Oct 25, 2007
Executives
David Hugley - Corporate Counsel James Truchard - President & CEO Alex Davern - CFO John Graff - VP of Marketing
Analysts
Antonio Antezano - Bear Stearns John Harmon - Needham& Company Anthony Wesley - JP Morgan Terence Whalen - Citi Investment Research Ajit Pai - Thomas Weisel Partners David Yuschak - SMH Capital Richard Eastman - Robert W. Baird
Operator
Good day, everyone and welcome to the National InstrumentsCorporation Third Quarter 2007 Conference Call. Today's call is being recorded.You may refer to the press packet for the replay dial-in number and passcode.
Thereplay will be available from 7:00 pm Central Time today, and will end at midnightCentral Time on November 1st. With us today are Dr.
James Truchard, President and ChiefExecutive Officer; Alex Davern, Chief Financial Officer; and John Graff, VicePresident of Marketing. For opening remarks, I would now like to turn the conferenceover to Mr.
David Hugley, Corporate Counsel. Please go ahead, sir.
David Hugley
Good afternoon. During the course of this conference call,we shall make forward-looking statements regarding the future financialperformance of the Company, including statements regarding our expected revenue,revenue growth, GAAP and non-GAAP net income, non-GAAP gross margin, non-GAAPnet margin, expected earnings per share, impact of stock-based compensation andamortization of acquisition related intangibles, recently introduced productsand expanding opportunities for growth.
We wish to caution you that such statements are justpredictions, and that actual events or results may differ materially. We referyou to the documents the Company files regularly with the Securities andExchange Commission, including the Company's Annual Report on Form 10-K for theyear ended December 31, 2006, and our quarterly report on Form 10Q filed August7th, 2007.
These documents contain and identify important factorsthat could cause our actual results to differ materially from those containedin our forward-looking statements. With that, I will now turn it over to the President and CEOof National Instruments Corporation, Dr.
James Truchard.
James Truchard
Thank you, David. Good afternoon and thank you for joiningus.
Our key points for Q3 are record revenue up 12.4% year-over-year, verystrong growth of our C Series products and platforms, and the introduction of anew version of our LabVIEW software platform. We turned in a strong quarter in Q3 delivering recordrevenue growth and strong operating leverage, but record sales in key productareas including USB data acquisition, distributed I/O, modular instruments andthe PXI platform.
In our call today, Alec Davern, our CFO will review ourfinancials; John Graff, our Vice President of Marketing will discuss ourbusiness, and I will close with a few comments before we open up for yourquestions. Alec?
Alex Davern
Good afternoon. Today, we reported record quarterly revenueof $184.4 million, a 12.4% increase over Q3, 2006.
Net income for Q3 was $21.5million, up 15% year-over-year, with fully diluted earnings per share of $0.27.This is above the mid-point of our guidance of $0.24 to $0.29 per share. Non-GAAP net income was $25.8 million, up 17% from Q3 2006with non-GAAP fully diluted earnings per share of $0.32.
This is also above themid-point of our guidance of $0.29 to $0.34 per share. For Q3 2007, non-GAAP operating margin was 16.3%, withnon-GAAP net margins up 14%.
A reconciliation of GAAP to non-GAAP results isincluded as part of our earnings release. In reviewing Q3, we are particularly pleased by the successof our system level platforms has enabled us to deliver record revenue andsolid earnings growth, despite the significant decline in the Global PMI duringthe quarter.
For the first nine months, we have delivered record revenueand strong operating leverage, which has allowed us to report of 25% increasein non-GAAP net income in what has been a challenging year for the industry sofar. This builds on the outstanding operational performance of the Company andall it's employees over the last four years, and positions us well to makesignificant progress towards achieving our goal of 18% annual non-GAAP operatingmargin.
Now, looking at revenue in more detail. Our virtualinstrumentation and graphical system design products, which represents a vastmajority of our product portfolio, had 14.3% year-over-year revenue growth inQ3.
This represents another quarter of strong year-over-year revenue growthdriven by our success in the areas of software, data acquisition, distributedI/O, modular instrument and the PXI platform. Additionally, we saw a $2.1 million sequential increase indeferred revenue on the strength of good software sales in Q3.
In contrastsales of our instrument control products, which now represent less than 10% ofour revenues were down 3% year-over-year in Q3. We believed at that time in ourinstrument control sales is related to the weakness of the Global PMI duringthe quarter and reflects the challenges faced by the industry in Q3.
On a regional basis, during Q3 we saw a growth in all ourregions. Year-over-year revenue growth was 20% in Europe, 15% in Asia and 7% inthe Americas,giving overall growth of 12.4%.
Our worldwide growth was, again, affected byyear-over-year decline in our sales in Japan. This decline was similar towhat we saw in Q2, and was reflective of the weak Japanese PMI during Q3.
Now, looking at the non-GAAP income statement in moredetail. Non-GAAP gross margin in Q3 was 75.4%, up from 74.7% in Q3 last year.The modest seasonal decline from Q2 is related to a shift in the regional mixas a result of the summer pause in Europe.Additionally the cost of transitioning our U.S shipping operations to Hungaryhad a slight negative impact on margins in Q3.
