National Instruments Corp (NATI) 2006 Q2 法說會逐字稿

Good day, everyone, and welcome to the National Instruments Corporation second quarter 2006 earnings release conference call. 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 7p.m. Central time today, and will end at midnight Central time on August 2nd, 2006.

With us today are Dr.James Truchard, President and Chief Executive Officer, Alec Davern, Chief Financial Officer, and John Graff, the Vice President of Marketing. For opening remarks, I would now like to turn the call over the Mr. David Hugley, Corporate Counsel. Please go ahead, sir.

Good afternoon. During the course of this conference call, we shall make forward-looking statements regarding the future financial performance of the Company, including statements regarding our expected revenue, gross margins, expected GAAP and non-GAAP earnings per sha, future product announcements, expanding PXI capabilities in RF and wireless areas, and expanding opportunities for growth. We wish to caution you that such statements are just predictions, and that actual events or results may differ materially.

We refer to you 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, 2005, and the quarterly report on Form 10-Q for the quarter ended March 31, 2006. These documents contain and identify important factors that is 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, strong sales of key products and strong operating leverage. We turned in a solid quarter in Q2, delivering excellent operating leverage and record revenue, driven by strong sales of our software, PXI, modular instruments and distributed I/O products. 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. Alec?

Good afternoon. Today we reported record quarterly revenue of $160 million. This represents a 14% increase in U.S. dollars over Q2, 2005, and a 16% increase in local currency. GAAP fully diluted earnings per share for Q2 was $0.21, with GAAP net income of $17 million. Non-GAAP net income was $20.5 million, up 33% from Q2, 2005, with fully diluted earnings per share of $0.25. For Q2, non-GAAP operating margin was 16%, up from 14% in Q2, 2005. Our non-GAAP results exclude the impact of stock-based compensation and the impact of the amortization of acquisition-related intangibles. A reconciliation of GAAP to non-GAAP results is included as part of earnings release. Please note that included in both GAAP and non-GAAP net income for Q2 of last year is a pretax credit of $1.9 million related to patent litigation expense, due to the settlement of a patent lawsuit.

In Q2 last year, we saw very strong sequential growth in both revenues and earnings. Given these tough compares, we are pleased to have delivered good year-over-year revenue growth in Q2, with very strong operating leverage. For the first 6 months, we have reported year-over-year revenue growth of 16% in U.S. dollars and 20% in local currency. This combined with the strong operating leverage in our business has allowed us to report a 38% increase non-GAAP net income for the first half, and has positioned us well for a significant increase in operating margin for the full year.

Taking a longer-term view, I want to reflect on the performance of the Company over the last 3 years. 3 years ago in Q2 of 2003, after a very weak period for the industrial economy, and having achieved our target of investing at least 16% of revenue in R&D, we increased our focus on achieving our target of 18% non-GAAP operating income. We knew that it would take several years to get back to 18%, but we were committed. Over the 3 years since Q2 2003, the Company has performed very well, increasing our revenue by 60%, from $100 million in Q2, 2003, to $160 million this quarter. Additionally, our non-GAAP operating margin has increased from 9% to 16%. And our non-GAAP net income has almost tripled from $7.4 million in Q2, 2003, to $20.5 million this quarter. We remain committed to our goal of returning to 18% non-GAAP operating margin.

Now, looking at Q2 revenue in more details, sales from our instrument control products were up 10% year-over-year. We believe this is indicative of a continued improvement in the test and measurement market in Q2. The first-year impact of acquisitions added $4.4 million to revenue in Q2. This is lower than last quarter as we passed the first anniversary of the acquisition of Measurement Computing Corporation during the quarter. Sales in the rest of our product portfolio, i.e. our virtual instrumentation platforms, were up 11% year-over-year on a tough compare.

Our growth in Q2 was driven by the success of our new products, especially in the areas of software, data acquisition, distributed I/O, modular instruments and PXI. On a regional basis during Q2, we saw growth in all regions. Revenue in USRs was up 6% year-over-year in Europe, up 19% in Asia, and was up 16% in the Americas, giving overall growth of 14%. On a constant currency basis, year-over-year revenue was up 15% in Europe and 21% in Asia for overall constant currency revenue growth of 16%.

