National Instruments Corp (NATI) 2006 Q3 法說會逐字稿

Good day everyone, and welcome to the National Instruments Corporation third quarter 2006 earnings release conference call. Today's call is being recorded. You may refer to your press packet for the replay dial and passcode. The replay will be available from 7:00 p.m. Central Time today and will end at midnight Central Time on October 30, 2006. With us today are Dr. James Truchard, President and Chief Executive Officer; Alex Davern, Chief Financial Officer; and John Graff, Vice President of Marketing.

For opening remarks I would like to turn the call over to Mr. Dave Hugley, Corporate Counsel. Please go ahead, sir.

Good afternoon, during the course of this conference call we shall make forward-looking statements regarding the future financial performance of the Company including statements regarding our expected revenue and earnings per share, future release and success of new products, growing revenues, and generating operating leverage. 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, 2005, and our form 10-Q for the quarter ended June 30, 2006.

These documents contain and identify important factors that could cause our actual results to differ materially from those contained in our forward-looking statements. Our non-GAAP results exclude the impact of stock-based compensation and the impact of the amortization of acquisition-related intangibles. Our GAAP results, and a reconciliation of GAAP to non-GAAP results, is included as part of our earnings release which is on our website at ni.com. 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, thank you for joining us. My key points today are record quarterly revenue and strong earnings growth, record sales of PXI, modular instruments, distributed I/O, Machine Vision and data acquisition products and strong software revenue growth in Q3. We turned in a solid performance in Q3 in all regions of the world, with strong growth of our virtual instrumentation products across a diverse set of applications.

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. Revenue for Q3 was $164 million, a record quarter and a 16% increase over Q3, 2005. Revenue was up 14% year-over-year in Europe, up 30% in Asia, and was up 11% in the Americas. On the product side, our instrument control business grew 1% year-over-year in Q3, and now represents just 11% of revenue. We believe the slowdown in instrument control growth reflects the recent slowdown in semiconductor capital equipment spending. The remainder of our product portfolio, i.e. our virtual instrumentation products, grew by 16% year-over-year. GAAP fully diluted earnings per share for Q3 was $0.23 with GAAP net income of $19 million, up 30% from Q3, 2005. Non-GAAP net income was $22 million, up 48% from Q3, 2005, with fully diluted earnings per share of $0.27.

We're pleased to have delivered good year-over-year revenue growth in Q3 with very strong operating leverage. For the first nine months we have reported year-over-year revenue growth of 16% in US dollars and 18% in local currency. This combined with the strong operating leverage in our business has allowed us to report a 41% increase in non-GAAP net income for the first nine months and has positioned us well for a significant increase in operating margin for the full year.

Now looking at the non-GAAP income statement in more detail. Non-GAAP gross margin in Q3 was 75%, up from 74% in Q3 last year. This improvement is attributable to very good software sales, the continued transition of our production to our Hungarian facility, and the transition of certain components to new, lower-cost suppliers. We are pleased to have achieved our goal of 75% non-GAAP gross margin in both Q2 and Q3. Non-GAAP total operating expenses in Q3 were $96 million, up 13% year-over-year, compared to an 18% increase in gross margin dollars year-over-year. Non-GAAP R&D expenses were up 28% year-over-year to $26.6 million in Q3.

Software development expenses capitalized in the quarter amounted to $2.3 million, compared to $4.2 million in Q3 last year. Also during the quarter, $2 million of previously capitalized software development costs were amortized to costs of goods sold, compared to only $1.8 million in Q3 last year. Non-GAAP SG&A expenses were up 8% year-over-year in Q3 and dropped from 45.5% of revenue in Q3 last year to 42.3% this year, demonstrating very good operating leverage.

Now turning to the balance sheet. In line with the forecasts from our conference call in July, inventory days decreased to 172 days from 185 days last quarter. As of September 30, 2006, the Company had $223 million of cash and short-term investments, up from $211 million last quarter. This is net of $16.5 million in cash which the Company used during Q3 to repurchase 608,000 shares of NI's common stock at an average price of $27. Today the Company also announced a quarterly cash dividend of $0.06 per common share.