We expect non-GAAP gross marginto be approximately 76% in Q4. R&D expenses were up 15% year-over-year in Q3.
Softwaredevelopment expenses capitalized in the quarter amounted to $1.7 million, downfrom $3.6 million in Q2. This reduction in software development costcapitalized is equivalent to 1% of revenue and relates to the release ofLabVIEW 8.5 in Q3.
Also during the quarter $2.2 million in previouslycapitalized software development costs were amortized to cost of goods sold. Now turning to the balance sheet.
As of September 30, thecompany had $276 million of cash and short terms investments, up $35 millionfrom June 30th. This cash balance is net of $8 million in dividends paid duringthe quarter.
For the full year our cash and short term investments were up by$26 million, and this is net of $68 million used to repurchase stock, and $19million paid in dividends during the first nine months. Now I would like to make some forward-looking statementsconcerning our expectations for Q4 and the full year.
Currently the company expects revenue for Q4 to be a newquarterly record, and to be in the range of $200 to $210 million. GAAP fullydiluted earnings per share for Q4 is expected to be in the range of $0.34 to$0.40 per share.
And non-GAAP fully diluted earnings per share for Q4 isexpected to be in the range of $0.39 to $0.45 per share. With non-GAAP gross margins of approximately 76% andnon-GAAP operating margins of between 19% and 22%.
For the full year of 2007 weare expecting to report record revenue approximately 76%, non-GAAP grossmargin, non-GAAP operating margin of between 17% and 18% and non-GAAP netmargin of between 14% and 15%. In Q4, the company expects a combined impact of stock-basedcompensation and the amortization of acquisition-related intangibles to be approximately$0.05 per share.
As these are forward-looking statements, I must caution youthat actual revenues, gross margins and earnings could be negatively affectedby numerous factors, such as any decline in the global economy, delays in newproduct releases, expense overruns, manufacturing inefficiencies and foreignexchange fluctuations. In summary, Q3 was a good quarter with record revenue growthand non-GAAP net income growth of 17% year-over-year.
Before I turn it over to John Graff, Vice President ofMarketing, I want to let you know that I will presenting at the Bear Stearnsconference in New York on November 13thand the Credit Suisse Technology Conference in Scottsdale on November 29. I look forward to seeing you there.
John Graff
Thank you, Alex. Weturned in a strong performance in Q3 with record revenue up 12.4%year-over-year.
Growth was driven by keyproduct areas, including USB data acquisition, distributed I/O, modularinstruments and the PXI platform. Our investment in new product R&D over the last fiveyears, continue to play a significant role in our revenue growth in Q3.
With strong adoption of LabVIEW software andvery strong growth of our FPGA based CompactRIO systems. Our mature instrument control business was slightly negativein Q3, inline with the broader test and measurement market, while the rest ofour business saw better than 14% revenue growth.
Our system level business had another strong quarter in Q3led by PXI and CompactRIO systems sales. We saw a record number of orders over $20,000, which accounted for over35% of bookings in the quarter.
This ledto a record average order size of nearly $3,400. These results are attributable to the success of our modularPXI and C-series based CompactRIO platforms, as well as, our increased focus onbuilding and leveraging expertise in our field sales channel.
Growing our fieldsales channel will a focus of investment moving forward to better identify andpursue large opportunities. A key highlight in Q3 was our annual NIWeek Conference,where we announced several key new products, including the nearest version ofour LabVIEW platform, LabVIEW 8.5.
We saw a record attendance in NIWeek thisyear, with over 2,500 customers, partners, trade editors and investors joiningus from 5,300 countries around the world. We had very strong attendance at ourproduct and technology sessions, including over 900 people in the RF andwireless session, and over 1,000 people in the graphical system designsessions.
In addition, a record number of companies exhibited at theNIWeek Expo, which continues to transform NIWeek from a user conference into acomprehensive global industry event. Much of the excitement at NIWeek thisyear, was centered on the release of LabVIEW 8.5.
This new version is optimizedfor use on new multicore processors that are common on today’s PCs. Theinherent parallelism in graphical nature of LabVIEW 8.5 makes it uniquelysuited for development on multicore machines, allowing users to benefit fromparallel processing with little to no change in their code.
This is notpossible with traditional programming tools. The early response for LabVIEW 8.5 from trade editors andthe readers has been very positive.
Journalists from leading technical tradepublications that feature LabVIEW 8.5 in articles about the benefits ofmulticore programming in test industrial and embedded applications. Mark David, Group Editorial Director for Electronic Designmagazine reported “LabVIEW 8.5's, it’s multithreading capabilities areparticularly powerful, and NI particularly Prescient in taking this approach,as we move into the era of multicore processing.”
After seeing a demonstrational LabVIEW 8.5, Eric Heikkilaembedded systems lead analyst for VDC Corporation said, "As per multicoreprogramming LabVIEW is far ahead of the curve. Many tool vendors still have totake time to address and organize how they will achieve effective multicoreprogramming in their environments, while these tool providers are stillfiguring that out, LabVIEW has already solved it".
The release is already benefiting customers as well. The MaxPlanck Institute in Germanyis using LabVIEW 8.5 with their Tokamak system for fusion research, and hasrealized dramatic performance benefits by leveraging a multicore system.