Now looking at the non-GAAP income statement in more detail. Non-GAAP gross margin in Q2 was 75%, up from 73.7% in Q1. The improvement is attributable to very good software sales and a transition of certain components to lower cost suppliers. We are pleased to have achieved our goal of 75% gross margin in Q2. Non-GAAP total operating expenses in Q2 were $94.9 million, up 12% year-over-year compared to a 14% year-over-year increase in revenue. Remember, that expenses for Q2 of last year included a $1.9 million credit to patent litigation.

Excluding the impact of the credit to patent litigation in Q2 of last year, our total expenses for the first half of 2006 would have increased in line with our goal of keeping expense growth in 2006 to 70% of the rate of revenue growth. Non-GAAP R&D expenses were up 17% year-over-year to $26 million in Q2. Software development expenses capitalized in the quarter amounted to $2.8 million compared to $3.6 million in Q2 last year. Also during the quarter, $2.5 million in previously capitalized software development costs were amortized to cost of goods sold, compared to only $1.8 million in Q2 last year. Non-GAAP SG&A expenses were up 7% year-over-year in Q2 and dropped from 46% of revenue in Q2 last year, to 43% this year, demonstrating very good operating leverage.

Now, turning to the balance sheet. Inventory increased by $9 million from March 31st. This increase was mainly in raw materials, and is primarily related to higher demand forecasted at our facility in Hungary, heavily influenced by the planned transfer of 1 of our 2 remaining Austin-based production lines to Hungary. The additional inventory is intended as a buffer to support continued production as both the capital equipment and the inventory needed to support its operation are physically moved to Hungary.

In our call in April, I had anticipated that this production line would move to Hungary in June, and that inventory for the quarter would be flat. This schedule has proved to be too aggressive, and the transfer has been delayed until Q4, resulting in the need for additional inventory in Q2. We are now rebalancing our inventory and looking forward, we anticipate a modest decline in inventory in Q3, with inventory days returning to a more normal level of approximately 140 days in Q4.

As of June 30, 2006, the Company had $211 million of cash and short-term investments, up from $176 million at December 31st. In July, the Board of Directors approved a quarterly cash dividend of $0.06 per common share. Now I'd like to make some forward-looking statements concerning our expectations for Q3. Given the continued strength of the JPMorgan Global Purchasing Managers Index during Q2, we currently expect revenue for Q3, 2006, to follow the seasonal pattern of being flat sequentially from Q2, and the be in the range of $157 million to $164 million. We currently expect that GAAP fully diluted earnings per share will be in the range of $0.16 to $0.21 per share for Q3, and that we will see a modest decline in inventory in Q3.

Regarding non-GAAP earnings per share for Q3, 2006, the Company expects the net after-tax impact of stock-based compensation to be $0.04 per share, and the net after-tax impact of the amortization of acquisition-related intangibles to be $0.01 per share. As a result, management expects that non-GAAP gross margins will be approximately 75%, and non-GAAP fully diluted earnings per share for Q3 will be in the range of $0.21 to $0.26 per share.

These are forward-looking statements. I must caution you that actual revenues, gross margins, inventory and earnings could be negatively affected by numerous factors, such as any decline in the global economy, delays in new product releases, R&D expense overruns, manufacturing inefficiencies, the impact of new product introductions on the sale of existing products,and foreign exchange fluctuations. In summary, Q2 was a good quarter with record revenue and non-GAAP net income growth of 33% year-over-year. With that, I'll turn it over to John Graff, Vice President of Marketing.

Thank you, Alec. We turned in a solid performance in Q2 in all regions, led by strong sales of software, PXI, modular instrument and distributed I/O products. New product revenues were once again very strong for the quarter, fueled by the record new product output of the past 2 years. Our continued growth in test and measurement applications, as well as strong success in selling our platform into industrial and embedded applications, drove our record revenues for Q2. After the expected seasonal decline in system level business in Q1, orders over $20,000 increased 18% sequentially in Q2, driven by the growth of our system level products like PXI, Compact FieldPoint, and Compact RIO. This in turn led to the increase in average order size to approximately $3,000 in Q2, up from approximately $2,700 in Q1.

