the cash that's expected there, any update on that?

I don't have any updates to give on ongoing litigation.

Eric Jacobson, Artemis Advisors.

Can you guys tell me what the cash flow from operations and the CapEx was in the quarter?

Eric, I'm not sure if I have that information right beside me. I think that the capital expenditures, let me just look here, in terms of CapEx for the quarter, I think we're running around $3 to $4 million. Perhaps if you could give me a call offline, we could talk about it.

Okay. Do you have the depreciation number by any chance?

I think it's approximately $3 million, but again, it's probably best if you can get with me offline. I just don't have that data right in front of me.

Okay, I certainly will. Thank you.

Do you have my number? It's 512-683-6977.

Richard Chu.

Thank you. I guess I get the sense that for the last few months the whole M Series DAc area has been ramping up more rapidly, the transition has been happening more rapidly than you expected. So I consider that to be better than planned. Could you talk about, rather than year-over-year terms, are there any product or product solutions offerings categories where despite the current environment, you feel you are seeing better than expected results, offsetting some of the negative areas that you cited elsewhere? That's number one.

Then secondly, can you clarify software capitalization for the quarter and how that might change in Q2? And third, any thoughts on options expensing issues?

Let me take a couple of them and Dr. Truchard may address the product transition one you talked about. In terms of software capitalization, we capitalized $3 million in the quarter and we amortized $2 million to cost of goods sold.

Looking forward, obviously, the scale at which we'll capitalize software will depend on products that are in beta and length of time. So I wouldn't care to characterize an exact number at this point in time.

In terms of option expensing, obviously, there's been a change in the plan and we were set to look to do that in Q3, in line with the FASBI and SEC's rules. I did feel that doing it midyear kind of was a bit silly, because of comparison confusion, etc., etc. So, our plan now is to follow the SEC's proposal and implement the expensing of equity-based compensation in Q1.

How will the recent change affect your stance on options grants?

We have, for any of you guys who have read the proxy, made a decision of the management team to switch away from stock options going forward, to restricted stock. Continuing to use our formula for the allocation of the stock pool, which is directly based on the revenue growth of the Company, which we feel has been very, very much aligned with the shareholders' interest.

And we believe, looking forward, that frankly, in my opinion, the calculation of the expense related to stock options is very difficult for investors to understand and creates a significant amount of uncertainty. We feel that the tax benefit for the Company is significantly greater with respect to stock than it is for stock options. And we feel it brings a lot more simplicity to the use of equity-based compensation for both shareholders and for the employees.

And so we have put that in our proxy statement and are encouraging our shareholders to vote in favor of that transition away from stock options to restricted stock for NI's equity-based comp in the future.

And the key linchpin of that whole approach has been where we have directly linked our issuance of our options in the past to the revenue growth of the Company, ensuring that the methodology used to allocate stock options to the employees is very much in line with the best interest of shareholders.

I'll ask Dr. Truchard, perhaps you might care to comment on that? He's the largest shareholder and an employee who never received stock options.

Yes, that's right. We've tried to make certain that the stock plan first options and now restricted stock, matches the performance of the Company, looking at the growth and keying it to the growth of the Company, for the [unintelligible] Company and then the best thing to the profitability and growth of the Company.

So we believe that's been a balanced plan. It's balanced in the interest of the shareholders with the interest of the employees and we think it's worked quite well to achieve our goals.

Is there a simple algorithm that you can communicate on the call?

Sure. Our base methodology has been revenue divided by 10%, multiplied by the outstanding stock of the Company. That's what we've used for stock options. And this is all outlined in the proxy statement, which I'd encourage you to read.

But when you look at the methodology in the past, when we issues stock options, we would take revenue divided by 10, and in a case of 2000, for example, when we grew 24%--sorry, it would be revenue growth, excuse me. We would issue 2.4% new options in 2001.

Similarly, in 2001 when we had 0 growth, the formula resulted in essentially no pool of new options for the employees. Really aligning the issuance of options with the growth of the Company.

As we go forward, we're electing to issue restricted stock in a ratio of 1 restricted share for every 2 stock options. And so we'll be applying a formula of 2 to 1 conversion factor to the preexisting formula we had used for the issuance of stock options.

And so we'll be continuing to align the use of equity-based compensation directly with the revenue growth of the Company in the previous year.

In terms of product offerings, new products especially, we had quite good success with the products we've been investing in over the last several years. For example, in the area of RF, we've seen good growth, new penetration, new applications, as John mentioned, like RFI and RFID and the like and telecom. Another area we've invested in the last several years has been switching, where switching is a proxy for building larger scaled test and measurement systems. That's gone very well.

Our motion products are starting to integrate with our strategy for programmable automation control in a nice way and we saw nice growth to that.

In the area we've invested in a new platform with our CompactRIO and that's off to a good start, especially in machine control applications, where we're seeing a very nice start, some nice initial design wins. And academic, an area we're expanding lab use capability to cover the areas typically found in teaching of engineering courses. We've been very successful and we see that as candidates for future customers, as these folks graduate as electrical engineers and mechanical engineers or aerospace engineers, having used LabVIEW in a variety of ways as their tool to learn with, we see them using that as they graduate.

So, our new areas have been a very bright spot for us. Unfortunately, they're yet a smaller part of our business, so they didn't offset the higher level. But we do feel that they're well placed. We've invested and now we're starting to see that return on that investment.

Richard Eastman.

Just one follow-up. In terms of Asia, Alex, could you just explain perhaps if you have any added insight into the sales falloff in Japan? I think when we had talked you said that the falloff in large system sales was significant there. Normally you don't have great vision into your end-markets, but given the shortfall, any way to pinpoint what industries accounted for that?

Well, we certainly saw--the ones where we saw the biggest hit in Japan were really the ATE semiconductor side and also in electronics, just to name a couple where we saw some significant weakness from an industry point of view.

We were pretty disappointed with the results in Japan and obviously we're working on that and focusing our efforts to try to see that improve as we go forward. We did have a pretty tough compare in Japan in Q1, and we did see some weakness in Japan a little bit as we went through the rest of the year. So we will see some easier compares as we move into the second quarter and beyond.

In terms of the economy over there, there's not a whole lot of current data, but it certainly looks like industrial production has stumbled in Japan in February and March.

Okay. How big is Japan as a portion of your Asian sales?

It's a significant portion of our Asian sales.

Does that mean greater than 50?

It's in that ballpark.

And gentlemen, that will conclude today's question and answer session. At this time, Mr. Davern, I'd like to turn the conference back over to you.

Thank you. I just want to remind you that we will be presenting at several upcoming investor conferences, the Baird's conference in May, SG Cowen conference on June 1st, and the Thomas Weisel conference on June 13th. In addition, our Annual NI Week Investor Conference will be held Tuesday, August 16th, and this is a key event for investors and analysts to see how we're expanding our market opportunity, strengthening our core.

Thank you for taking the time to join us today and we will talk to you next time.

And that will conclude today's conference call. We do thank you for joining us and have a great afternoon.