Leadresearcher Dr. Louis Giannone, said "in the first design stage of ourcontrol application program of LabVIEW, we have obtained a 20 times processingspeed-up on an auto-core processor machine over a single core-processor".
In addition to strong software growth in Q3, many of our keyhardware products, including, our products and platforms based on C seriesarchitecture had a very strong quarter as well. Our C series technology wasfirst to introduced with our Compact RIO platform in 2004.
Since then we'veadded many new C series products including USB data acquisition devices, ourCompact DAQ USB data acquisition system in 2006, as well as several new Cseries modules. The C series architecture has given us not only greattechnology leverage across a broad range of products but also significantrevenue growth.
Our USB data acquisition devices including the C seriesbased Compact DAQ system had record revenue in Q3 and continue to sell to ahigher percentage of new customers than the company average. We continue to talk with new users with the release of sevennew USB data acquisition devices in the quarter, broadening our offering to atotal of 45 devices to address the wide-range of bench tops and portablemeasurement needs.
The addition of these new USB data acquisition devicesfurther increased the average selling price for USB data acquisition in Q3. PXI revenue reachedin all time record in Q3 as we saw the record number of PXI systems for thefourth consecutive quarter.
Growth of PXI systems benefited from continuedstrong sales of the new low-cost integrated chassis controller, as well asstrong early sales of new PXI Express chassis and controllers. PXI modular instruments also had a record revenue in thequarter, driven by very strong growth of high-speed digitizers and dynamicsignal analyzers.
In it's 10th year, PXI continued to be a growth driver forthe Company and continued to expand in the new opportunities and applicationsaddressable at PXI Express. At NIWeek we announced the new PXI Express embeddedcontroller with a dual core processor, in addition to new high density harddrives for data and bandwidth intensive test applications.
Together, ourmulticore processor based controllers, PXI Express chassis and new high-densityhard drives enable PXI to serve very high-speed data streaming applications,that previously were only possible with dedicated proprietary systems. In describing how a company benefits from the latest PXItechnology, Mark Jewell Wireless Business Development Manager at AmFax said,"With LabVIEW and a PXI dual core embedded controller, we are achieving a5x speed savings versus our previous generation, GPIB racked instruments fortesting RF modules and cell phones."
Our industrial and embedded business had another strongquarter in Q3, driven by record revenue for FPGA based CompactRIO systems, aswell as, new embedded design wins. One recent CompactRIO design win was Sanarusmedical, where designers developed a medical machine to treat non-benign breasttumors with a novel minimally invasive procedure.
Their machine uses CompactRIOto control a cryogenic breathing process to destroy and remove affected tissues. Engineers at Sanarus chose CompactRIO over a customoutsource design to speed time to market while minimizing development risk.
Inour FPGA based hardware and software are also controlling one of the world’smost complex scientific experiments. The European organization for nuclear research, morecommonly known as CERN is the world’s largest particle physics laboratory, andis nearing completion of the large Hadron Collider.
Build as the most powerfulinstrument ever built, the Particle Collider is 27 kms in diameter, andproduces a proton beam with as much energy as a 400 ton train traveling at 200miles per hour. When operation begins in May 2008, researchers will use theCollider to recreate and study the conditions in the universe immediately afterthe big bang.
CERN will use more than 100 PXI chassis for running LabVIEW realtime, and FPGA based control modules to monitor and control the particle beams. CERN engineers chose PXI due to its small size and lowercost then a traditional VME and PLC based systems, and the use of NI FPGAhardware enables CERN to avoid having to design custom controlled hardware.
We gained further traction in industrial and embedded spacein Q3 with the release of new versions of LabVIEW FPGA and real time modules inaddition to the new multicore capabilities in LabVIEW 8.5. Last month, LabVIEW 8.5 was awarded the Embedded SystemsConference Best in Show Award from BBC.
The award noted the NationalInstruments for “continue to draw interest from embedded development themeslooking to rapidly build, optimize and debug designs based on increasinglycomplex multicore hardware environments.” Winning this award at one of the world’s foremostconferences on embedded technology and design is a strong testament to NI’searly success and adoption in the embedded market, and illustrates the growingopportunity we have in this space for LabVIEW as a systemdesign tool.
In closing, we were pleased with recordrevenue in Q3 with strong growth in our broad- based software and data acquisitionbusiness, as well as, record system level sales driven by our PXI andCompactRIO system platforms. In addition to the release of LabVIEW 8.5 for multicore andFPGA based systems, help drive broad adoption of our software platform andfurther strengthens our position in the embedded market.
With that I’ll turn it over to Dr. T.
James Truchard
Thank you, John. When we first shared our vision ofgraphical system design three years ago, we described how graphicalsoftware-centric approach to test industrial and embedded design helps abstractcomplexity to make engineers and scientists more efficient.
As a result of this abstraction of complexity, LabVIEW isbeing used in a broad array of applications from 10-year old studentsprogramming LEGO Mindstorms robots to leading physicists that CERN programmingthe world’s most powerful instrument, and the award to study the origins of theuniverse. Q3 marked another major milestone in the evolution ofgraphical system design with the release of LabVIEW 8.5, the inherentparallelism of LabVIEW makes it uniquely positioned to leverage multicoreprocessors with little to no change in the way users develop their code.