Looking at software sales for the quarter in more detail, we were very pleased with sales of LabVIEW 8 in Q2. As we have stated in past calls, revenue from new software releases typically ramps up over a 6 to 9 month period. This pattern demonstrated itself once again in Q2, as more customers adopted our LabVIEW 8 family of measurement and control software, which was first introduced in Q4, 2005. By selling more software to more customers, we continued to further expand our reach in test control and design applications. As we have stated often in the past, LabVIEW represents the most strategic sale we can make, as it not only helps drive short-term revenue success as it did in Q2, but also for the long-term potential to sell customers additional hardware and software.

In data acquisition, our USB-based products performed well. We continued to invest in our USB data acquisition products to leverage the ease of use and ease of connectivity provided by USB, as well as to access the large and growing market of notebook computers, which now represents more than half of all PC sales. In Q2, we introduced a new data acquisition system, CompactDAQ, that brings the ease of use of USB and the flexibility of a modular platform to portable and benchtop applications.

Based on the same Compact rugged hardware architecture as Compact RIO, CompactDAQ delivers a fixed function personality that leverages our existing DAQ software technology, as well as seamless integration with our LabVIEW Express software. We are very pleased with early customer success with CompactDAQ across a wide variety of industries, from oil and gas, to laboratory research, to automotive.

One customer, Halliburton, is using CompactDAQ in their oil rigs cement analyzers for monitoring the curing rate of cement at high temperatures and pressures. The small size of CompactDAQ helped Halliburton minimize the footprint of the analyzer for deep well use, and the modularity of the platform gives them the ability to incorporate additional measurements types for special deployment requirements.

In automotive, Honda is using the system for a test bench that simulates road conditions. Mike Dickinson, Transmission Research Engineer, Honda R&D America, said, " this system will revolutionize in-vehicle data acquisition for us. With the CompactDAQ system, we effectively transform a myriad of wires and equipment into a smaller, cleaner, cheaper and more intuitive package." We are very pleased that CompactDAQ, as well as our other USB data acquisition products, continue to have success in bringing new customers to the Company.

Sales of our PXI and modular instrument products were strong in Q2, as virtual instrumentation continued to see strong adoption in the test and measurement market. PXI is now used by many of the world's leading multinational companies, including Boeing, Microsoft, Flextronics, Siemens, Honeywell and Samsung among others. And we continue to leverage the advancing performance of commercial technologies to bring greater speed, higher performance and lower cost to the PXI platform. For example, in Q2, we announced the industry's first dual core PXI embedded controller with the 2 gigaHertz Intel Core Duo processor, improving the performance of automated test applications up to 100%.

Another key technology that is bringing improved performance and capabilities to PXI is PCI Express. The latest PXI technology, PXI Express, can help customers solve some of the most demanding applications, such as those in the military and aerospace market, where customers key care abouts include leveraging commercial off the shelf technology, reducing test system footprint, and insuring reliability of the system over many years. We are pleased with the continued interest in PXI, specifically related to the compatibility and longevity of the platform brought about by the evolution of the PXI Express.

For example, the new PXI Express standard supports the U.S. Department of Defense's next test vision of synthetic instruments, providing the data bandwidth required by high-speed streaming communications applications. Whether it's testing military radios, monitoring the wireless spectrum, or verifying cellular base stations, RF and telecom applications continue to be a large growth area for NI. We continued our investment in this area in Q2 with our announcement of several new PXI switching modules that extend the frequency range of our switch platform to 5 gigaHertz. These modules, which are the latest additions to the more than 125 available switch configuration from NI, complement our growing product offering for communications test, and allow us to address a wider range of applications in telecommunications, military aerospace, and automated tests.

