National Instruments Corp (NATI) 2007 Q2 法說會逐字稿

Good day, everyone, and welcome to the National Instruments Corporation second quarter 2007 conference call. Today's call is being recorded.(OPERATOR INSTRUCTIONS) You may refer to your press packet for the replay dial-in number and pass code. The reply will be available from 7:00 P.M. Central Time today and will end at midnight Central Time on August 2, 2007. 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. David Hugley, General Counsel. Please go ahead, sir.

Good afternoon. During the course of this conference call we should make forward-looking statements regarding the future financial performance of the Company, including statements regarding our expected revenue growth, non-GAAP operating margin, expected earnings per share, improvement in instrument control product sales, future product announcements, future growth for PXI, growth and investment in industrial and embedded applications, 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 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, 2006, and our quarterly report on Form 10-Q filed on May 8, 2007. These documents contain and identify important factors that could cause our actual results to differ materially from those contained in our forward-looking statements. With that I will now turn it over to the President and CEO of National Instruments Corporation, Dr. James Truchard.

Thank you, David. Good afternoon and thank you for joining us. Our key points today for Q2, are solid revenue growth, 22% net income growth, and strong sales of software, data acquisition, PXI, and distributor I/O products. We turned in a strong quarter in Q2, delivering solid revenue growth and excellent operating leverage. Growth was driven by many key product areas, including record revenue for USB data acquisition, RF instrumentation, and distributed I/O. 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. Today we reported quarterly revenue of $179.5 million, a 12% increase over Q2 2006. Fully diluted earnings per share for Q2 was $0.26, with net income of $21 million, up 22% year-over-year. This compares to our guidance of $0.23 to $0.28 per share. Non-GAAP net income was $25 million, up 22% from Q2 2006 with non-GAAP fully diluted earnings per share of $0.31 compared to our guidance of $0.28 to $0.33 per share. For Q2 2007, non-GAAP operating margin was 16.4% with non-GAAP net margins of 13.8%. Our non-GAAP results exclude the impact of stock-based compensation and the impact of amortization of acquisition-related intangibles. A reconciliation of GAAP to non-GAAP results is included as part of our earnings release.

For the first six months, we have delivered strong operating leverage, which has allowed us to report a 29% increase in non-GAAP net income for the first half. This performance has increased our non-GAAP operating margin for the first half of the year to 16% in 2007 from 14% in 2006. Our performance in Q2 builds on the excellent operating performance of the Company over the last few years and has positioned us well to achieve our goal of 18% non-GAAP operating margin for the full year.

Now looking at revenue in more detail, our Virtual Instrumentation and Graphical System Design products, which represent the vast majority of our product portfolio had 15% year-over-year revenue growth in Q2. This represents another quarter of strong year-over-year revenue growth for these products and an increase in their year-over-year growth rate. Our growth in Q2 was driven by the success of our new products, especially in the areas of software, data acquisition, distributed I/O, marginal instruments, RF, and PXI.

Additionally, we saw a $3.5 million sequential increase in deferred revenue on the strength of good, software sales in Q2. In contrast sales instrument control products while flat sequentially were down 8% year-over-year in Q2 compared to a 6% year-over-year decline in Q1. The decline in our instrument control products was related to a tough compare in Q2 and the weakness of the global PMI early in the quarter. With the improvement in the global PMI in June and easier compares, we are cautiously optimistic that we will see an improvement in the year-over-year performance in instrument control in both Q3 and Q4. On a regional basis during Q2, we saw growth in all regions. Year-over-year revenue growth was 19% in Europe, 14% in Asia, and 7% in the America, giving overall growth of 12%. Our growth in Asia was affected by a year-over-year decline of our sales in Japan and this is reflective of a weak Japanese PMI during Q2.

Now looking at the income statement in more detail, non-GAAP gross margins in Q2 was 76%, up from 75% in Q2 last year. R&D expenses were up 11% year-over-year in Q2, and software development expenses capitalized in the quarter amounted to $3.6 million compared to $2.8 million in Q2 last year. Also during the quarter, $2.1 million in previously-capitalized software development costs were amortized to cost of goods sold. Now turning to the balance sheet, inventory days increased -- excuse me, inventory days decreased to 155 days from 168 days last quarter on increased revenue and a slight reduction of inventory. As of June 30, 2007, the Company had $241 million of cash and short-term investments down $4 million from March 31. This is net of $39 million which the company used to repurchase 1.3 million shares of the Company's common stock at an average price of $29.69. The results on net of $5.6 million of dividends paid during the quarter.