Now, I'd like to make some forward-looking statements concerning our expectations for Q4, 2006, and Q1, 2007. Given the relative strength of the JP Morgan Global Purchasing Managers Index during Q3, we currently expect revenue for Q4, 2006, to follow the seasonal pattern of being up sequentially from Q3 and to be in the range of $177 million to $184 million. We currently expect a GAAP fully diluted earnings per share will be in the range of $0.26 to $0.31 per share for Q4. Regarding non-GAAP earnings per share for Q4 the Company expects the net after-tax impact of stock-based compensation to be $0.03 per share and a net after-tax impact of the amortization of acquisition-related intangibles to be $0.01 per share. As a result, management expects non-GAAP fully diluted earnings per share for Q4 will be in the range of $0.30 to $0.35 per share.

Concerning Q1, 2007, our seasonal pattern for the last few years has been for revenue in Q1 to decline as much as 5% sequentially from Q4. This decline reflects the seasonal strength we typically see in large system orders in Q4. We expect this pattern to repeat in Q1, 2007, and for revenue and earnings to decline sequentially from Q4. That these are forward-looking statements, I must caution you that actual revenues, gross margins, 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, and foreign exchange fluctuations.

In closing, I want to reflect on the performance of the Company over the last three years. Three years ago, in 2003, after a very weak period for the industrial economy, NI turned its focus from an intense ramp-up in our R&D investments to meeting our operating margin target. We knew it would take several years, but we remain committed to our goal of returning to 18% non-GAAP operating margin. The 41% increase we delivered in non-GAAP net income over the last nine months has moved us much closer to that goal. With that I'll turn it over to John Graff, Vice President of Marketing.

Thank you, Alec. As Alec said we turned in record quarterly revenue in Q3 and we saw growth of our virtual instrumentation products driven by record revenue of Machine Vision, data acquisition and modular instruments as well as our PXI and distributed I/O hardware platforms. Record sales of these platforms in Q3 led to strong growth in order over $20,000. This led to an average order size of $3,150, a new quarterly record and up from $2,830 in Q3, 2005.

One area of record revenue in Q3 was data acquisition. We have continued to aggressively invest in our data acquisition product family to expand our offering with higher performance and easier to use products. One new data acquisition hardware platform, Compact DAQ, continued to see strong adoption in Q3 as customers take advantage of high performance measurement capabilities in an easy-to-use, compact form factor based on USB. In addition, in Q3, we released new, higher performance USB modules based on our award-winning M-series technology. And we're pleased that these products contributed to the strong growth in our data acquisition average selling price in Q3.

A key event for us each year in Q3 is NIWeek. And our 12th annual conference was a great success. With representation from over 60 countries, NIWeek demonstrated the growth and adoption, as well as the future opportunities of graphical system design across test, control, and design applications. One particular area of success at NIWeek was the specialized summits, expos, and technical tracks in diverse areas such as RF communications, signal processing, and embedded design. Those of you who attended our annual investor conference saw firsthand the excitement among our customers and partners, and we thank you for coming.

At NIWeek we celebrated the 20th anniversary of LabVIEW, by releasing LabVIEW 8.20. This new version builds upon LabVIEW's success as a robust development platform to help engineers design prototype and deploy their systems. New features, from textual math integration to improved control design tools and improved functionality for RF communications tests, allow customers to meet an expanding set of application needs. Researchers at the University of Illinois are using the new MathScript textual map functionality in LabVIEW to test an existing algorithm to improve the effectiveness of hearing aid devices.

Since LabVIEW is an open programming language, they easily incorporated their existing code into LabVIEW and tested its effectiveness in a real-world environment with microphones. By using this approach of algorithm engineering and seeing real-world results immediately, the professors are able to make modifications quickly and converge on a solution in less time. The early response to LabVIEW 8.20 from industry analysts and technical trade press has been excellent.

Alex Mendelsohn, editor eeProductCenter.com, stated, quote, There isn't an automation story I can write that doesn't include LabVIEW, end quote. Mark Hoske of Control Engineering stated in his article that LabVIEW has, quote, revolutionized the way thousands of engineers and scientists work, providing improved product quality, shorter time to market, and greater engineering and manufacturing efficiency, end quote. And Dan Strassberg, senior technical editor at EDN magazine wrote that LabVIEW has quote, a diverse range of capabilities and uses, most probably now including system level EDA, embedded system development, and FPGA-based rapid prototyping, end quote.