As I mentioned at the start, we are very pleased with the success we saw in Q2 in industrial applications with our graphical system design family of products, for applications like advanced control and monitoring of an oil drilling system, and precision hydraulic motion control for industrial machinery. Our Compact FieldPoint and Compact RIO, industrial measurement control hardware platforms, at a very strong Q2, that led to record revenues for distributed I/O products.

By combining the rugged, deterministic performance of these off the shelf hardware platforms with the ease of use of LabVIEW graphical programming and the reliability of LabVIEW RealTime and LabVIEW FPGA, customers, especially OEMs, continued to see the benefits of designing, prototyping and deploying their next generation systems more quickly, and at less cost than traditional approaches.

Our partnerships with leading academic research and teaching institutions around the world play a key role in providing early customer feedback that enhances the development process of new products. For example, Virginia Tech students use LabVIEW and Compact RIO and to completely prototype an engine control unit for their design of an environmentally friendly crossover sports utility vehicle at the second annual Challenge X competition sponsored by General Motors and the U.S. Department of Energy.

James Kolhoff, General Motors Powertrain Software Engineering Director stated, "National Instruments software and hardware platforms for graphical system design give the competing Challenge X teams high level tools, allowing them to quickly design, prototype and deploy innovative control strategies for new hybrid and fuel cell vehicles. In this research phase of development, the NI platform is being used to improve fuel efficiency and performance at a lower cost for future GM vehicles." We are pleased that in June, Virginia Tech took top honors in the Challenge X competition.

We will be demonstrating the progress we have made with graphical system design at the upcoming Graphical System Design Summit, a 2-day event held in conjunction with NI Week. The summit will feature technical experts from industry and academia, including Analog Devices, General Motors, Intel, the University of California at Berkeley, WinRiver, and Xilinx, who will present technical how-to presentations and case studies on trends and innovations that impact how engineers design, prototype and deploy their embedded and control systems. NI Week is shaping up once again to be a very exciting event, with several new product announcements planned, as well as many customers and partners demonstrating their use of the NI platform in leading edge application. Our investor day coincides with the first day of NI week, August 8th. We hope to see many of you there.

During NI Week, you also see the launch of the new LEGO Mindstorms NXT robotic system that was collaboratively developed by the LEGO Group and NI. The software in the new Mindstorm system was created entirely in LabVIEW, specifically the LabVIEW Express technology, so that children and adults can quickly and easily build custom robotic inventions in a matter of minutes. While the development effort was small and the revenue will not be material, we are very excited to demonstrate not only the ability of LabVIEW to run on a high-volume embedded platform, but more importantly to show the ease of use and productivity that graphical development brings to children, scientists and engineers.

In summary, we are pleased with solid revenue growth in Q2, driven by strong sales of our software, distributed I/O, PXI and modular instrument products, and strong operating leverage as we grew revenue faster than expenses. With that, I will now turn it over to Dr.T.

Thank you, John. We are pleased to turn in our sixteenth consecutive quarter of year-over-year revenue growth, delivering record revenue and strong operating leverage in Q2. As Alec and John highlighted, we are pleased with the strong sales of our key products including software, distributed I/O, modular instruments and PXI in all regions of the world. In the past few years, we have increased our leadership position in data acquisition by investing in R&D, leveraging commercial technologies, and delivering new products. For example, our M Series devices defined a new price for performance standard in data acquisition, while our growing line of USB products addressed our customers' need for easy to use, portable measurement devices, as the demand and use of notebook computers continues to rise.

In Q2, we expanded our selection of data acquisition products with the introduction of CompactDAQ, which allows us to further strengthen our product portfolio, and address new opportunities in benchtop and portable applications. We are pleased with the early acceptance of CompactDAQ, as many new customers realize the benefits of modularity and ease of use in building their applications.

As we build on the successes of our first 30 years, we look to the important role that graphical system design is playing as we expand our vision for virtual instrumentation to address the opportunities in areas such as embedded design, rapid prototyping and advance control. The combination of modular hardware systems including PXI and Compact RIO and graphical LabVIEW software provides a rapid prototyping platform that offers an easy migration path to move directly into production, bypassing the costly process of designing, deploying and custom electronics.