Unliketext based programming languages, that are serial in nature, LabVIEW lets userseasily visualize and program parallel applications, so engineers and scientistswith little and no programming background can spend more time problem-solvingand less time writing code. As Intel and others continue to advance processor technologyby adding additional CPUs on a single chip, the benefit of LabVIEW’s intrinsicability to target multiple cores should become even more compelling.
Graphical system design built on 20 years of success withvirtual instrumentation by combining flexible graphical programming softwarewith increasingly powerful technology, such as multicore processors andreconfigurable FPGAs. This unique approach allows us to further disrupttraditional test industrial and in embedded markets, while expanding ouropportunities in these areas.
New products and technologies, such as PXI Express, modularinstruments, a LabVIEW FPGA and CompactRIO, have helped us sell into verydemanding applications, including experimental physics applications and thehigh end machine control, that previously required custom hardware design. I believe that our graphical system design approachsurpassed industrial embedded applications, as they find a unique anddefensible position for National Instruments.
With recent successes insemiconductor, RF and [No Error] test applications, as well as embeddedsuccesses with applications, search is on, our vision for graphical systemdesign is being validated for both virtual instrumentation as well embedded. I was pleased in Q3 with solid execution across all areas ofour business which helped drive record revenue and strong net income growth forthe quarter.
Growth was led by record revenue in many product areas, includingrecord revenue for USB data acquisition, distributed I/O, modular instrumentsand the PXI platforms. Continued efficiency improvements over the last four yearshave allowed us to maintain a strong R&D investment, while improving ournon-GAAP operating margin towards our goal of 18%.
In summary, I am pleased with record revenue and strongearnings growth in Q3 and believe we are well positioned for success in Q4 andinto the next year. Thank you.
We will now take your questions.
Operator
Thank you. (Operator Instructions) And our first questioncomes from Antonio Antezano with Bear Stearns.
Antonio Antezano -Bear Stearns
Good evening.
Alex Davern
Hi Antonio, how are you?
Antonio Antezano -Bear Stearns
Good. The first question is more market related, I guess,now that October is almost over, I was wondering, what is that you are seeingin the quarter, when we look at the Global PMI, it was September it was stilldeclining and for this month the, the Flash PMI for Europewas very weak, again.
So, I was wondering what is -- where you are seeing in, Iguess, for your business in October and how confident in the quarter?
Alex Davern
Well, it’s Alex here. I will take a stab at that question.Obviously, you know, we’ve based our guidance on expectations and building inour expectation on the economic data that we have access too, and obviously welook at that PMIs, as you all are aware.
And we have seen the Flash PMI forOctober. As we look out, we are also taking into mind the run rates of ourbusiness, the seasonal patterns we have seen in the past, and the trends wehave seen in different product lines.
And as always, we built all of that intosetting our expectations for Q4.
Antonio Antezano -Bear Stearns
Then, as we go forward, I guess, for next year theexpectations are, again, market related: That the euro would slow down maybe,with some recovery in the US and Japan. But on under those assumptions, to whatextent you can keep those profit margins, especially gross margin, because, Iguess, to some extent there was a positive thing by the Pound strengthening in Europe this year.
Alex Davern
Well, I guess my answer to that would be two things,Antonio. First, you know, we have seen the industry and many of our peers havea pretty tough year this year.
And we have managed to sustain our revenuegrowth and then improve our revenue growth as we have gone through the year,despite some of the noise that’s been out there around, you know some of ourpeered companies, and the PMI being up and down, etcetera, during the course ofthe year end where we really are focusing our attention is the success we havehad in building our business especially around these new system level platformsthat really validates the investments we’ve made in R&D over the last sevenyears and is giving us the ability as we did in Q3 to grow our business,despite the drop in the PMI during Q3. So as we look out in the future, we are really focused onwhat we control.
As we’ve talked about in our investor conference at NIWeek inAugust, we are focused on our buyers now as we come close to 18%, is toaccelerate our investments in our technical field sales and marketingresources. And we believe we have a very rich product portfolio.
And we will becontinuing to invest in that, to try and take advantage of the opportunitieswe’ve opened up over the last couple of years, and that’s how we’ll approachnext year.
Antonio Antezano -Bear Stearns
Thanks. Just one follow a very detail question, your G&Aspending was a bit high from what I expected I think close to 8%.
What is yourexpectation going forward or there was some any kind of one-time off there or?
James Truchard
We did have some restructuring charge in our G&A numberfor Q3 and for Q2, and that did cost some modest increase there. We wouldexpect that rate of increase to weaken or ease off a little bit as we go intoQ4 and then into Q1 next year.
Antonio Antezano -Bear Stearns
Okay. Thank you.
Operator
With Needham & Company, John Harmon has our nextquestion.
John Harmon - Needham & Company
Sorry, how are you? Good afternoon.
James Truchard
Hey, John, how are you?