We saw strong revenue growth in software for the quarter driven by the strong adoption of the LabVIEW platform. One customer, Indian Railways, research designs and standards organization, used LabVIEW to create an automated system to check train wheels for irregularities at high speeds. The system was designed in LabVIEW and prototyped with our CompactRIO hardware platform, allowing the customer to quickly deploy it to several locations with no software modifications.

The next phase of the project includes deploying the system with the same LabVIEW software to an analog devices black-thin processor on a custom electronics device. By giving the customer the ability to deploy an NI CompactRIO reconfigurable hardware for small quantities, or black thin processor for larger quantities, the customer benefited from the flexibility of this approach to choose the deployment platform that was ideal for their specific application. We continue to expand the capabilities of LabVIEW to target a variety of third-party processors, and in Q3, were pleased that LabVIEW won the Best in Show award at the Freescale Technology Conference for its integration with their cold-fire processor.

The growth and adoption of PXI continued in Q3, and we continue to leverage commercial technologies to introduce new products that improve PXI's performance while lowering its cost. In Q3 we released the new PXI-1033 chassis, priced at $999, that provides a new, low-cost entry point for PXI systems. And the new eight-channel PXI-5105 digitizer is the lowest price per channel, high-speed data acquisition product in its class. This new digitizer module expands our family of high-density, simultaneous sampling data acquisition products to more than 20 modules, giving customers a broader range of devices to choose from for their test applications.

In addition to driving down the cost of tests, we also continue to introduce products that provide expanded capabilities and increased performance. In Q3, we announced the new PXI-5152 digital oscilloscope, which extends our digitizer offering to two gigasamples per second and delivers an 8X increase in sampling rate from our previous digitizer offerings. Engineers can configure this PXI digitizer through software to perform custom measurements in many application areas such as semiconductor chip characterization, ultrasonic non-destructive tests, and military communications. A key driver of improved PXI performance is PXI Express, which provides a 40X increase in bandwidth over traditional PXI, and is ideal for demanding test applications in RF and digital tests. At NIWeek, leading test companies, BA Systems, Teradyne, and Advantest, joined NI at a press conference to discuss plans for PXI Express in their test system.

Peter Hansen, instrument product line manager at Teradyne said, quote, Teradyne is interested in PXI Express for future development of complex instruments that serve the military and aerospace community, for applications that require high bandwidth with low overhead in the management of real-time data, end quote. Furthering the reach of PXI Express systems into high-frequency communications test applications, in Q3, BAE Systems, NI, and Phase Matrix, Inc., announced a joint initiative to develop a PXI Express-based test system for military and commercial RF and microwave applications. Wade Lowdermilk, engineering fellow at BAE Systems said quote, by working with National Instruments and PMI to build a synthetic instrument, we are giving engineers a faster and more cost-effective test and measurement solution. PXI Express is a critical part of this new solution because it provides the increased bandwidth needed for RF and microwave applications, end quote.

In Q3, we also announced the industry's first data acquisition modules for PXI Express, as well as the industry's first PXI Express controllers. These new products take advantage of the dedicated, high-speed bandwidth of PXI Express technology while maintaining compatibility with today's PXI systems. In Q3, our distributed I/O products achieved record revenues with very strong growth as more industrial customers took advantage of graphical system design and added complex measurements to their applications. One customer, Nucor Steel, needed to accurately control the process in melting scrap metal. The current method of controlling the electricity that flowed into the heaters caused system inefficiencies and energy waste.

The fast analog measurements and high performance of the FPGA in CompactRIO allowed Nucor to increase performance of their system while lowering energy costs. In Q3 we continued to fill out our industrial product line and released several touch-panel screens that serve as human-machine interfaces, or HMIs, for industrial and machine control application. These, coupled with the LabVIEW 8.20 touch panel module, released at NIWeek, allow customers to see and interact with their rugged and embedded real-time systems.

Another key part of our industrial measurement and control platform is Machine Vision, giving customers LabVIEW based inspection capabilities which they can integrate with our Compact FieldPoint and CompactRIO platforms. In Q3, our Machine Vision products had a record quarter with very strong growth from our vision software products and PCI express-based frame grabbers. Customers in a wide range of industries, from Sylvania Lighting and consumer goods to John Deere in heavy machinery, have adopted NI Machine Vision to increase their production through-put and yields.