We look forward to hearing more about how our lead users and partners are employing LabVIEW in new areas at the Graphical Systems Design Summit during NI Week. Our twelfth annual NI Week conference is only 2 weeks away, and we look forward to welcoming customers, members of the press, partners and exhibitors as we celebrate the success of virtual instrumentation.

With numerous conference sessions and technology summits, NI Week is a key event for launching new products, meeting with strategic partners, and learning how our customers from all regions of the world are successful in solving test, control and design applications. I will kick NI Week off with a keynote address, outlining the success of LabVIEW over the past 20 years, the current success of graphical system design in the industrial space, and our future opportunities in high-growth areas such as RF and high-speed digital tests. We look forward to seeing you there.

In summary, we are pleased with record revenue and solid operating leverage, driven by strong sales from many of our key hardware and software products, and believe that our investments in new products are paying off. We are well positioned for success in the second half of 2006. Thank you for taking the time to join us today. We will now take your questions.

[OPERATOR INSTRUCTIONS] Antonio Antezano, Bear, Stearns.

I was going to ask whether you could share with us how the order flow was during, or throughout the the second quarter, whether there was any difference between April, May and June in terms of order inflow.

The quarter was the same type of linearity that we typically see in Q2. So no change from our normal pattern.

All right. But not even like a significant change in June?

No, typically, we do somewhere around 37, 38% of our revenue in the last month.

Right.

And that was typical and consistent in June.

All right. And then, just looking forward in terms of the outlook in each region, if you could give us some color, what your assumptions are right now for the third quarter?

Well, overall, if I look at the JPMorgan Global Purchasing Manager's Index from an economic point of view, and you break that down to the regional components, you continue to see quite strong industrial activity across all the regions. We've certainly seen a recovery in Europe and Japan. The U.S. continues to be strong. Capacity utilization is quite strong. So, also I guess the durable goods orders that came out today would indicate that the industrial economy appears to be in pretty good shape around the world.

If I might just 1 additional here.

Sure.

In Europe, the year-over-year growth was -- or the difference between the growth in local currency and the nominal growth was significant. And despite the fact that the Euro I think, is [inaudible] during the quarter, I believe that was because of some hedging activity in the prior quarter. But going forward, is there any change in terms of hedging, or would you expect some kind of reversal of that?

The currency issue has been a headwind for us in Europe for the last several quarters, and we would expect, as I said on the last call, that headwind will dissipate as we go into Q3 and Q4. So as I look right now in the next 2 quarters, we expect that gap to narrow significantly starting in Q3.

Thank you.

Ajit Pai, Thomas Weisel.

Congratulations on a very solid quarter. A couple of quick questions. The first one would be when you have a look at your operating margins in '99 and 2000, they were in the 18 to 20% range. So it's been about like 5 years right now, and you've been ramping your margins every year for the past 5. Could you give us some indication as to what the drivers over there are, how the Hungarian plant has ramped right now during the capacity utilization, and whether you can still look at an 18% plus operating margin in this economic cycle?

Sure, Ajit. As you're aware, we made a conscious decision when the big economic slowdown happened in 2001, to accelerate and lift our level of investment in R&D in order to provide a new product investment that would ensure we saw the type of revenue growth that we've seen over the last 3 years, with revenue up 60% over the last 3 years. And as a result of that, we accepted the fact that we were going to see a shrinking of our operating margin during that time.

As you also alluded to, we made a transition to a new production facility in Hungary, which initially hurt our gross margins for a period of time. We're now seeing the benefits of the fruits of our labor there, where our investment in R&D, which we're targeted at keeping around 16%, has produced several years now of record new product output. Hungary has ramped up very, very well, and we now have the productive capacity to deal with an annual revenue level of somewhere around about $1.2 billion. And we continue to expect to gain operating leverage from that operation.

With 75% gross margins -- non-GAAP gross margins in Q2, we hit our gross margin target in the second quarter, we're very pleased by that. We're also aggressively pursuing moving to lower cost component suppliers where possible to aid that. So looking out from where we were a couple, 3 years ago when we decided to stabilize our level of R&D at 16, and focus a little more attention on the operating margin side, we have seen pretty tremendous recovery in operating margin from about 9% there 3 years ago, to 16 now, with a tripling of our net income on a non-GAAP basis.

