National Instruments Corp (NATI) 2006 Q4 法說會逐字稿

Good day, everyone, and welcome to the National Instruments Corporation's fourth-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 7PM Central Time today and will end at midnight Central Time on February 6, 2007.

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

Good afternoon. During the course of this conference call, we shall make forward-looking statements regarding the future financial performance of the Company, including statements regarding our expected revenue and earnings per share, future 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 Form 10-Q for the quarter ended September 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 our GAAP and 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 and thank you for joining us. Our key points today are record quarterly and annual revenue, record quarterly and annual net income, and strong acceptance of our industrial and embedded platforms.

We turned in a solid performance in Q4 in all regions of the world, with strong growth of our software and hardware products across a diverse set of applications. In our call today, Alec Davern, our CFO, will review our financials; John Groff, 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. We are pleased today to announce record quarterly and annual revenues and record quarterly and annual net income. Revenue for Q4 was $181.5 million, a record quarter and a 14% increase over Q4 2005. Revenue was up 11% sequentially from Q3.

Revenue for the quarter was up 15% year over year in Europe, up 13% in Asia and was up 13% in the Americas. Revenue from our instrument control products declined by 5% year over year in Q4 compared to a 1% year-over-year increase in Q3. We believe this slowdown in instrument control reflects a stronger compare with Q4 2005 and the recent slowdown in the traditional test and semiconductor capital equipment markets. Instrument control now represents 10% of our revenue, down from 12% in Q4 last year.

The net year-over-year impact of acquisitions on revenue this quarter is immaterial at approximately $500,000. The remainder of our product portfolio, i.e., our virtual instrument products, had 16% year-over-year organic revenue growth, the strongest performance of the year. The continued strong organic growth of our virtual instrument products, despite the slowdown in the Global PMI, validates our strategy of heavy investment in R&D to drive new product success.

GAAP fully diluted earnings per share for Q4 was a quarterly record of $0.30, with GAAP net income of $24.4 million. Non-GAAP net income for the quarter was also a record at $28 million, up 23% from Q4 2005, with fully diluted earnings per share of $0.34. Our non-GAAP operating margin came in at 18.3% of revenue, with net margin of 15.4% of revenue. Both are the highest margin percentages since 2000.

We are pleased to have continued to deliver good year-over-year revenue growth in Q4 with very strong operating leverage. Included in GAAP and non-GAAP net income for Q4 are a couple of items, one positive and one negative, which were not included in our guidance. First, included in operating expenses was a $490,000 charge to patent litigation to increase our existing accrual, which we recorded in Q4 2004, to cover the cost of our ongoing patent case with The MathWorks. The stay on this case was lifted in Q4, and the charge represents the increase which was needed to our existing accrual to cover the additional costs we believe will be incurred to take this case through trial.

Secondly, as a result of late extension of the R&D tax credit by Congress, our GAAP and non-GAAP effective tax rates for the fourth quarter were lower than the rates we had recorded for the first three quarters of the year. Congress' late approval resulted in us reducing our Q4 tax provision by $547,000 to reflect the retroactive benefit for the first nine months of the year. This brought our effective non-GAAP tax rate to 21% for Q4 and 23% for the full year.

Now, looking at our full-year results, today we reported record annual revenue of $660 million, with revenue growth of 15.5% in U.S. dollars and 16.1% in local currency. Our non-GAAP operating income for the year was a new record of $105 million. Non-GAAP net income for the year was also a new record at $87 million, a 35% increase year over year.

Record annual revenue combined with strong operating leverage allowed us to report this 35% increase in our non-GAAP net income for the year, increasing our non-GAAP operating margins from 14% in 2005 to 16% in 2006, the highest operating margin percentage since 2000.

Now, looking at the non-GAAP income statement for Q4 in more detail, non-GAAP gross margin in Q4 was 75.4%, up from 73.9% in Q4 last year. This improvement is attributable to good software sales, the continued transition of 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 margins in each of the last three quarters.

Non-GAAP total operating expenses in Q4, including patent litigation, were $103.6 million, up 16% year over year. Included in total expenses for Q4 is approximately $1 million related to the decision to move the whole Company to an annual raise cycle in October. Traditionally, NI has done raises twice a year, in April and October, and for several years, we have been considering a move to an annual cycle in line with common industry practice. The impact of this decision increased our Q4 total operating expenses by $1 million more than our historical cycle. This decision will also impact our Q1 expenses.