As we have discussed in the past, the Company's priorities for the use of cash are for dividends, opportunistic stock repurchases, and acquisitions in that order. Given these priorities and a significant improvement in our operating performance, the Board of Directors has today approved an increase in our quarterly dividend to $0.10 per share from $0.07 per share previously. This $0.10 dividend will be payable on September 4, to shareholders of record on August 13. Additionally, today the Company announced that the Board of Directors has also approved a new share repurchase plan, increasing the number of shares that the Company is authorized to repurchase to 3 million shares as of today. We believe that the increase in our quarterly dividend and in our stock repurchase authorization reflect the prudent use of our cash and reflects management's confidence in returning to our model of 18% non-GAAP operating income. Now I would like to make some forward-looking statements concerning our expectations for Q3 and for Q4. We currently expect revenue for Q3 to follow a seasonal pattern and to be in the range of $179 million to $187 million. Due to the anticipated release of new versions of several key software products during Q3, we expect to see a $2 million sequential decrease in the amount of software development costs capitalized. We expect this decline in software development cost capitalized combined with a planned increase in head count to result in an approximately $3 million sequential increase in R&D expenses in Q3.

As a result, we currently expect a GAAP fully diluted earnings per share will be in the range of $0.24 to $0.29 per share for Q3. Non-GAAP fully diluted earnings per share for Q3 is expected to be in a range of $0.29 to $0.34 per share. For the full year , management expects to report a new annual record for revenue and for both GAAP and non-GAAP net income. Currently, the Company expects revenue for Q4 to be in a range of $200 million to $212 million. GAAP fully diluted earnings per share for Q4 is expected to be in a range of $0.34 to $0.40 per share with non-GAAP fully diluted earnings per share expected to be in a range of $0.39 to $0.45 per share. In Q3 and Q4 the Company expects the combined impact of stock-based compensation and the amortization of acquisition-related intangibles to be $0.05 per share per quarter.

Now before I leave the topic of future guidance I would like to review how we believe our seasonal earnings pattern will involve as we move closer to our non-GAAP operating margin goal. Over the last four years, we have significantly increased our non-GAAP operating profitability, moving from 9.5% in 2003 to 12% in 2004, 14% in 2005, and 16% in 2006. This has resulted in sequential gains in our third quarter non-GAAP diluted earnings per share that are greater than would be expected in our operating performance was stable at our model. As we moved to our goal of 18% non-GAAP operating margin, we expect our sequential earnings model for Q3 to move back to the seasonal earnings pattern we had seen pre-2001, which is for earnings per share to be relatively flat sequentially from Q2 to Q3 with a significant sequential increase in Q4. As 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, expense overruns, manufacturing inefficiencies and foreign exchange fluctuations.

In summary Q2 was a good quarter with good revenue growth and net income growth of 22% year-over-year. With that I'll turn it over to John Graff, Vice President of

Thank you, Alex. We turned in a strong performance in Q2 with revenue growth driven by continued strong success of our Virtual Instrumentation and Graphical Design products. While our instrument control products saw an 8% year-over-year revenue decline in Q2, the rest of our business saw 15% revenue growth, up from 13% in Q1. We believe this is indicative of growing momentum of our business in Q2, as well as the recent uptick in the industrial economy. These business trends are charted in the slides accompanying this call, which are also available on the Investor Relations' section of our Web site. Instrument control products now represent only 10% of our business. The decline in instrument control revenue in Q2 was much more pronounced than our BXI products than in our larger, high-volume GPIB business. BXI has historically sold to a relatively small number of customers, primarily military and aerospace accounts. While we saw a decline in our BXI controller business in mill aero, which is consistent with the decline of the overall BXI market, we were very pleased to once again see strong growth of PXI in this area in Q2. As our PXI business and mill aero grew in the quarter, we not only replaced the BXI controller business, but also captured more of the instrumentation content, thus increasing our share of wallet in these accounts.