So, this year we're, for the first half, our non-GAAP margin is up about 2 points, and our goal was to grow expenses at 70% or less of revenue in 2006 and 2007. With a goal of getting back to 18% operating margin for the full year of 2007. And so that's obviously a goal. It's not a forward-looking statement to say we'll achieve that goal, but that is the goal that we're focused on as we look out to 2007.

Okay. The second question would be just looking at the gross margin question that you just raised, which is that outside of the manufacturing, the software component, how has it changed from '99 through 2006, first half 2006 as a percentage of the overall revenues? And then also inflationary pressures, are you beginning to see inflationary pressures in the labor side as well as on the component side?

Well let me address the last question first. On the component side, we are not seeing much in the way of inflationary pressures. We typically have very good, deep relationships with our key component vendors, and we tend to have stable pricing there.

In a number of areas we are pursuing lower cost suppliers on lower value, shall we say, technology components. And in those areas, we're reaping the benefits of significant cost reductions in several areas. So I would say that's moving to our favor. On the issue of software as a percentage of revenue, it has remained remarkably stable over the last number of years, although as John alluded to in the conference call, Q2 was a strong quarter for software, and we are seeing the ramp up now from LabVIEW 8.0, which we released last fall. Okay?

Yes. Congratulations again, on a really solid quarter.

Rob Mason, Robert W. Baird.

Yes, Alec, I wanted to see if you could share with us the outlook for instrument control. It was good to see that that part of the business contributed to the growth rate in the quarter. It sounds like maybe you're a little more optimistic about that business. Is that a fair characterization?

Well, certainly we saw a recovery from low points last year. And the best growth in instrument control that we've seen I believe in at least 2 years, so that is encouraging. We would obviously like to see the overall market for T&M continue to grow and instrument control we believe, is a reasonably good proxy for that over a fairly long period of time.

So it's good to see that growth rate come back. We had a pretty easy compare on instrument control compared with Q2 last year, so we'll see how it plays out going forward. But certainly, I view that as a positive sign for the overall industry, to see that number coming back up towards the 10% mark.

Do you think that that is a business that could grow sequentially then, in the third quarter?

You know, I'd focus everybody's attention back, it's only about 12% of our revenue. So any sequentially move in that is not really going to have a material impact on the Company overall.

Okay.

And so I would hate to predict down to that level of detail.

Sure, sure. Touch on the large systems business real quick. You did mention some nice sequential growth. I was curious how that might have compared year-over-year.

Rob, this is John. Yes, we did see, as we've highlighted as our kind of standard pattern now, where the large system business is really strong Q4, declines in Q1, and then we have a slight bounceback. Trying to look at the data in front of me.

I think the sequential bump was pretty consistent to the trends we have seen in past years. So, nothing really out of the ordinary. A lot of the success driven by the platforms like PXI, Compact FieldPoint, and then really strong growth with the Compact RIO platform.

Okay. Well, has that portion of the business, and maybe you can share with us maybe what percent of sales it is now, refresh us. But has that changed the nature of your backlog such that it provides you a little more visibility? Historically you've had very short shipping cycles. Has that, as that has ramped up, provided you incremental visibility on your business as you look out over the next several months?

It's -- Rob, it's Alec here. I'll address that question. From a backlog strategy point of view, it's remained very consistent. Anywhere from 2 to 4 days worth of backlog, so it hasn't shifted really from that point of view. We've certainly made a position, and pride ourselves on rapid delivery, and being a very, very easy company to do business with for our customers. And we apply that same philosophy to the system level business as we do to the individual board-based business. So it hasn't really changed our backlog picture from that point of view.

Okay.

This is John. On the orders over 20k, it's approximately a third of our revenue. And as I mentioned in the call, the growth there plays a role in taking our average order size up to $3,000, which is the general trend that we've been outlining over time, is that the order size has been going up driven by the large system sales.