The core of our embedded and industrial platforms is LabVIEW Real-Time and LabVIEW FPGA. With these two add-on modules, customers can use LabVIEW graphical programming to create high performance, rugged, and reliable, embedded systems. Combined with embedded hardware platforms such as CompactRIO and PXI, LabVIEW is leading our penetration into the embedded control space. One customer, Nexam, is using CompactRIO and LabVIEW deployed in a remote operated underwater vehicle for natural gas exploration in the North Sea. By using LabVIEW and CompactRIO, Nexam's was also able to deploy quickly in extreme conditions and lower maintenance costs due to the reuse of LabVIEW for controlling both the embedded undersea unit and for the land-based monitoring system.

In summary, we are pleased with record revenue in Q3 led by strong growth of software and record revenue for data acquisition, PXI, modular instruments, Machine Vision, and distributed I/O, and we are excited by the early response to LabVIEW 8.20. With that, I'll turn it over to Dr. T.

Thank you, John. We are pleased with record quarter revenue and strong earnings growth in Q3. Our virtual instrumentation products continued to perform well with strong growth in software revenue and record sales of our PXI, modular instruments, distributed I/O, Machine Vision, and data acquisition products. This year, we have made significant progress toward our operating margin goal and I would like to thank all our employees for their efforts. While we plan to continue to make significant investments in R&D and in our technical sales resources, we will be very focused on driving operating efficiency as we strive towards this operating margin goal in 2007.

At NIWeek this year we expanded our vision of graphical systems design by outlining our opportunity in tests and our future potential in embedded development. In addition, the many (inaudible) summits and presentations outline how pervasive LabVIEW has become as industry leaders and customers showed how LabVIEW's unique combination of parallelism, front panel user interface, graphical data flow diagrams, make it such a flexible and powerful tool that can leverage new technology like multicore processors and PCI Express. When we invented LabVIEW 20 years ago, our goal was to do for test and measurement what the spreadsheet had done for financial analysis.

Over the years, LabVIEW has evolved into a robust development platform with a broad set of tools that make design, prototype, and deployment easier than ever. Our latest release of LabVIEW extends that goal by broadening the tools that scientists and engineers can use to design their systems. For example, LabVIEW now integrates textual math into its graphical programming environment allowing customers to easily test their algorithms by connecting to real-world signals. This algorithm engineering is vital in any industry where the development cycle is constrained.

Going forward we will continue to innovate with LabVIEW in our hardware platform, pushing it into new application areas such as high speed, digital tests, high-frequency RF, and embedded design. We continue to be proud of the unique culture we have built, and I believe this is a key reason that earlier this month Business Week named National Instruments one of the 50 best places to launch a career, included among multibillion dollar companies such as Disney, Lockheed, and Google. National Instruments is staffed with talented employees, and we continue to hire bright individuals, provide training, and give them engaging responsibility. Our continued success is built on meeting our growth goals and providing new career opportunities for our employees so that there may be able to grow with the Company and be challenged.

As we build on the success of Q3, we continue to look forward to continued adoption of our software and hardware platforms, our continued investment in R&D, and, as a result, have resulted in compelling system-level products for our customers and going forward we will continue to align R&D sales and marketing to strengthen our core and expand our opportunities. Thank you for taking the time to join us today. We will now take your questions.

(OPERATOR INSTRUCTIONS) And we'll take our first question today from Will Stein from Credit Suisse.

Thank you. Just a -- first a quick question on the buy back. I noticed in the last two quarters you haven't -- you hadn't purchased any stock, but in this quarter I think you spent about $16.5 million. Can you comment on the policy on the buy-back, whether anything's changed there?

Will, it's Alec here. No, our policy has been to be opportunistic in buy-backs, to leverage the corporate resource obviously at a time when the -- perhaps the valuation in the market is significantly different than our long-term view of the value of the Company. We have continuing authorization after the buy-back in Q3 to repurchase about 1.5 million additional shares as we go forward.

Great. One other question. Regarding instrument control sales versus virtual instrumentation, I think the growth rate seemed to have slowed a bit in the instrument control. Is there something you're seeing going on in the general purpose test market that should be cause for concern there, and does the growth in the virtual instrumentation segment more a sign of share gains or any comments you can have along those lines would be helpful?