Our investment in new product R&D over the last five years played a significant role in our revenue growth in Q2. With USB data acquisition, RF modal instrumentation, and distributed I/O products having record quarters. We were also very pleased with the continued strong growth of large system sales. Orders over $20,000 were up sequentially from Q1 and saw strong year-over-year growth, increasing our average order size to an all-time record of $3,330. Key to our system level success was the continued strong growth of PXI-based RF instrumentation and FPGA based CompactRIO system sales, which both posted record quarterly revenue in Q2.

Software growth in Q2 was driven in part by strong sales of volume license agreements, where customers had chosen to standardize on NI software and make it more widely available to engineers within a particular site, division, or company. Our focus on growing software and top accounts drove standardization and large contract renewals in accounts ranging from major Telecom companies to large government research labs. Software growth in the quarter was also helped by the extension of the LabVIEW platform and other NI software on to the Microsoft Vista operating system, as well as the release of the LabVIEW SignalExpress interactive measurement software in March. LabVIEW SignalExpress provides the acquisition and analysis power of LabVIEW through an interactive environment that does not require programming. This opens new opportunities for LabVIEW and bench top measurement applications, including instrument control and data logging, and helps drive strong unit growth of the LabVIEW platform in Q2. LabVIEW continues to see strong adoption and usage in university classrooms and labs around the world. One example is at the Lever Research Group, which is in the department of chemistry at Harvard University, researchers there recently, developed a LabVIEW and PXI-based system to detect specific bio-molecules and virus using nano wire arrays. The nano wires have potential application in detecting disease markers of breast and ovarian cancers, as well as pathogen used in biological warfare. According to the group the LabVIEW and PXI based system with less than one fifth the cost and one fiftieth of our (Inaudible) instrumentation system .

As I mentioned previously, we continued to see very strong growth in data acquisition, fueled by our expanding line of USB devices and our modular USB-based CompactDAQ system. The release of higher end USB devices has steadily increased the average selling price of our data acquisition devices over the past year and helped drive record revenue in Q2 for USB data acquisition. Many of our USB data acquisition devices, including CompaqtDAQ, leverage our C Series modules, which integrate connectivity, signal conditioning, and A to D converter. With over 30C Series module now supported on CompaqtDAQ, we're seeing success in applications ranging from bench top data applications to industrial and embedded systems. CompaqtDAQ and all of our USB data acquisition devices continued to successfully sell to first-time NI customers, further expanding the reach of virtual instrumentation and seating further platform opportunities. PXI continued to be a growth driver for our business in Q2 and we were pleased with the third straight record number of PXI system orders in the quarter. System growth in Q2 benefited from the success of a new low-cost integrated chassis and controller, which provides a new entry price point for PXI systems.

PXI modular instruments had another strong quarter as well, with growth led by very strong sales of our RF modular instrument, in addition to strong PXI switching and digital multimeter sales. This is the fifth year since our first RF product introduction and in Q2 our RF products had record revenue and triple digit revenue growth. RF sales were driven by large orders from design wins and applications such as spectral monitoring, as well as success with emerging wireless standards. We are very excited about new PXI opportunities and addressable applications with the introduction of PXI Express, which provides up to 45 times the bandwidth of PXI. In May we released the first digitizer and high-speed digital I/O modules for PXI Express, as well as an 18-slot PXI Express chassis. These products complement our previously released line of PXI express embedded controllers and data acquisition modules and all of these PXI express products are compatible with over 1200 existing PXI devices for more than 70 vendors. In addition of the sales successes, PXI and PXI express received very strong interest, at the fourth annual automated test summit held last month. Over 1800 attendees participated in the on-line event, which covered the latest trends and technologies in test and measurement and featured key partners, including Intel and Tektronix.

Industrial and embedded applications were again a growth driver for us in Q2, led by record CompaqtRIO revenue. CompaqtRIO and LabVIEW FPGA continue to see success in applications ranging from embedded data logging to unmanned vehicle control. In its third year since release, CompaqtRIO had triple digit revenue growth in Q2 and continues to pull our graphical system design approach into new areas and new applications. The oil and gas industry was a significant growth area for our industrial products in Q2. For example, Petrobras, one of South America's leading petroleum companies designed an HMI schematic system for its mud gas separator using LabVIEW.