And Rob, we will go into a considerable amount of detail on this issue of order size, et, cetera, at the investor conference at NI Week, in 2 weeks' time.

Okay. Very good. Thank you.

David Yuschak, Sanders Morris Harris.

Congratulation, gentlemen, on a good quarter there. Just on the gross margin itself, would you characterize that maybe the gross margin was maybe a a little bit more pleasant than you initially thought maybe as you looked at the upper and lower end of your own guidance going into the quarter? You guy always been good at expense control. Certainly that showed up in the quarter on the operating expense side. I'm just wondering if the gross margin may have been a more pleasant surprise for you in this quarter?

Yes, it certainly was at the upper end of our expectations, Dave, it's very good point. And we have been working and the manufacturing and R&D teams have done a tremendous job over the last couple of years on a couple of key level components that we were looking to transition to different suppliers on, and we closed a lot of those out leading into the end of Q1 into Q2, which certainly helped us out. And then also we're very pleased to see the ramp-up of LabVIEW 8.0 also as an ingredient to that.

And it's a pleasure for me to able to give guidance at about 75% gross margin for Q3, as well. So I'm glad that we're, at least in Q2, hitting that target. That makes the challenge of hitting 18% operating margin is a lot easier if we can hit the 75% gross margin target.

So it's fair say then, to summarize that manufacturing efficiencies keep getting tightened down, that's helping you there?

Yes, absolutely. And I'd also refer back, too, to the very, very differentiated product portfolio that we have, which is allowing us to maintain very good margins and pricing in our products. And you know that differentiation that we offer in software, and a very high value to customers. We'll show a lot more new initiatives on that at NI Week again, in a couple week's time, as we hope to preserve that position as an innovative Company that can command good pricing for its products.

Now, one other question I've asked in past conference calls and we kind of talked about it a bit, is how the impact on gross margin can be as your new products mature. Is that at all beginning to add to the gross margin as well? Or is it still the idea that you're still bringing on enough new products that covers that up, that potential up? Or is there enough bench strength coming out of these newer products that are beginning to mature that even with new product rollouts, you can still push gross margin higher?

That's a good question, Dave, and obviously as products mature and gain in scale, the average cost to build goes down, as you build them in larger volumes. So their margins do improve. But we are very focused on continuing to bring out a lot of new products. And so I think in the aggregate, when you net it all out, that's probably a wash.

Okay. That's it for now. I'll get back in queue for anything else.

John Harmon, Needham & Co.

Just a couple of questions for you. First of all, when the instrument control business was a bit slower, you talked about its exposure to the semiconductor test sector. Kind of a rhetorical question, I guess. But has that portion of its sales rebounded as the broader industry has?

John, it's Alec here. There has been some improvement there, but it's now, compared to 4 or 5 years ago as percentage of revenue -- of instrument control revenue, it was quite significant. It's now at a much lower level, and so it doesn't of quite the same impact. But certainly, that was much better in Q2 of this year than Q2 of last year.

Okay. Thank you. And Dr.Truchard talked about the topics of his opening address at NI Week, but I'm just curious kind of what the major themes are going to be. You're going into NI Week this year with a new version of LabVIEW under your belt. So I suspect it will be more about applications than products this year. Though, you did mention new communication products, I believe.

That's right. At NI Week, we'll be showing off some of the technology that's really maturing at this time, and really getting ready to go prime time as we look at this area of graphical systems design. We've had some excellent successes there. We also will be showing how a graphical system design can be applied to new areas, like digital tests, where we see a -- we've had some success stories. And also we'll be showing some ways we can be successful in digital tests in the future. Also we'll be showing how RF is building position in modular instruments, as well.

Dr.Truchard, you mentioned that there was a seminar going on alongside NI Week. It sounds like there's more to the phrase "graphical system design" than what the words really mean. Is it something above and beyond building a virtual instrument with the graphical user interface of LabVIEW?

We've been adding our technology for going into industrial control, including advanced control, where we are adding all the elements for doing things like prototyping, ECUs in automobiles, as we mentioned in the Virginia Tech story. We are also looking at advanced control in the -- on the plant floor for manufacturing applications, as well.