Certainly. Our strategy, as you're well aware, has been to invest very heavily in R&D. To drive the new product development that would allow us to gain share and enter into new markets. And that's been at the core of the Company's strategy since the Company was founded. But most particularly in the last 6 or 7 years, since we had the kind of tech bubble burst in 2001. So our strategy has been to grow a lot faster than the market overall. We've successfully done that, I think here in Q3 and throughout 2006. Or goal is going to be to continue to grow at a much faster pace than the market, and that's certainly what we'll be working toward.

We do see more volatility in terms of our instrument control business over the last number of years, and it tends to track what's going on in the semiconductor, capital equipment space, and then also in the general T & M space. And obviously we've seen some slowdown in the capital equipment side, especially in semiconductor, that's been announced from some companies that have published their results in the last number of weeks or days, and we saw that reflected in our instrument control business in Q3. The impact on our business there tends to be pretty immediate. And so we're very pleased with the ability of the Company to continue to grow strongly and have record revenue in what was a very strong, sequential quarter by historical standards despite the fact that instrument control has seen some slowdown here in Q3.

Thank you.

And we'll take our next question from Antonio Antezano with Bear Stearns.

Good afternoon.

Hi, Antonio.

Hi. In terms of your outlook, the guidance for revenue implies a range of growth between 11% and 15% in Q4, over Q4 last year. And I was wondering if you could give us more color in terms of the market assumptions by region for Q4.

In terms of our guidance and expectations on the macro side, I really try to focus in on the JP Morgan Global Purchasing Manager Index. As you're familiar with. We will certainly look at the individual components, but I really focus on it at a global level.

Right.

We are assuming some decline in the global [Stovall] PMI in Q4. And that is factored into my assumptions. We also did have a very strong Q4 last year. It was the strongest quarter of the year. And it's our toughest compare as we enter into Q4. So expecting to continue to see double-digit revenue growth in Q4. A record revenue quarter and obviously a finish with we hope will be a record revenue year in the fourth quarter.

Okay. In the third quarter, Europe grew, local currency, about 10% and Asia, 28%. Is the difference in performance just related to macro environment, or are there some Company-specific I guess activities that probably were contacted in Asia for that very significant growth there?

Well, we've had tremendous growth in Asia in the last number of years. And I think Asia, sales operations, marketing, G&A teams have done a tremendous job at execution against the market opportunity available to us in Asia. Certainly the stronger macro environment there in terms of the growth of those regional economies, their ability to continue to produce engineering talent, which creates demand for our products, is probably a key differential. We've seen very good growth throughout the Asia region. And that's also mimicked in Europe. We see very strong growth also in eastern Europe. So we believe we're very well positioned in the emerging countries. And certainly feel like we've done a good job of execution there. And that we do have opportunity to continue to gain share in those regions.

Is -- has there been any, let's say, a specific initiative in Asia in recent months, or it's just, let's say, normal organic growth of the Company there?

It's the normal execution of machine, but I think there's been tremendous intensity of focus by our Asian team around executioning as the business opportunity for the last number of years. I think this is a very, very good execution.

Our newest data acquisition products that work with the notebook computers have been well accepted there because of small footprints that we can achieve with USB. So that certainly has been an initiative on our part. But generally we've invested in this market because of its rapid expansion over the last years.

All right. Thank you. I'll go back to the queue.

Thanks, Antonio.

And next we'll hear from Ajit Pai with Thomas Weisel Partners.

Yes, good afternoon and congratulations on a very solid quarter.

Thank you, Ajit. Appreciate it.

A couple of quick questions. The first one is just looking at the average order size and how it's been trending over the past four quarters, I think you do provide us color but I missed it today. Could you give us what's been happening there?

Ajit, this is John. As we mentioned in the call, in Q3 we saw our average order size come in at 3,150, which is a new, all-time high, that was driven by a lot of continued success in orders over 20-k. Those orders were actually up 29% year-over-year. So as we have continued success with system platforms like PXI and CompactRIO, that's in turn driving those large system sales and the corresponding impact on average order size.

Okay. And then just looking at the sort of industrial automation initiative, you've started focusing on that space I think a couple of years ago, and then Machine Vision in specific, in these two markets right now you've had, could you give us some color on the Machine Vision side as to who exactly you're competing with or taking share from because the overall market seems to be slowing just based on Cognex's recent set of announcements. And then on the industrial automation side, what has been the progress over there overall as of broadly as a percentage of the revenue is how much has it gone to right now and what is it growing at right now?