Another example is PMX exploration and production, the leading oil and gas producer in Mexico that recently implemented LabVIEW for supervisory control of crude oil production and distribution across the country. To continue the momentum of NI graphical system design hardware and software in the oil and gas industry, we recently kicked off the oil and gas industry symposium. A series of day-long industry events beginning in May and will be held in 13 targeted cities around the world. Our FPGA software and hardware products continued to drive us into new applications in Q2 and have been key to some very large system successes, including custom digital protocol testing for mill aero, as well as deterministic control of high end machines. We also continue to see success with our FPGA-based devices replacing or even eliminating the need for custom hardware. One example is NASA's use of LabVIEW's FPGA software and hardware to test the James Webb space telescope, which NASA is planning to launch in 2013, to succeed the Hubbell Telescope.

Engineers at NASA designed an algorithm in LabVIEW FPGA to control 250,000 on board micro-shutters, which control light exposure to the telescope. The algorithm was deployed to FPGA base data acquisition device to acuate and test the shutters at 240 cycles per minute. David Ratchen, lead testing engineer at NASA Goddard Space Flight Center said, quote, LabVIEW FPGA and our series intelligent and data acquisition saved hundreds of man-hours and thousands of dollars. The decision to go with commercial, off-the-shelf hardware instead of a customer solution provided a more cost-effective method, end quote. In closing, we were pleased with our results in Q2 in both our broad-based high volume business as well as our system level test, industrial, and embedded business. Our strong investment in new product R&D continued to drive broad adoption of our software platform, very strong growth in USB data acquisition, further growth in penetration of PXI and modular instrument, and growth into new areas with our graphical system design platform for industrial and embedded applications. with that I'll turn it over to Dr.

Thank you, John. I was pleased with solid execution in Q2 across all areas of our business. Much of our success can be attributed to strong investment in R&D over the past several years, which has produced significant new products such as USB data acquisition, LabVIEW FPGA, CompaqtRIO, and PXI modular instruments. This aggressive investment strategy allowed us to further conduct traditional test, control, and design markets. Over the same period we made significant efficiency improvements in other areas of business, which are allowing us to maintain this strong R&D investment while improving non-GAAP operating margin towards our long-term goal of 18%.

I recently attended the annual design automation conference as well as NI-hosted embedded technology forum, which tracked machine builders and embedded designers. At both events, it was evident that our vision for graphical system design is gaining further traction and adoption. Companies that in the past used NI hardware and software to test their designs are now using LabVIEW to design and prototype as well. Our strong awareness and large customer base for LabVIEW is an asset we will leverage as we grow the LabVIEW platform as a productive tool for customers designing, prototyping, and deploying a broad range of systems and devices.

Already the capabilities of LabVIEW FPGA and CompaqtRIO have helped us sell into some very demanding applications, including custom digital testing in mill aero, and hi-end machine control. I believed our graphical system design approach is very well-positioned to take advantage of new trends and technologies in test, industrial, and embedded applications. In particular, the inherently parallel graphical approach of LabVIEW makes it uniquely suited for execution on multicore processors and refigure FPGAs. With the shift toward multicore processors on the PC and continued adoption of FPGAs and embedded designs, LabVIEW allows users to benefit from parallel processing with little to no change in their code.

This is not possible with traditional programming tools. Multicore FPGA and other new technologies will be key topics at this year's NI week held in Austin from August 7 to 9. NI week will once again be a key event for new product releases and technology demonstrations in addition to providing an important forum for customers, members of the press, partners and exhibitors to learn and discuss the latest trends and technologies in test, control, and design. I will kick off the conference with a keynote on Tuesday, August 7, addressing the state of the union of graphical system design, including new technology trends and customer successes. Our investor conference will immediately follow. We look forward to seeing you there. There in summary I am pleased with solid revenue and earnings growth in Q2 and our investments in new products resulted in record revenue in key areas and we are well positioned for a successful second half of the year. Thank you. We will now take your questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question comes from Antonio Antezano with Bear Stearns.

Good afternoon, everyone.

Hi, Antonio. How are you?

Good. I guess, operating margins, your target remains 18% for the full year, so that would assume an improvement in the second half. What is going to drive that -- mainly focus in Q4 where you have the significant growth in revenues?