Non-GAAP R&D expenses were up 21% year over year to $28.7 million in Q4. Software development expenses capitalized in the quarter amounted to $1.1 million compared to $2.3 million in Q4 last year.

Now, turning to the balance sheet, in line with the forecast from our conference call in October, inventory days decreased to 155 days from 172 days in Q3. As of December 31, 2006, the Company had $250 million of cash and short-term investments, up $27 million from $223 million last quarter.

Today, the Company announced that the Board of Directors has approved a $0.01 increase in the quarterly cash dividend to $0.07 per common share. Additionally, the Company announced that the Board of Directors has approved a new share repurchase plan, increasing the number of shares that the Company is authorized to repurchase to 3 million.

Now I would like to make some forward-looking statements concerning our seasonal expectations for Q1 and 2007. Given the reduced strength of the JPMorgan Global Purchasing Managers' Index during Q4, we currently expect the industrial economy to be weaker in the first half of 2007 than it was in 2006. Our seasonal pattern for the last few years has been for revenue in Q1 to decline from 5% to 7% sequentially from Q4.

As a result, in recent years, approximately 19% of the Company's annual profits have been recorded in the first quarter and over one-third of the annual profits have been recorded in Q4. Currently, we expect revenue for Q1 2007 to be in the range of $167 million to $175 million. This compares to revenue of $155 million in Q1 last year. We currently expect that GAAP fully diluted earnings per share will be in the range of $0.18 to $0.23 per share for Q1 versus $0.15 in Q1 last year.

Non-GAAP fully diluted earnings per share for Q1 is expected to be in the range of $0.22 to $0.27 per share, and this compares to non-GAAP fully diluted EPS of $0.20 in Q1 last year.

On a separate note, given that Congress has already approved the R&D tax credit for 2007, we're guiding to a 23% non-GAAP effective tax rate for 2007.

These are forward-looking statements. I must caution you that actual revenues, earnings and effective tax rate could be negatively affected by numerous factors, such as any decline in the global economy, delays in new product releases, expense overruns, manufacturing inefficiencies, tax law changes and foreign exchange fluctuations.

In closing, I would like to thank all of NI's employees for a very good financial performance in 2006, with record revenue, record profits and strong cash flow. With that, I will turn it over to John Graff, Vice President of Marketing.

Thank you, Alec. We are pleased to end a record year, with record quarterly revenue in Q4. Our investment in R&D over the past few years has fueled strong growth across many products, including record revenue in Q4 for data acquisition, distributed I/O, modular instruments, PXI, software, signal conditioning and machine vision.

Our success in larger systems sales built around product platforms like PXI, CompactRIO and Compact FieldPoint continued in Q4, as our average order size came in at $3240. This, combined with a record number of orders in Q4, demonstrates that we are continuing to take our products to a broader set of customers while generally increasing our share of wallet at existing customers.

Our record revenue in Q4 for data acquisition products was driven by our continued investment in higher-performance and easier-to-use products. Our USB data acquisition products have enjoyed tremendous success over the past few years, strengthening our leadership position in portable, easy-to-use measurement.

In Q4, we further strengthened this position with the introduction of two additional USB data acquisition devices, adding to our family of over 40 products. Our highest-performance USB data acquisition platform, CompactDAQ, which is built on our C Series architecture, continued to see very strong adoption in Q4, as customers took advantage of its measurement capabilities and an easy-to-use compact form factor. Since it fills the previously underserved opportunities in benchtop test and validation, a wide range of end user customers have selected CompactDAQ for diverse applications such as remote monitoring, benchtop electronic test, and in-vehicle data logging.

In addition to end users, we are pleased with the number and variety of OEM opportunities that CompactDAQ is designed into, including machine monitoring and sensor measurements.

We saw record revenue in software for the quarter, driven by the continued strong adoption of the LabVIEW platform. We were especially pleased with very strong sales of LabVIEW FPGA, which is taking us into new industrial and embedded applications. At NI Week, we released LabVIEW 8.20, building upon the product's success as a robust development platform to help engineers design, prototype and deploy their systems.