Let me start with the second part on industrial automation or industrial control applications. As we mentioned in the call we're very pleased with the success we're having there. Again our platforms like our distributed I/O platforms, which is CompactRIO and Compact FieldPoint, see record revenues and those have a disproportionate share of their businesses in these industrial or embedded applications. They're driven by the success of LabVIEW Real-Time and LabVIEW FPGA. So often what we're able to do is offer customers a unique value proposition that takes advantage of capabilities they weren't able to deal with previous products or previous technologies. So we're very pleased with the success we're having there.

Machine Vision plays right into that, it's a good platform completion product in that it is a measurement offering that fits into many industrial applications. And one of the strengths we have is our ability to integrate it right alongside measurement and control. And so often the success we have is that ability to tightly integrate it and, of course, tie it together with LabVIEW. So we're very pleased with the success of Machine Vision. We know there's a little -- the Cognex results showed some uncertainty, I guess especially in certain markets, but it doesn't seem to be slowing us down at all.

Okay. And then could you -- could you have the headcount for the quarter?

Yes, it's -- Alec here, has it -- we were a little over 4,100 employees at the end of September. 4,115.

4,115. And was it all organic the growth, or did you get some through acquisitions?

We added a number of people, about 70 people through the IOtech acquisition last year in Sept -- in October. So you could back that out --

But sequentially there is nothing between June and September.

Between June and September, I believe we added about 100 people. I'll have to go back and double check. It's about a 10% organic headcount increase.

Okay. Thank you.

If you want a round number.

Okay. Thanks.

(OPERATOR INSTRUCTIONS) And we'll now take a question from John Harmon with Needham & Company.

Hi, good afternoon.

Hi, John.

Just a couple of quick questions.

Sure.

You mentioned this in your remarks that some of the slowness you thought you saw in traditional instrumentation, control cards, was due to slowness in the -- from the semiconductor industry. And I believe people were talking about just a -- things being slow right now, just due to typical seasonal slowness. Is that what you're feeling, seeing, or do you think -- do you think there's some other kind of slowdown going, and the reason I'm asking is because the last time there was a slowdown it did hit your results quite a bit. Although it is a smaller percentage of sales today.

Yes, I mean, our business is significantly less I guess exposed to the instrument control business than we were a number of years ago. Going back 5, 6, 7 years ago this was over 30% of our revenue and had a big impact on our marginal results. Our goal, obviously, over the last decade or more has been to get to what we call the other side of the cable. To develop the measurement and control capabilities so that we can actually do the measurement and control directly ourselves as opposed to in-surfacing to other people's instruments. And we've been tremendously successful at that strategy over the course of the last decade.

So while we still see some moderate impact to a slowdown in instrument control our business is less exposed than it was in the past. And we're very much focused on expanding our opportunity in the areas that John talked about earlier on. And we're certainly seeing some success there. I think that this is less of a concern to us now than it would have been a number of years ago. I think when you look at some of the results from a couple of the ATE players, it's logical to believe that certainly the slowdown that they may have seen in their business, maybe a little bit more than just a seasonal slowdown and that there's some correction going on in that part of the semiconductor capital equipment market. But that is today a very small percentage of our revenue.

Okay. Thank you. And you don't really give this number, but I was wondering if the growth rate of your software sales is roughly in line with the growth of everything except instrument control or a little faster or a little slower?

It was faster, John. We had tremendous response to LabVIEW 8.20 and we have seen software revenue growth in excess of the Company growth rate here in Q3.

Is that typical? You've been seeing that for some time, or was it due to the upgrade?

We're very pleased with software sales the last number of years. We've invested very heavily in software. And we believe it's a crucial, critical part of our business. And certainly the upgrade, LabVIEW 8.20 was very well received. And that certainly was an incremental benefit to our software business.

Okay. Thank you very much.

No problem, John. Thank you.

And now we'll take a question from Craig Bell with Sanders, Morris, and Harris.

This is Dave Yuschak, Alec.

Hi Dave, how are you?

Fine. Hey, on your guidance for the fourth quarter, up -- at the upper end of your EPS range, does that mean that you maybe expect more out of Hungarian operation as far as gross margin contribution and can you maybe give us an idea as to how much potential gross margin (indiscernible) get out of that as you finalize some of the things you're doing there?