Yes,, Antonio, that is correct. When we've been at 18% as a more stable model back in 2001. We typically saw -- we generally see a decline in revenue from Q4 to Q1. So in that time frame, we would see our lowest operating margin in the first quarter and it would jump a little bit in Q2 as we see revenue growth increase sequentially.

That was our historical pattern. Revenue growth in Q3, revenue would be pretty flat in Q3, but we often saw an increase in cost as a result if NI week and recruiting for engineering at that point in time. Because of the budgetary buying cycle of our customers, historically we'd see a significant increase in revenue in Q4 and because we have had a fairly significant amount of fixed cost in our expense model, historically when we were steady at 18, we saw a pretty significant jump in profitability in Q4, with operating margins significantly higher than 18 in the fourth quarter. Then that would revert back to the model again the following sequential Q1, you would see the model repeat itself. That was the pattern we would see when we were steady at 18.

Now that you are giving guidance for Q3 and Q4, your assumption behind that earnings guide us is that you get an 18% operating margin for the full year?

We're working toward that goal. And that would mean we're going to see greater an 18% operating margin for the Q4 if we hit our goal.

Okay. In terms of your guidance for Q3. If I take the mild point of your guidance, that would imply 11.5% year-on-year growth to be precise versus 12% in Q2. So why would you -- what scenario would you see a slowdown, especially with a lower PMI, as you mentioned has recovered in recent months.

That's certainly a good point. We saw a recovery of the global PMI in May and June, which were glad to see. We also do believe as I talked on the call that we should see a more favorable environment for instrument control business in the second half. The one thing that gives me some pause, obviously, we saw a slowdown and negative year-over-year growth in our Japanese operation in the second quarter. If you -- Japan had grown at the same rate in Q2 as it did in Q1, we'd be at 14% in Q2, so that one element that gives me a little bit of caution. I think our group in NI Japan management is doing an outstanding job of execution in what's a tough PMI environment in a Japanese economy. We want to be a little cautious until we see how things go and the PMI looks in July and August. We do believe that the environment is improving as we look out to the second half and we are looking for revenue growth to accelerate as we move towards Q4.

One final question. As you hit the 18% operating margin, then I guess this question was asked before last quarter, but what would be your strategy going forward in terms of SG&A spending? Would you keep that 18% operating margin and maybe try to boost topline growth with increased SG&A?

Yes -- put it this way, we would expect to hope to generate leverage in certain areas of our business once we get to 18%. We're not going to stop looking for leverage in areas like manufacturing and SG&A and other places. If we are successful in generating that leverage, we are going to focus on investing that back into the business to try to stimulate top line growth in the areas we believe will provide the greatest top line benefit. We have a very strong product portfolio, and we certainly see areas where we believe, for example, field sales force deployment, etc., where if we were spending more, we would get more growth. So we would like to switch our focus more heavily in 2008 towards the top line if we're successful in meeting our 2008 operating margin goal in 2007.

I'll go back to the queue.

Thank you, Antonio.

We'll take our next question from Ajit Pai with Thomas Weisel Partners.

Good evening. The first question with growth rates. At your investor conference, you talked about addressing the goals of 18% operating margin and 20% revenue growth, when you discussed the corporate strategy. After that, I think at least in today's conference call as well as when you confirmed our attendance there, you haven't talked about the 20% revenue growth. Can you walk us through whether that's a goal that's changing now and how you expect to get there? That's the first question. Then the second question is just very broadly, when you're looking at your end markets, you've talked about a weak Japan, you've talked about a pretty strong Europe. In North America as well as in Asia, non-Japan Asia, you're seeing all the semi cap equipment vendors and semiconductor industry disappoint. Is that something that you think is going to be a significant headwind going into the second half?

Let me answer the second half first. You had a lot in one question. As we look out, we were pleased to see a pickup in Europe in Q2 and a pickup in growth in North America in Q2. Non-Japan Asia grew very well for us at 25% so we were very happy with that. Obviously, there's been some disappoint as you said, around semiconductor cap equipment in Japan and in Asia in general both from guys Teradyne, also at Mantes who brought out their results last night. We do sell into customers in that space and certainly, we saw that impact in our instrument control business in Japan in Q2.