In anticipation of the Windows Vista launch, we have been preparing LabVIEW and our complete software portfolio so NI customers can transition smoothly and have access to the tools, resources and knowledge required to migrate to this new operating system.

While LabVIEW is obviously a key component of our software portfolio, there are several complementary NI software products that have enabled our hardware platforms to enter new application areas. For example, in Q4, we introduced new versions of DIAdem, our data analysis and data management software; LabWindows/CVI, our text-based test and measurement software; and Measurement Studio, our set of software tools for Microsoft Visual Studio users.

The adoption of our entire family of software products was reflected in strong development system revenue growth as more customers adopted and standardized on NI software. For example, Airbus selected LabVIEW and DIAdem as its European-wide standard tool for processing wind tunnel test data. With DIAdem, Airbus test engineers automated time-consuming, repetitive analysis procedures and streamlined the data reporting process to reduce analysis time and make important engineering decisions for their airliners sooner.

Another customer, Motorola, standardized on TestStand, our test executive software, to reduce their cost of test. TestStand had previously been used in the Motorola cellular base station group, and the management team in charge of standardization was impressed with the return on investment gained from using TestStand in this function.

In Q4, our distributed I/O products, including CompactRIO and Compact FieldPoint, achieved record revenues on very strong growth as more industrial and embedded customers took advantage of graphical system design. The core of our embedded and industrial platform is LabVIEW Real-Time and LabVIEW FPGA. With LabVIEW's graphical programming, customers can create high-performance rugged and reliable systems with embedded hardware platforms such as CompactRIO and PXI, opening up new opportunities for design wins.

For example, in machine control, one customer, Euro Electronics, an Italian manufacturer of heavy machinery, used CompactRIO and LabVIEW FPGA for high-speed motion control of servohydraulic cylinders used in an aluminum die casting press machine.

We are pleased with the adoption of CompactRIO by our partners, as they've integrated the rugged platform into their machines, designed custom modules for the platform, and used it for prototyping their own products. In Q4, three of our alliance members created new modules for CompactRIO, adding a wide variety of functionality to the platform for automotive, aerospace and military in-vehicle applications.

In Q4, NI announced the release of the new cRIO-9012 high-performance real-time controller in collaboration with Freescale Semiconductor and Wind River. The controller is based on Freescale's PowerPC processor and Wind River's VxWorks real-time operating system to deliver fast performance while maintaining the ruggedness, reliability and low cost of the CompactRIO platform.

The companies are working together to help engineers simplify embedded system development through graphical system design. The collaboration on this CompactRIO controller illustrates the three companies' ongoing strategic relationship dedicated to improving the development of embedded devices.

In Q4, PXI products delivered record revenue, showing continued strength as a market-leading modular test platform. As the PXI standard enters its 10th year, we are pleased that some of the largest test and measurement companies have joined the PXI platform, validating PXI's importance as an industry standard in automated test.

In Q4, PXI had success across all ends of the performance spectrum, from lower-cost DC measurement capabilities to high-end RF test modules. By offering a complete modular system at a low cost, PXI-based low-frequency measurement systems are an accepted standard for DC electronic measurements, offering significant benefits when compared with incumbent technology that in many cases is over 15 years old.

When combined with our software for high-frequency applications, PXI is uniquely suited to tackle the demanding high-end digitization required by today's military, aerospace and communications industries because it is based on PC-based technologies. As higher-performance analog to digital devices are released from silicon vendors, members in the PXI Alliance can incorporate these technologies quickly into new PXI products.

Over the past year, military aerospace has been one of our best customers of PXI-based modular instrument products. In Q4, we were able to successfully close with our partners some large opportunities, including one for in-the-field diagnostic and measurement systems and another one for carrier-deployed aircraft testers.

We are excited about opportunities for NI and PXI in mil aero applications. The Department of Defense, through the Navy's [NIX] test program, has specified that future automated test equipment use an architecture built on modular hardware and reconfigurable software called synthetic instrumentation. For over 20 years, NI has been building a successful business around software-centric test systems and modular hardware. In fact, a recent report by Frost & Sullivan, a leading market research firm, stated, "Often industry participants use the term synthetic instrumentation and virtual instrumentation interchangeably. In reality, synthetic instrumentation is a subset of virtual instrumentation."