John Harmon - Needham & Company
Good. Just my two questions are, if you could just, similarto the last question, you made some pretty negative comments about the state ofthe test and measurement industry this year linking them to the performance ofyour instrument control cards which were down during the year, I don’t thinkthings are quite that bad out there, is that really what you intended to getacross?
And my call, if you could, you spoke so quickly in the introduction ifyou could repeat your expectations for next year, please?
Alex Davern
Sure. Let me take the first part first.
We have not givenany specific expectations for next year, John. What we are saying is that webelieve we’ve done a good job this year of sustaining our revenue growthespecially in Q3 despite the downturn in the PMI.
We have lot of new productplatforms where we have a lot of room to run and good revenue growth, and we’llbe continuing to commit lots of resources behind those as we go into next year.We will be giving more detailed guidance about our expectations for next yearin the January call. In relation to state of our instrument control business andthe overall market space.
Even I judge our competitors generally on their orderflow, and that’s how I look at the state and health of the market, and so Ilook at year-over-year relative order flow as a deciding factor. Our instrument control business saw some improvementsequentially.
We were minus 8% in Q2, minus 3% in Q3, which is we guided in ourJuly call that we expected the year-over-year decline to moderate in Q3. So we saw some sequential improvement in that, but from myperspective of looking at this industry and looking at the order flow, I thinka number of companies have had a pretty tough time this year.
John Harmon
Okay. Thank you.
Needham& Company
Okay. Thank you.
Operator
Mark Moskowitz with JP Morgan has our next question.
Anthony Wesley - JPMorgan
Hi, this is [Anthony Wesley] calling in for Mark.
James Truchard
Hey, Anthony. How are you?
Anthony Wesley - JPMorgan
Good, good. Have a couple of questions here.
First in termsof your business that you classified is the industrial embedded. I think you'vespoken 25%, 30% of your business is related to that.
What is the sales velocityof that segment? Should we assume it's above the 14% that you named for thevirtual instrumentation and graphical system products?
John Graff
This is John. As you mentioned, you know, we estimate thatthe industrial embedded is approximately -- the range is 20 to 30.
It’s hardfor us to quantify it exactly by the nature of this. Some of the products likeLabVIEW or PXI or CompactRIO are sold both in the test applications, as well asindustrial embedded.
Having said that though, we do feel we are getting a lot oftraction. We're newer in industrial and embedded applications.
So to answer toyour question, we do believe, it is at a higher growth rate, there is somevelocity. We are seeing some design wins, which is the couple we mentioned inthe call.
And we believe there is a lot of potential for us, and so we continueto invest in the product development to fill out our platforms, by servingthose applications, as well as some investment in sales resources to go afterthose opportunities.
Anthony Wesley - JPMorgan
So what are we going forward then? The swing factors forthat segment, how should we look at the, for example your system order size, isthat above or below the corporate average for that segment?
How should we lookat next year?
John Graff
Yeah. It’s again, we can't quantify it exactly, the natureof what I said earlier, but in aggregate, the order sizes are larger than thecompany average.
And so those play a key role in driving that increase inrecord average order size and obviously they played the key role in the recordrevenues for the quarter.
Anthony Wesley - JPMorgan
Okay. And then, moving on to your instrument controlproducts, can you talk a little bit about the impact of the semiconductorequipment market to that segment, as of this quarter and then what you arelooking forward to next?
John Graff
Well, this is John. Sort of, we did see weakness obviouslyin the semiconductor segment.
We have traditionally had an element of ourinstrument control business that fills into the semiconductor capitalequipment, as well as the semiconductor test vendors. And so, obviously, wesell from weakness there in the quarter, and also on the year.
Anthony Wesley - JPMorgan
And, your view next quarter?
James Truchard
Yeah. We don’t relate to talk to breakout the expectationsfrom a product line basis, but we did say, Antonio, or Anthony, in the Julycall, is that we expected the performance of instrument control business toimprove in the second half of 2007, because we would get easier comparison.
Thedownturn on the spending capital really started in the second half of lastyear, and we certainly saw that improvement come to fruition in Q3, andsuddenly the comparison do get easier sequentially as we go into Q4. So, we’llsee how that plays out.
What I would emphasis now, although it’s the mostsensitive part of our business to the overall PMI, it is now a pretty smallpart of our business, and it's below 10%.
Anthony Wesley - JPMorgan
Okay, thanks. And then one last question, can you talk alittle bit about the currency impact here, revenues and margins this quarter?
Alex Davern
Sure, our strategy and currency is being generally, weadjust pricing periodically to respond to exchange rates. And we did some ofthat as we went through 2007.
On the headline rate, I think we were at about10% local currency growth. So, about two point swing there and some of that iscompensated by, for example, a decrease in pricing as we did in Europe, but we’ll tell you to focus on a dollar numberbut it's about a 2% differential.
Anthony Wesley - JPMorgan
Okay. Thank you.
Alex Davern
Thank you, very much.
Operator
We will now hear from Terence Whalen with Citi InvestmentResearch.
Terence Whalen - CitiInvestment Research
Thanks for taking my question and a good job in a difficultenvironment.
Alex Davern
Thank you, Terence.
Terence Whalen - CitiInvestment Research
So my question relates I may have missed this, did you givea stock buyback number this quarter? Unidentified Company Representative No, we did not buy stock back during the third quarter,Terence.