So that will be a little bit of a headwind for us, but we think overwhelmingly as we look at the global PMI, as we move out to Q4, that we should be able to overcome that headwind and see improved revenue growth as we move towards the fourth quarter. That would be the point I would like to push on there. In terms of our strategy and our corporate goals of pushing our growth to 20% revenue and 18% operating margin, those remain the corporate goals we're driving the business too.

Obviously, we've had a very hard and laser-like focus on getting back to 18% over the last three or four years and you've seen the execution of the entire company on that goal has been phenomenal and I'm very proud of everyone in the organization as we move towards that goal. We will be talking at NI week and investor conference about our strategies to work to accelerate our topline growth. That will be the core focus of the organization and the senior management team as we look forward from here. And we continue to remain optimistic that we can put in place the strategies that will help us achieve that goal. I will say in caveating that, we need the industry to grow in the high single-digits for us to have a realistic shot at 20%. We certainly didn't see that kind of performance out of the industry in Q1 or Q2. I believe we very successfully out grew the overall T&M space by at least 10 points in the second quarter, as we did in the first quarter and we're certainly going to push to keep that separation of very high growth relative to the space overall as we move forward.

Got it. And then the follow-up would be just the stock-based compensation. Could you give us a break down between R&D, G&A, and sales and marketing for that?

Ajit, I don't have that in front of me. Perhaps we can talk offline or do it in an e-mail exchange. It will be very, very similar to last quarter and previous quarters.

Got it. I'll get back in queue.

Pretty stable. I just don't have it with me at the moment.

Okay, thanks.

Thank you. Next we'll hear from Rob Mason with R.W. Baird.

Alex, you noted in the third quarter that head count would be an incremental, sounds like, $1 million. Now, what is current head count?

Right now, we're at a little under 4400 people, so 44,369, so up about 9.5% year over year.

And the plans for the balance of the year --?

Q2/Q3 time is a prime hiring time for us for engineering talent, for our field sales force and for our engineering group. We will continue to be and are very aggressive right now in terms of recruiting talent into the company. We feel very optimistic about the portfolio products we have available to us and as we gear up towards pushing more dollars into customer-facing activities, we will be continuing to bring that talent into the business as we move forward.

One of the key points I'm trying to make on the call here, I want people to understand, obviously, our cost model is impacted by the timing of the release of new products for us on a software side. Last year we saw a significant increase in R&D costs from Q3 to Q4 related to the release of software product last year. Obviously, software product releases changes timing a little bit here and there. We expect to see that biggest sequential impact this year from Q2 to Q3 with a smaller increase sequentially in R&D from Q3 to Q4 that we saw last year.

Okay. Just with respect to head count, should we assume the 9% growth rate holds through the year?

I think that's a good working assumption to work with.

Okay. Quickly, I believe you're consolidating some shipping points in Hungary.

Correct.

I was just curious where that stands? What degrees of extra costs or inventory might be involved there and when it might be finished?

We don't anticipate any increase in inventory. Some of you might be aware from conversations in the past, we are and have as of July 1, effectively shipped our distribution point for shipments into the United States for the NI-branded business from Austin, Texas, to DeBrason, Hungary where we have our European distribution center and where we do our production. A team on both sides of the Atlantic has done an outstanding job in the last four weeks of pulling it off, shifting the inventory, and we've been shipping products into our U.S. customers now for the last two, three weeks. This is something we had piloted with NI Canada, our sales into Canada in January and with sales to our ancillary brands Measurement Computing and IOTech, two of the companies we bought a number of years ago, they've been receiving their shipping into the U.S. customers direct from Hungary for almost a year now.

So we feel real confident in execution there. The team has done an outstanding job and we're optimistic at this stage we won't see any hiccups in Q3. The value to the Company from a cost point of view is a key element, but also from a value to our customer. By the consolidation of our inventory distribution locations, right there at the point of production, we expect to be able to continue to offer best-in-class delivery to our customers globally.

Okay. Just if I could squeeze one more in. Is R&D still expected with respect to the 8% -- excuse me, 18% operating margin goal, is R&D still expected to be 16% of sales?

That is correct.

Roughly? That's the target. Do you happen to have that number on a non-GAAP basis?