Two other areas that had strong growth in Q4 were sound and vibration and digital test. In Q4, we announced the industry's first high-speed digital I/O instruments for PCI Express. Using this high-performance bus, the new digital I/O boards can directly stream data to and from the host processor at full data rates up to 200 megabytes per second. These devices open up new application areas, including interfacing the memory devices, emulating communication protocols, and testing image sensors and display panels.

In summary, we're very pleased to deliver record revenue for the quarter and the year. As we look back on Q4 and 2006, we are pleased with the growing adoption of virtual instrumentation and test and measurement, as well as the success of graphical system design in industrial and embedded applications. We're pleased with the growth in new customers, as well as our ability to capture more revenue through our system-level platforms. Our results for 2006 give us confidence as we look ahead to 2007.

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

Thank you, John. I would like to start by congratulating all of NI's employees for another record year in 2006, with record revenues and net income. This represents the 29th year of revenue growth in the Company's 30-year history. Our virtual instrumentation products continue to perform well, with significant progress made in advanced technologies such as LabVIEW FPGA.

I'm pleased with the significant progress in system-level design in both virtual instrumentation and embedded industrial applications, with the success of advanced technologies for graphical system design such as LabVIEW FPGA and our highly leveraged C Series hardware architecture.

With the latest release of LabVIEW, we continue to deliver on our vision of graphical system design with our software platform creating more complex devices from RF instrumentation in wireless test systems to digital instrumentation for emulating hardware devices. The FPGA capabilities in LabVIEW, when combined with CompactRIO and PXI, have opened new opportunities in the industrial and embedded space, in addition to addressing new applications in test.

Now engineers can not only replace custom electronic designs in embedded systems such as autonomous vehicles or industrial machines, but they can implement customized modulation schemes, special signal processing, bit error rate testing and order analysis, all in customizable hardware on our world-class modular instruments.

This is all part of our embedded and graphical system design strategy and allows our customers to more efficiently design, prototype and deploy their systems while greatly improving their proponents.

I'm pleased that the software-centric view of virtual instrumentation is being adopted as the demands of next-generation systems align with the benefits of this approach. The idea of customizable software, coupled with general-purpose hardware, fits well with our 20-year history of providing graphical programming with LabVIEW and cutting-edge general-purpose hardware such as data acquisition plug-in cards, PXI modular instrumentation hardware or CompactRIO rugged control systems.

We have seen great success in industries such as military, aerospace, consumer electronics and communications, which require this kind of flexibility. We are also pleased that NI was chosen as one of FORTUNE Magazine's 100 Best Companies to Work For, making the eighth consecutive year the Company has appeared on this prestigious list. I'm proud of our innovation and our open culture, and I'm pleased that the employees recognize the Company's engaging environment.

This year, we made significant progress toward our operating margin goal, and I would like to thank all of our employees for their efforts. For 2007, we will leverage our existing infrastructure and expand our efforts in sales in R&D to continue to close larger opportunities and deliver higher performance measurement products. In the coming quarters, I will focus on driving new product innovation and maintaining budget discipline while positioning the Company for success over the long term.

Thank you for taking the time to join us today. We will now take your questions.

(OPERATOR INSTRUCTIONS). Antonio Antezano, Bear, Stearns.

In terms of revenue, it seems that it came within your own expectations, but when I look at the mix, North America came much stronger than we were expecting, given the weakening PMI index in the U.S., whereas Asia came lower than expected, given, I guess, the very strong performance in Asia in Q3. So if you can comment on that, please.

Sure. We were very pleased, obviously, with our performance in North America. I think we are seeing tremendous success for new products in North America and very good acceptance there. I'm certainly very pleased to see that.

In Asia, I think it's really a factor of just the history. We had a very, very strong Q3 in Asia, and Q4 last year was our strongest quarter for Asia -- excuse me, Q4 last year was our strongest quarter for Asia, with several big orders, so we had a really tough compare in Q4. For the year, Asia in 2006 was up 20%, and we really had tremendous execution there. So I think just the slowdown in year-over-year growth is just directly reflected to a very, very strong quarter in Q4 of '05 and is not an indication of the strength of the business overall.