Terence Whalen - CitiInvestment Research
Okay.
Alex Davern
When I was going through the cash situation for the fullyear, I did mention the stock buyback for the full year.
Terence Whalen - CitiInvestment Research
I see, I see. Okay, thanks.
Alex Davern
I should say, looks for the first nine months?
Terence Whalen - CitiInvestment Research
Right. Inclusive of 1Q and 2Q.
All right. Okay.
Then thesecond question is one on seasonality, I think, that Europeis seasonally your strongest geography in the fourth quarter and growth maybe30% sequentially sometimes, is that a sort of level of sequential growth thatwe could expect maybe based on your corporate growth of roughly 13%?
Alex Davern
Well, I guess, that's the question, Europe certainly hasbeen, the key driver for sequential growth in Q4 over the years and we haveseen, the pattern of revenue being double-digit sequentially in Q4, verysteadily executed throughout the last ten years or so, even in 2001, forexample, we saw that same pattern come to fruition. So the momentum that hasbuilt behind our pattern around the seasonal spending and yearend budgetsspending has tended to be pretty strong.
And through Q3, we certainly had noreason. And obviously, we are giving -- building into our guidance today, theexpectation that will recur in 2007.
Terence Whalen - CitiInvestment Research
Okay. Then, one last one, if I could.
On Asia-Pacific,Japan, I think, you’ve mentionedin the past that Japanwas over 50% of that region. Obviously, Japanis under growing Asia ex-Japan want to get an update roughly of what mix ofbusiness is Japanfor overall revenue?
Thank you.
Alex Davern
Sure. Let met just make a correction there.
The Asia/Japanbusiness, of course, is our largest geography within Asia-Pacific, but it isnot over 50%. It’s less than 50%.
But it is the largest single country inAsia-Pacific for us. We saw some modest improvement in our sales from theyear-over-year performance in Q3.
We have seen a slight double-digit decline inQ2. And we saw high single-digit in Q3.
So some modest improvement, despite thefact that the PMI clearly worsened in Japan in Q3. And so that was whatwe saw in the quarter.
I can’t remember if there was a second part to your questionthat I missed?
Terence Whalen - CitiInvestment Research
Just current proportion Japan of total RASB.
Alex Davern
We do not disclose by country. So the best I can tell you isthat it is the largest country in the region but it is less than 50%.
From aperformance in the rest of Asia, and let me also say for our Japan team, you know, we have seen some prettybad numbers from some of our peers in Japan. And I feel like our Japaneseteam is on a very good job of executing it in a very tough environment.
And weare proud at the efforts of the team that it continued to execute goingforward. And in the rest of Asia we've seenrevenue growth above 20%, so that’s continued in Q3.
And there certainly seemsto be a lot of momentum in the emerging countries in Rest of Asia. And we willbe continuing to expand our investment in those regions to take advantage ofany opportunities to gain market share that we may there.
Terence Whalen - CitiInvestment Research
Great, thanks and good luck.
Alex Davern
Thank you.
Operator
Ajit Pai with Thomas Weisel Partners has our next question.
Ajit Pai - ThomasWeisel Partners
Good afternoon.
James Truchard
Hi, Ajit, how are you?
Ajit Pai - ThomasWeisel Partners
Good. Couple of quick questions, the first one I think, Johnmentioned the metric I think orders of about $25,000 and was 35% of orders.
Youmeasure that in terms of number of orders or did you measure that in terms ofthe revenue in orders?
John Graff
That 35% was in the revenue.
Alex Davern
It was orders over 20,000, Ajit, not 25,000.
Ajit Pai - ThomasWeisel Partners
Okay. So that’s 20,000.
Could you compare that metric that35% relative to the prior quarter as well as the quarter a year ago and give ussome color as to what that was about 3 years ago?
John Graff
Unfortunately Ajit, I don’t have that in front of me, but wecould follow-up and we have shared that in the past calls.
Alex Davern
Yeah, year-over-year the average order size is up about 7% andwe’ll have to check the two year number, but that’s those answers has been inpast calls.
Ajit Pai - ThomasWeisel Partners
Okay. And then just some color…
Alex Davern
Ajit, I could probably tell you that the value of ordersover 20K is a percentage of revenue that proportion is definitely beenincreasing over the last number of years.
Ajit Pai - ThomasWeisel Partners
Okay. And then just looking at CERN order that you talkedabout I think you mentioned 100 systems.
So assuming that is over 20K is thatthe order of magnitude of that particular project somewhere between $2 and $5million to a good low-end of the range towards the high-end of the range. Andalso how much of that has already been shifted and how much is going to beshifted and is there a services component to that as well?
James Truchard
So a lot of good questions there, Ajit. I just quantify withthis business actually came to position in the first quarter, and we've beenworking with CERN on the ability to publicize it, and we’re talking about nowas a public, and they are moving towards deployment, but we actually shift andrecognize the revenue on this order back in the first quarter.
In terms of its value, it’s certainly a lot more than$20,000. It was one of the larger orders in history to company when we bookedit and shipped it in the first quarter, and there is a services component.