Sure, we do typically see, or historically have seen, a higher gross margin in Q4 from Q3, that's typically been for a number of factors. Number one being that it tends to be our highest revenue quarter, which is what we're guiding to again this year. We do expect a sequential increase in revenue in Q4. That tends to create more leverage and creates opportunity for an improvement in margin. The other thing typically, we also see is usually our European business tends to have its quietest quarter in Q3. That tends to be one of our higher gross margin areas and it tends to historically has come back quite strongly in Q4. And those two reasons combined have led us to traditionally have higher margin -- gross margin in Q4 than we do in Q3. And I don't see anything that would change that equation this year.

But -- but is -- is Hungary becoming -- even though those have been the traditional factors, I'm just trying to figure this, can Hungary keep carrying -- boosting those prospects to get more leverage in what would typically be considered a seasonally strong period anyway?

Sure. We do expect the Hungarian operation to continue to drive leverage. But, this is a longer term game. You're not going to see any kind of dramatic step function in the space of one quarter from that source. It's going to be more of an evolution than a step function in any short period of time.

Okay. And then --

We are expecting good gross margins in Q4, and obviously that's built into our earnings assumptions.

Okay. Just one last question. As you look into 2007, what factors do you think you need in place to get, say, revenue gains in the 20% plus area?

I mean, critical for us at a broad -- broad backdrop we've always said we want to grow at a multiple of the industry. And so we'd like to see decent industry growth next year. But we have really focused on trying to take control of our destiny by focusing on new product success and -- and I'll ask Dr. Truchard to add some commentary there.

Sure. We've been investing heavily in new products to expand our role in tests and measurements, our modular instrumentation, PXI, and PXI Express now, in the industrial area, industrial control area, and software area. We've been investing in products like FieldPoint and Compact FieldPoint and CompactRIO, all designed to take us into industrial space. We've been seeing design wins for customers that will OEM our products going forward. So in the space and industrial area, we've -- we've seen some nice design wins and we hope to continue that.

The -- so -- your longer term strategy is to not to so much to stay focused on the macro environment for test and automation as much as trying to find in-roads then into solutions and applications that can be used to get you there with the new products. Is that kind of fair to say?

Absolutely. I mean, we're cognizant of the macro environment, but our whole strategy in terms of ramping up our investment in R&D was to give ourselves greater control over our destiny and not to be so dependent. Obviously it's an impact on our business. We talk about it a lot. But over the longer term, the future of the Company's going to come from the new products, as Dr. Truchard laid out.

All right. Thank you very much.

And we'll now take a follow-up question from Antonio Antezano with Bear Stearns.

Thank you. In terms of end markets, have you seen or can you identify the best end markets that you have right now or that you saw in the third quarter at least?

Yes, Antonio this is John. Give you a little color on the industry side. In Q3, we saw strong growth in the mil, aero and defense industry as well as biomedical and consumer electronics. So those all saw good, strong quarters. On the flip side, communications was down as well as customers in the process industries.

(indiscernible).

So, again, it's -- as you've heard from us many times, the diversity of our business where none of those [end] industries more than 10% of our business, another key success factor.

Right. Right. And then given the strong cash position that you have, are you looking after acquisitions -- potential acquisitions or how is the pipeline or what type of priorities you have for the use of cash now?

It's Alec here, Antonio. Obviously our number one priority is going to be continuing to fund the dividend that we've already established and that's something that I think everybody would expect. As we look beyond that we are actively examining acquisitions, but we're being very selective. As has been our historical practice. So we're focusing on opportunities that really leverage and strengthen the core platform. And although we have a long-term goal of 2% to 3% of revenue coming from acquisitions, that's something that's more of a guideline. And we're really focused on looking for the quality and the strategic fit as our main priorities. We will also be opportunistic in stock buy-backs if there -- if we perceive there's a significant gap between the market's valuation of the Company stock and our perception of the long-term value.

Thank you.

Thank you very much, Antonio. I appreciate it.

And it does appear at this time we have no further questions. I'd lake to turn the call back over to Mr. Alex Davern. Please go ahead, sir.

Thank you for joining us today. We will be presenting at the Bear Stearns Conference in New York on November 14th and at the Credit Suisse Tech Conference in Scottsdale on November 28th. We look forward to perhaps seeing you there. Thank you very much.

And that does conclude today's conference. We thank you for your participation, and have a great day.