All right. Now, in terms of margins, your gross margin was very strong also, very close to 75%, and is that being driven by maybe a change in mix, you have a stronger mix of software now than in prior years? Is there any kind of ongoing change going on in terms of your mix? And I guess in your outlook for 2007, you mentioned that there could be a good chance of getting to the 18%, but with, I guess, the week outlook that you have for the first half of 2007, how is that changing your outlook for margin next year, or sorry, this year?

Well, in terms of the margin question, certainly we are pleased to come in at 75.4% gross margin in Q4, and to have hit the 75% target the last three quarters in a row, so we feel pretty good about that. Software had a very good year in 2006, and we've had a number of other initiatives under way also to drive good gross margins. We certainly hope to see a good continuation on the success of the software business in 2006 as we go into 2007.

In terms of as we look out further, obviously we're really pleased to see record revenue and profitability in 2006, and we are optimistic about 2007. As we said in the press release, we're expecting to report record revenue and record net income again in 2007. For Q1, we're guiding to double-digit revenue growth, essentially, and a significant increase in EPS.

Our guidance for Q1 is tempered a little bit by two factors. The first is that Q1 of last year was our strongest revenue growth quarter of the year, so that's a pretty tough compare for us, and our compares get easier once we get past Q1. Then secondly, the Global PMI, as you mentioned earlier on, did weaken in Q4, especially in the U.S., and we did see an impact of this on our instrument control business in Q4.

As we look out further into 2007, we'd hope to see the PMI recover, which would make us more optimistic about a better topline growth as we get later in the year. And certainly for software, LabVIEW 8.20 has provided us a lot of good momentum, and we certainly are quite optimistic and will be focusing a lot of our effort on continued growth in software for 2007.

William Stein, Credit Suisse.

Just following up on that margin question, you guys have talked about hitting 18% operating margins in 2008. Do you have a target for 2007, and are you sticking to that 18% goal for 08?

Yes, the 18% goal for 2008 remains our goal, Will. We set that goal back in 2003 and we have come a long way since then, and we've increased our revenues by almost 60% since 2003 and obviously our operating margin has come up from 10% in '03 to 12% in '04, 14% in '05 and now 16% in 2006. We will be continuing to focus on driving operating leverage in 2007. We will be looking to increase our revenues faster than both our headcount and our expenses, and we will remain very focused on that commitment to try to get to 18% in 2008.

So no specific guidance for '07 or specific internal targets that you're looking ahead?

We certainly obviously had specific internal targets, but it's been our practice just to give guidance out one quarter.

Okay, and then just one more on the product side. Can you talk about any success you've had on the RF side, or perhaps it is not RF, but in cellphone testing equipment? I know that that is something that you guys have been targeting in the past. I'm just wondering if there are any successes to highlight there.

Will, this is John. To start, we continue to be really pleased with our growth and success with our RF instruments that are part of our modular instrumentation and PXI platforms. They continue to deliver growth rates significantly above the overall Company average. I can't -- we've seen success in cellphones, but we've seen success in many areas. As RF and communications technologies become more ubiquitous, it's driving a lot more demand for high-quality, fast-production testing of those devices. So I don't have specific data in front of me that's specific to the cellphone industry, but I can say we're very pleased in seeing strong growth in our RF instrumentation.

Mark Moskowitz, JPMorgan.

Thanks for taking my questions. Alec, first, can you help us out here? I think we all agree that the U.S., the PMI definitely weakened in the fourth quarter, but if we look at the non-U.S. sectors from a production perspective, it looks as if non-U.S. verticals are starting to show the first signs of slippage as well. Could that be another driving force behind why Asia slowed sequentially there for you?

I don't think so at this point. When we look, Mark, at the PMIs in Korea, in Japan and in China itself, in general, the industrial economies appear to be staying quite strong there at this point. And really, when we look at our trend in revenue in Asia, at least from my point of view, I really see this as an issue with a very tough compare in Q4 and don't see any systemic slowdown in our Asian business other than that tough compare. We had a number of big orders in Asia last year in Q4, which were a good stimulus for us, and I expect to see good continued execution out of our Asian operations as we look out into 2007.