And we’re very, very pleased and excited about the abilityto publicize the success of a real lead user, building what is an incredibledevice and then certainly something will be highlighting in our marketingmaterials going forward.
Ajit Pai
Yeah. Just one thing Alex to clarify on that, I mean it wasthe 100th system, so do you assume that each one of the systems hasover $20,000, so which would sum up to over, you know, a couple of -- between 2and 5 million.
Thomas Weisel Partners
Yeah. Just one thing Alex to clarify on that, I mean it wasthe 100th system, so do you assume that each one of the systems hasover $20,000, so which would sum up to over, you know, a couple of -- between 2and 5 million.
Alex Davern
You know, I should -- I’ll let you add a lot of value andlet you speculate if that’s okay.
Ajit Pai
Okay.
Thomas Weisel Partners
Okay.
Alex Davern
But it certainly was one of the largest orders we havereceived as a company when we booked it…
Ajit Pai
Just one sort of housekeeping question, which is thenon-cash compensation, are you going to breakdown of how much of it was in thecost of good sold in each of the expense line categories please?
Thomas Weisel Partners
Just one sort of housekeeping question, which is thenon-cash compensation, are you going to breakdown of how much of it was in thecost of good sold in each of the expense line categories please?
Alex Davern
The cost of good sold breakdown is in thepress release, Ajit, if you want grab it. On the rest of the expensecategories, I don’t have, I mean right now, we can follow-up.
Ajit Pai
Okay. Thank you.
Thomas Weisel Partners
Okay. Thank you.
Alex Davern
No problem.
Operator
(Operator Instructions) And David Yuschakwith SMH Capital has our next question.
David Yuschak
Yeah. Congratulations, guys on a good quarter in difficultenvironment.
I was just kind of curious, as you look at your actual results,and I think you were looking at 179 to 187 million in this quarter in yourguidance, where were you at variants most in the upside and the low end andupper end versus what you actually received and what were your expectations?
SMH Capital
Yeah. Congratulations, guys on a good quarter in difficultenvironment.
I was just kind of curious, as you look at your actual results,and I think you were looking at 179 to 187 million in this quarter in yourguidance, where were you at variants most in the upside and the low end andupper end versus what you actually received and what were your expectations?
Alex Davern
Well, we came in slightly above the midpoint of ourguidance, Dave, so I would say we were a little bit over the midpoint of ourexpectation. This year, Dave, there is just one thing that we’re, I have been alittle bit surprised about in Q2 and Q3, not obviously in guidance for Q3, butwas been the weakness of Japan, if we look at the full year, in terms of ourexpectations coming into the year.
And that’s something we hope sorts itselfout as we go over to next couple of quarter. For Q3, it is pretty much on trackwith what we expected.
David Yuschak
But if you look at the upper end -- to get to the upper endof that range would have just basically the continuation of Japan, and capture from getting atthe upper end of that range, would you say that?
SMH Capital
But if you look at the upper end -- to get to the upper endof that range would have just basically the continuation of Japan, and capture from getting atthe upper end of that range, would you say that?
Alex Davern
I think, we were a couple of million dollars off the upperend in range, so we were at 99% of the upper end of the range, if you like. Andonce you get back down to that level of granularity, it’s just close as we canprobably call.
David Yuschak
Okay.
SMH Capital
Okay.
Alex Davern
You feel like we were being realistic.
David Yuschak
Okay. But Asia has to be a pleasant surprise for you, givenwhat Japanhas gone on?
SMH Capital
Okay. But Asia has to be a pleasant surprise for you, givenwhat Japanhas gone on?
Alex Davern
Yeah. Non-Japan, Asia has been as continued has continued toretain a lot of momentum, and as I said, you know, I think our team in Japanhas done a great job of executing in a tough environment and delivering goodvalue to our customer base, and we are excited about the success of our newproduct platforms in Japan.
But certainly, in light of the Japanese situation, the restof Asia, it’s really good to see a continuedmomentum.
David Yuschak
Would North America be a problem for you, if you continue tosee some concerns domestically, because that seems to be your base concern isright now compared to say, Europe, what you, particularly what you are doing inAsia, as well, I am just kind of curious, ifthat’s the more vulnerable part of your market place right now?
SMH Capital
Would North America be a problem for you, if you continue tosee some concerns domestically, because that seems to be your base concern isright now compared to say, Europe, what you, particularly what you are doing inAsia, as well, I am just kind of curious, ifthat’s the more vulnerable part of your market place right now?
Alex Davern
Well, we certainly, we saw a pretty significant drop-off inthe PMI in North America in Q3, as we did in Japan and globally, and the thingI feel really good about it and I want to congratulate all of the employees ofthe company is that the success of the new product platforms that we havedriven, which have opened up new market opportunity for us has really allowedus to grow despite the drop in the PMI in Q1 and in Q3. And I think that thereis a lot of opportunity there for us and we need now to make sure that we areinvesting enough and we are driving enough investment into the success of thoseproduct platforms at the marketplace, so that we can realize the fullpotential.
And I think our story really if we look at it now maybe compared towhere we were seven years ago, Dave, is that we have been able to grow despitethe significant drop in the PMI in Q3.