Okay. Thank you very much.

Hopefully you'll make it down to NI Week, because I think it's going to be an exciting one.

I'll see you there. Thank you.

Antonio Antezano.

Just 1 follow-up. In terms of any share repurchase activity during the quarter?

Antonio, it's Alec here. No, we did not buy back any shares in Q2.

What is your -- you have an existing program -- ?

Correct, we do. We have an option -- the authority to buy back over 2 million shares.

Over 2 million shares, all right.

I don't remember the exact number, it was slightly over 2 million shares.

All right. Thank you

Ajit Pai.

Yes, regarding acquisitions, the other use of your cash, could you give us some color as to what the strategy over there, were there any thing's changed?

No, nothing changed. We're certainly very pleased with the execution on the 3 acquisitions we did last year. We've seen tremendous improvement in the profitability of those businesses since we bought them, leveraging our scale, and buying power and manufacturing capabilities. And the team in place from an integration point of view, as well as the employees at IOtech and Electronic Workbench and MCC who joined the NI family, have done a tremendous job on execution there.

Looking forward, as we've said, our long-term strategy is somewhere from 2 to 3% of revenue, over a longer term period would come from acquisitions. But they will be opportunistic, and so we're not going to pursue them in any year just for that revenue growth. But we continue to look for strategic opportunities that would add to the long-term value of the business. And that's something we actively continue to look at.

Thank you.

David Yuschak.

On the operating expense side, you guys have always been good at tightening down the hatches when things get tough, and spend even during tougher times to get through the next up curve. I'm just wondering as you look at your infrastructure today on the operating expense side, how comfortable are you now? Because in some respects, during some of this tougher periods, you guys have not spent maybe as much as you had in the past, and maybe it's kind of suggesting confidence in what you have today. And what would it take you in ramping up those expenses to support even higher levels of sales? What kind of things do you need to see?

Well, I'm unsure if I under the question right [inaudible] but when I look at our structure right now, we continue to make the infrastructure investments where appropriate. When I look at it, that we -- especially in R&D, which is the biggest area of leverage, where we've made massive investments over the last 5 or 6 years. We also as we talked many times in the call, and investor conferences, we're very focused on ramping up our field sales force.

And we continue to invest in that. So I do think, in terms of the key infrastructure areas, R&D, the field sales force, the manufacturing operation, IT, those types of areas, there's a lot of leverage. And we're able to absorb a significant amount of revenue growth without incurring a significant amount of new cost. And that is really the basis behind our goal of growing expenses in '06 and '07 at about 70% of the rate of revenue growth.

If we can achieve that goal, and we do see an improvement in gross margin from 2005, then that allows us to generate a lot of leverage from that. And that is certainly our objective. Whether we'll achieve that or not, we'll see. But that's certainly the goal.

So you're really kind of measuring your operating expenses based off of this 70%? Is there -- but I'm just kind of curious, as you look at the potential for maybe the manufacturing economy stays stronger longer gets better, is there things out there, though, that you think you may need to spend in case you would get a pleasant surprise on the top line?

I'd classify our 70% target on expense growth relative to revenues as a goal for '06 and '07, with an objective of getting us back to 18% in '07. Once we're back to 18%, then we'll reconsider our options, and depending on what the economic environment is at that point in time, we may choose to be more aggressive.

Right. We've been investing over the long-term for the last several years. We got a lot of new technology that's coming to fruition. We're talking about the graphical system design and the successes in the industrial arena, as well as our newer areas like RF. At this point, I believe solid execution is the key. We'll be focused on execution, seeing that these products do come to market the way they need to. And we're really feel that the investments we made in R&D and now delivering in the way we hoped.

Okay. Thanks.

And that's all the time we have for questions today. I'll turn it back over to any of our speakers to make any closing remarks.

Thank you for joining us today. We will have our investor conference Tuesday, August 8th, in a couple week's time, which is also the first day of NI Week. So we look forward to seeing you there. If you need any conference detail, please contact Investor Relations. Thank you.

That does conclude today's conference. Everyone, have a great day.