Okay, so you're not concerned that, whether you look at it from a year-over-year perspective or even a sequential perspective versus the overall Company, that Asia is showing any sort of signs of acceleration?

Yes, Q3 was a phenomenal quarter for Asia, for our Asian business, so you've got to factor that into the equation as you look at all these numbers.

Sure. And it appears that National Instruments does have some offsetting factors here in terms of what's going on in the broader demand environment, particularly given all your new products and your new end markets that you're addressing. Can you give us a sense, if you could, of the change, if there has been a change, in terms of the overall contribution levels from new products introduced in the last six to 12 months? Has that changed at all?

The best way I can answer that question for you, Mark, is there definitely is some changes in the mix of our business. Our instrument control business, as I talked on the call, is down 5% year over year in Q4, and that tends to be the part of our businesses that's most tightly coupled to the trends in the PMI and the trends in the overall T&M sector, and I would also add in there capital equipment for semiconductors as well in that bucket.

And so you see the drop in the PMI in Q4 and you see our instrument control business responding to that, being down 5% year over year from a pretty good quarter in Q4 of '05. On the flip side, the rest of our product portfolio had its strongest revenue growth of 2006 in Q4, where we had 16% organic growth in our virtual instrument business, which I think really shows the strength of our product portfolio in that area and the success of our strategy of making very focused investments in that area as a way to drive market share gain.

So I take it as a very encouraging sign personally that despite the drop in the Global PMI during Q4, we saw the strongest revenue growth for this area, which is really where almost all our new product development is going on, that we saw its strongest quarter in the fourth quarter.

Okay, and then just lastly, can you maybe share with us your view in terms of what Microsoft Vista can do for you, or can it help or hurt your position going forward from a virtual perspective?

This is John. In general, as these commercial technologies like Vista, the bus platforms within the computers evolve, our approach of hardware and software is kind of uniquely positioned to take advantage of them. As I mentioned in the call, we've been working in conjunction with Microsoft have our software and products ready for the migration. Exactly how that will roll out, we'll wait to see about how quickly corporate customers will adopt Vista.

The plus side is as people start evolving to new computer platforms, many of which will have PCI Express and higher throughput, higher memory, that combined with our latest products opens up new application opportunities such as in digital test and communications that we mentioned. So in general, we view these as positive opportunities. We think we have an excellent track record in helping our customers migrate and move to new platforms like Vista.

Ajit Pai, Thomas Weisel Partners.

Congratulations on another really solid year. A couple of quick questions. The first is on headcount. Could you give us the headcount at the end of the quarter?

Sure. We finished the year at 4149 people, which is up 9% year over year, as against a 16% increase in gross margin dollars. So we're going to continue obviously to focus on that operating leverage and look to grow revenues faster in '07 than headcount also.

Right, and then when you are looking at the reason why you changed your compensation increases being twice a year to once a year, and also looking at the fairly robust economy and sort of low unemployment numbers, is it becoming more difficult for you to attract talent right now? And is that what's driving some of this change, or is there something else that's going on?

We have a tremendous recruiting machine, and I think as you've seen from us being named to the Fortune's 100 Best Companies to Work For again in 2006, for the eighth year in a row, we really focus very hard on retaining and attracting the best and brightest talent.

Certainly, as we've been looking to make this change to an annual raise for several years, it does allow us to front-load a little bit here in the fourth quarter in terms of salaries, which we're very happy to do, given we've hit our 18% operating margin target in Q4 and the employees have made tremendous contribution towards yet another record year. So we're very focused on the attracting and retaining talent, and that's certainly something we're going to take very seriously as we go into the next few years.

Okay, and then just shifting to looking at the tax rate you talked about, I think you talked about a 27% tax rate for '07.

No, a 23% tax rate for '07.

Got it. Sorry.

What I was saying in the call is because Congress, they delayed and delayed and delayed and finally approved the R&D tax credit sometime in December last year, but they did it for two years this time, which is helpful. So we're guiding down our tax rate to 23% for next year from 24% we've have the first nine months of this year.

Right. And when we go back and you look at the past three years, typically in the first quarter, while your revenues are sequentially down, your gross margin typically improves in the first quarter. Do you expect to see a similar pattern this year as well?