David Yuschak
And one last quick question, on the gross margin was downabout 50 basis points in the second quarter, was there anything particularthere that may have produced that?
SMH Capital
And one last quick question, on the gross margin was downabout 50 basis points in the second quarter, was there anything particularthere that may have produced that?
Alex Davern
Well, we are up about, I guess, about 80 basis pointsyear-over-year, and what you’re seeing is that sequentially in the thirdquarter we traditionally have a seasonal decline in gross margin.
David Yuschak
All right.
SMH Capital
All right.
Alex Davern
That's heavily driven from one of highest gross marginregion is Europe, and it falls as a proportionof the mix in the third quarter. We also transition our distributionoperations, our U.S.distribution operations out of Boston to Hungaryduring Q3.
David Yuschak
Okay.
SMH Capital
Okay.
Alex Davern
And we did pick up some cost as a result of that kind ofone-time transition, and I want to also congratulate all the employees involvedin that exercise because they carried it off pretty flawlessly, and wedelivered all of our U.S. revenue direct from that location to our customers inthe U.S.
in Q3, and that was a very good operational performance.
David Yuschak
That's why your figures just dropped a little more in thatthird quarter versus we’re traditionally, and I just don't seem to have it beenin here.
SMH Capital
That's why your figures just dropped a little more in thatthird quarter versus we’re traditionally, and I just don't seem to have it beenin here.
Alex Davern
That's correct, Dave.
David Yuschak
All right, thanks.
SMH Capital
All right, thanks.
Alex Davern
Thank you, very much.
Operator
And with Robert W. Baird, Richard Eastman has our nextquestion.
Richard Eastman -Robert W. Baird
Alex, could you give us a headcount number at the end of Q3?
Alex Davern
Sure, we had 4,459 people, so up little over 10%year-over-year, as you aware Q3 is our big, big hiring quarter. And we hadadded about 200 people roughly in the third quarter.
So we do a lot ofengineering and application engineering sales graduates that we'll hire in Q3.
Richard Eastman -Robert W. Baird
Okay. And then, I just had a question, maybe a biggerpicture question about, we've been adding infrastructure on the -- essentiallyon the industrial and embedded side of the business not only products but also fieldsupport.
Have we been doing that geographically or has most of that investmentbeen in the U.S.?And if I look at that product line, the industrial embedded line, all theproducts that you talk about being in that, has that growth been driven by salesin the U.S.or have we managed to add infrastructure in global sales, geographically?
James Truchard
Well, actually Europe hasbeen a real star in this new area of graphical system design for embedded. Weare seeing some really nice applications we mentioned to turn one but we alsosaw a lot of machines and equipment being built using that technology.
So Europe has certainly done well. We've seen good strongapplications as well in Japanand the U.S.,of course.
So it’s a pretty well have been across the Board that there is moreopportunity to expand in this area, geographically. But we are off to goodstart.
Alex Davern
In terms of the investment in this sales resources that hasbeen geographic. In addition to any kind of geographic expansion in the field,we've been putting some business development and some expertise focused aroundour real-time and FPGA-based products globally.
James Truchard
Great. Rick, I need for you to go on with your follow-upquestions.
Alex, I need to make a correction. The actual headcount at the endof September was 4,559.
I think I had just spoken I said 4,459. I think when Ispoke, said 4459.
Richard Eastman -Robert W. Baird
Okay, 4.559. And then, one last question.
Alex, when yougive this geographic growth rates the traditional instrument control businessis that more reflected in North America or isthat spread out geographically?
Alex Davern
No that’s spread out geographically in some regions there isslightly more concentrated then others. But it’s got a very good geographicdistribution.
Richard Eastman -Robert W. Baird
Okay.
Alex Davern
It’s probably moved a little bit more to Asia over theyears, as more production has moved to Asia,but it’s quite less by now.
Richard Eastman -Robert W. Baird
Okay. Great thank you.
Operator
We have our final question in the queue. It will come from,Antonio Antezano.
Antonio Antezano -Bear Stearns
What is your outlook for the tax rate and whether there isany by front corporate tax reduction in Germany?
Alex Davern
I'd say Antonio, when you asked it I told you we had a small-- actually our tax rate this quarter is a little bit less then 22. We pickedup a couple of hundred thousand dollars on benefit from the reductions of thetax rate in Germanywhich they reduced from 40% to 30% which I think is pretty progressive for theGermans.
And that was an impact on some deferred tax assets we had in Germany.In terms of our global scheme and the tax rate going forward it’s a prettymodest impact, so we’re still looking at 22% for Q4.
Antonio Antezano -Bear Stearns
And the same for next year I guess?
Alex Davern
Next year it’s little too early to give guidance on that,we’ll give guidance on that in January.
Antonio Antezano -Bear Stearns
Okay. Thank you.
Operator
And gentlemen, it appears that we have no further questions.I would like to turn the conference over to, Mr. Davern for any closing oradditional comments.
Alex Davern - CFO
Thank you for joining us today. And we look forward toseeing you either in New York or Scottsdale if you’reattending those Investor Conferences.
Operator
And thank you everyone that does conclude today’sconference. We thank you for your participation on behalf of NationalInstruments and today’s speakers.
I would like to wish everyone a great day.