I don't have it right here in front of me. We can chat about that later. The target for 16% non-GAAP and R&D is not something we plan on changing going forward.

Okay, all right. Thank you.

Thank you. Moving on we'll hear from Will Stein with Credit Suisse.

Hi, good afternoon.

How are you?

Good. Can you spend a little time discussing component pricing and the current lead time environment and perhaps your expectations going forward?

Sure. We're real pleased with pricing where we are at the moment. We've turned in our highest gross margins at 76% since the third quarter of 2000. So as we've gained scale and improved our relationships with our key vendors and also made some sourcing decisions, we've been able to leverage that from a price point of view very effectively. At this point we are not seeing any change in the market in terms of lead times or pricing on components from what we've seen in the previous six months. So I don't have anything significant in terms of sequential change that we've observed.

Okay, great. Thanks.

Thank you very much.

Thank you. Next we'll go to Mark Moskowitz of JPMorgan.

Yes. Good afternoon. Alex, I was wondering if you could help us out in terms of getting back to the crossover to the 18% operating margin range. Given the R&D piece is still core to the D&A of the Company and you're going to still stand around 16%, earlier John made some comments about an increase in traction with new NI customers. Can you maybe give us a point of reference in terms of how much new or incremental customers could help drive this crossover into the 18% operating margin in terms of your ability to pull back on SG&A potentially is this.

Sure. As we look forward, we have been promoting and driving an opportunity into new market areas around areas like embedded, graphical system design and RF and other modular instrument aspects of our business. As we go forward our long-term model is to reduce G&A, for example. We're currently running above 7%. Our long-term goal is to try to bring that down toward 6% as we go forward. As we're able too -- if we're able to develop leverage in that area and perhaps also in the gross margin area, we will really be wanting to redeploy that available dollars back into those customer-facing aspects that we think can fully leverage the product investments we've made, while keeping our operating margin target at 18. So while we're under 20% in terms of revenue growth, we're not going to try to exceed the operating margin of 18. We're going to try to keep it at that level and reinvest those dollars back if growth. I'll hand it over to Dr. Truchard and John to talk about our vision for those new markets.

This is John. First, in terms of acquisition and new customers, that's kind of a basic philosophy that we always have baked into our D&A as we make decisions on new product R&D. We're looking at a combination of areas where we can get more share of wallet and existing applications or customers we serve, but then we also look for ways to expand in the new application, new areas. Those of you that make it down to the investor conference, this is what we're going to focus a lot of our discussion about, how we see opportunity to increase share of wallet in our core test of measurement space. There are success in automated tests like digital and RF that we mentioned in the call, and we also see lots of new opportunity for us in the industrial and embedded. This is where our graphical system design approach, we're really pleased with the early success and I'll turn it over to Dr. T to comment on that.

Sure. Over the last five years, we've been doing several things. One, we've been refreshing our product line and adapting to the adoption of USB in the marketplace. But we have also been investing in the strategic initiatives with graphical system designs, industrial embedded applications. We've made great progress on both of those while simultaneously bringing back gross margin -- our operating income. So going forward, we'll be looking to work at the percentage levels of R&D we're at while completing areas we've been working in graphical system design and working on the new customers, which we've established some very nice examples and we'll be talk about talking about more of those examples at NI week.

I appreciate the three-pronged response to that first question. Maybe we could shift the gears here to the embedded industrial control piece. Maybe I missed it. Did you say how much of your total revenues came from that growing segment? And then the second part of to the question would be how should we think about that business coming something of a mid-30s, even 40% of revenues down the road?

This is John. In past conference calls, we've mentioned that we have a rough estimate anywhere from 20 to 30% of our business we could classify as being industrial and embedded. As we mentioned in the past, it's hard for us to quantify it exactly, primarily due to the fact that our products, both hardware and software can be sold in such a breadth of applications. So things like LabVIEW and LabVIEW real-time on the hardware, PXI and CompaqtRIO are sold in the research, in the manufacturing test, as well as industrial. We survey our customers regularly and frequently and we get an idea from them in terms of how many of them tell us their application is in what we might classify as industrial and embedded.