That depends on a variety of factors such as what's going on with the dollar and various different factors at that particular point in time. So I would be more inclined to think of gross margin to being flat sequentially to plus or minus a couple tenths of a point.

One of the points I was trying to make in the call as we went through here is that as we've evolve as a company over the last number of years and our average order size has gotten bigger, we found that the sequential revenue growth in Q3 and Q4 have gotten stronger in the second half than they used to be. Q3 used to be a negative quarter, for example, sequentially. And that has led also to a more significant sequential decline over time in Q1. And we want to make sure that people get the geography of the earnings picture properly distributed among the year and that they have appreciated that change that we've seen in the quarterly mix of revenue and profitability over the last number of years.

Richard Eastman, Robert W. Baird.

A couple of things. One is, Alec, can you tell us what the percentage of sales is for the year or the quarter of orders greater than 20,000 -- large orders?

This is John. For the quarter, orders over 20,000 came in at 33%, so a third of our business is now representing these larger system sales.

Are these configured such and shipped such that you have a general sense of the industries that -- I don't know if I want to say early adopters, but the industries that maybe are preferring the systems at this point? Do you have a sense of that?

Yes, we can look. There's two primary areas that are driving that. One on our kind of traditional test and measurement space is really driven by the success of PXI, our modular instruments and then our core software position with LabVIEW and our other software tools, where we're just getting increased share of wallet to these customers in a market we've served for 20-plus years.

The second driver is our success in these new industrial embedded applications, and this is where platforms like CompactRIO, Compact FieldPoint, as well as PXI, now coupled with software tools like LabVIEW Real-Time and LabVIEW FPGA are getting designed into applications like embedded measurements, industrial machinery and other really new application areas for us that typically have a much higher average order size. So those are the two fundamental areas that are helping drive those system successes.

And just one other question in terms of the mix of business -- the embedded industrial applications that you referred to and Dr. T. referred to, how do you view that as a percentage of the business at this point? Because that -- it would seem to me a lot of the new product intros over the last few years have really been targeted at bolstering and broadening your product offering in that embedded -- industrial applications. Do that make up 20% of the business at this point?

Yes, Rick, again, you're absolutely right that a lot of the investments in the new product effort you've seen from us in the last few years is designed to help open up what we see as really significant long-term opportunity for us. As we've mentioned in the past, it's hard for us to exactly quantify it because products like LabVIEW and PXI can be sold into both research laboratory production test as well as these industrial applications. Having said that, looking at the mix of our products and some of the customer data, it's our estimate that we're now 20% to 30% of our business you could classify as serving these industrial and embedded applications.

John Harmon, Needham & Co.

I don't want to spoil a great year with this kind of question, but of course, it's one of those things I have to ask. How do you guys feel about this 20% revenue growth rate target? It certainly grew faster in '06 than in '05. Do you feel your growth rate is accelerating and in terms of your product portfolio, is there an acceleration built in there as well that could help get you to that growth rate?

Well, we were pleased to have another record year again, John, in 2006. Obviously we had a record now in 2003, 2004, 2005, 2006, and hoping for another here in 2007. We're certainly very focused on that revenue growth target. We came in at right about 16% revenue growth in 2006, which was obviously up from 2005, and I'm particularly pleased to see that our virtual instrumentation platform, which now obviously is the biggest part of the Company by far, had its strongest quarter in Q4 despite a weaker PMI.

Having said that, this has been a tough market the last four or five years overall for T&M companies recovering from the bubble of 2001. So frankly, delivering 20% the last five years has been much tougher than it was the previous five to 10 years. While I believe we have gained market share, a lot of market share in the last five years, and probably gained market share more rapidly this decade than at any time before, that overriding economic pressure in the industry has been a bit of a headwind.

Our strategy for that has been to try to separate ourselves from the economic impact on the industry by heavy investment in R&D to drive ourselves into new areas that are growing faster. And we've certainly seen the success of that in growing our virtual instrumentation product. We're going to continue that strategy. Now, whether or not we cause an acceleration or whether the economy will slow that down a little bit in '07, it's a little bit harder to predict, but we believe that that's a winning strategy and we're very focused on that.

I will ask Dr. Truchard to comment also on his thoughts on 20%.

Well, I think that's exactly right. Of course, it's been a tough industry over the last five years. We have been investing into new products. Those new products really made for a good year this year. We've seen success. We have validated many of our ideas about customers' needs and how we can extend LabVIEW's capability, and with the introduction of graphical systems design, we have seen the benefits of it both in our virtual instrumentation and in the industrial embedded area. So we're going to continue to focus on the opportunities for growth and we believe that's a very important strategy for us.

And what's the outlook for your instrument control hard business, given that more and more instruments these days are shipping with ethernet connectors and USB ports? Are customers buying into controlled instruments or current instruments that are shipping today?

This is John. We continue -- I think the biggest driver of GPIB is going to continue to be the overall health of the traditional instrument ATE business. There's a lot of existing instruments out there with GPIB, and so actually one industry editor just published an article that talks about GPIB was going to be here for a long time.

On the other hand, you're right that there's a trend toward new buses, ethernet, USB. You heard a lot about the significant growth we're having with our USB measurement products. So what I really kind of transitioned to is it's really back to software, and this is again where we think we are uniquely positioned as a software platform that lets customers choose between continuing to use GPIB and the long history of instrumentation there, or incorporating ethernet instruments or PXI, USB, PXI Express.

It's Alec here, John. I would like to maybe add on a couple of points to John's commentary. When you look at our instrument control business, as we talked at NI Week, over the last 10 years, our compound annual growth rate in the instrument control business now is about plus 1%. So it's been a fairly stable business for the last decade.

Obviously, as a company, we have been adapting to that transition, and what was 40%, 50% of our revenue is now down to 10% of our revenue as we successfully migrate those GPIB customers to become measurement customers of National Instruments, where we can capture a much greater share of wallet or much greater dollars per test application.

The other thing that tells is that instrument control, having been flat for 10 years, is still here 10 years later. And it's highly probable that we will still have a solid, good business in instrument control 10, 15 years from now.

David Yuschak, Sanders Morris Harris Group.

Congratulations on a good quarter. I just wanted to confirm something you said earlier, Alec. Did you say in the quarter it cost $1 million more in operating expenses because of the annual salary review?

Correct, Dave. We made that decision, and because we went from biannual to annual, effectively the scale of our pay raise in October was double what it normally would be in our normal cycle, and the impact of that is about $1 million in Q4. That obviously will bleed over into Q1 as well.

The same amount of impact potentially there?

Correct.

So looking, when you back that out, from an operating expense point of view, you turned in a darn good quarter again.

I think Q4 was an awesome quarter. I really, I can't emphasize enough how much I appreciate the effort of all the employees across the Company to drive our operating margin up by 60%, from 10% to 16% over the last three years, while growing the Company almost 60% on the top line, I think is a really phenomenal performance.

So looking at 2007 from an operating expense point of view, given the kind of performance you showed here in the fourth quarter and in the year, it's not likely we're going to see that without having to start adding more people again. Is that a fair assessment or not?

We would anticipate probably adding personnel at about 70% the rate of revenue growth in '07, which would be somewhat similar to what we did in 2006.

Okay, so you're still staying to that target of --

I firmly believe we still have leverage that we can make from the very significant investments we made in the first half of this decade. And our goal is going to be to try to drive that leverage and try to hit our 18% operating target in '08.

One of the things about the early part of this decade, we were playing a little catch-up after the bubble, where we were underinvesting basically in the new products, so we've done that over the last several -- the last five years, and now we feel we have a good base that we're working from. We've got software products that really are delivering a new level of capability to our customers with our graphical system design and RF and digital and embedded. And then we've got a new suite of [data] position products that serve the modern computers with USB and PCI Express. So we've done a lot of good investment to really make our product line have the right capabilities.

Ladies and gentlemen, this does conclude the question-and-answer session today. At this time, I'll turn the conference back over to our speakers for any closing remarks.

Thank you for joining us today. Dr. Truchard and I will be presenting at the Thomas Weisel conference in San Francisco next Monday, and we hope to see you there. Thank you.

Ladies and gentlemen, this does conclude today's presentation. We do thank you for your participation. You may now disconnect.