So those are some of the factors we use to estimate that 20 to 30%. We do see a significant and large opportunity in that space. Now, we're not at a point to give you guidance in terms of when that might be 30 to 40%. Hopefully at NI week through some of the things you'll see and the customer success we talk about, you'll get an idea that we do see it growing faster than the rest our business and we'd expect to continue that over the next five to ten years. As Dr. T. mentioned, that's driving a lot of the product R&D decisions.

Lastly, Alex, is there ever the potential for an argument where National Instruments could decouple from the global PMI? It seems relative to a lot of other companies out there, your revenue base and your gross margin and profit profiles have been a lot more sturdy than a lot of peers out there?

Mark, given that I'm an Irish guy, there's always the potential for an argument. I think that that is clearly the strategy that we're looking to pursue. I don't believe we'll have ever fully separate ourselves from the PMI because we sell to such a broad base of customers and have such a diversified user base, but our goal of course is to stand out significantly from the rest of the industry and I think we've clearly done that in the last six months, probably last six years, but certainly in the last six months, and we've had a rate of growth that's been significantly greater and we'd like to continue that. Our goal should be over time, if we're successful in our strategy that we can grow at a higher rate for the same average level of PMI. That's certainly what we're going to try to execute on as we go forward and we'll talk more about our strategy for trying to promote growth longer term at NI week, the week after next.

Thank you.

Thanks very much, Mark.

Next we'll hear from John Harmon with Needham and Company.

Hi. Good afternoon.

Hey, John, how are you?

Good. My first question that contains two questions so I can get around your guideline --

That's the average so we'll let you go with that.

That would be par for the crowd I'm in. I've never seen you give two quarters of guidance before. What's the reason behind that? And you talked about Q2 to Q3 EPS being generally flattish historically. Certainly, revenues have been flattish, but you're looking for high single-digit millions of revenue coming up sequentially. Is that from that mysterious new software product introduction?

The reason I'm giving two quarters of guidance at this point in time is that the timing around the release of our primary software releases this year has shifted a little bit from last year and I wanted people to be able to get visibility into that increase in R&D expenses into third quarter, which is something that really occurred in Q4 last year and have them be able to appreciate and separate out that impact. We're very excited to have these products which we will be releasing here in the third quarter. I can't get really specific beyond that point, but the release earlier this year than last year is certainly a positive in our view, so we wanted people to understand that dynamic. I also wanted to point out, as we look into next year and as we move to hopefully steady state of an 18% operating model that that will cause a slightly different dynamic in terms of the sequential earnings numbers than we've seen than perhaps over the last couple of years. So that's the answer to the first question. Now I can't remember what your second question was.

You haven't heard it yet. The second question is regarding your use of cash, you said that you preferred dividends over share buybacks and you doubled your dividend. Is that related just to the recent strength in your stock price or from some other philosophy?

Well, the number of inputs there, obviously, we increased our dividend from $0.07 up to $0.10 a share. So when you look at that increase, it is certainly significant. We have obviously as a company been very successful and very significantly growing our non-GAAP operating income and net income over the last four years. We have increased the dividend steadily over that time, but not at the same rate as our profitability has grown, so we are looking at a little bit of a catch-up and we now feel increasingly confident in our goal of trying to hit 18% this year, as we said in the call.

To hit 18% this year, we needed to increase our operating margin by two full points for the year, and we're execute on that for the first half of the year, so obviously we're more confident on that. Our cash flow generation and our cash capital requirements from a capital expenditure point of view are modest, which gives us the ability to generate a lot of cash relative to earnings and so we see dividends as a very tax efficient way to return that was to the shareholders have certainly have had a number of inputs from large institutional shareholders that have expressed that view over the course of the last number of years. On buybacks, our strategy is to be opportunistic. We bought back about 2.4 million shares over the first half of the year at an average price of I think around $28 a share roughly. Our strategy is to be opportunistic. We want to certainly be -- have the capacity to buy stock and certainly the board has supported us in our strategy for the deployment of cash and we don't anticipate changing those cash priorities in the short-term.

Great. Thank you very much.

That is all the time we have for questions. I would now like to turn the call back to Mr. Alex Davern for any additional or closing remarks.

Thank you for joining us today. We look forward to seeing you at NI week. That's Tuesday, August 7, and we'll even exciting show so hope to see you there. Thank you.

This concludes today's call. We thank you for your participation and have a wonderful day.