b063009.htm
 
 

 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

T  Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal quarter ended:  June 30, 2009 or

£  Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ________________ to ________________

Commission file number:  0-25426


National Instruments logo

NATIONAL INSTRUMENTS CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
 
74-1871327
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
     
11500 North MoPac Expressway
Austin, Texas
 
 
78759
(address of principal executive offices)
 
(zip code)

Registrant's telephone number, including area code:  (512) 338-9119
__________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes T  No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes £  No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer T                                          Accelerated filer £                                Non-accelerated filer £                                            Smaller reporting company £
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £  No T

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Class
Outstanding at August 3, 2009
Common Stock - $0.01 par value
77,625,779


 
 

 

NATIONAL INSTRUMENTS CORPORATION

INDEX

     
PART I.  FINANCIAL INFORMATION
Page No.
     
Item 1
Financial Statements:
 
     
   
 
June 30, 2009 (unaudited) and December 31, 2008                                                                                                  
3
     
   
 
(unaudited) for the three and six month periods ended June 30, 2009 and 2008
4
     
   
 
(unaudited) for the six month periods ended June 30, 2009 and 2008
5
     
 
Notes to Consolidated Financial Statements                                                                                                  
6
     
 
 
Condition and Results of Operations                                                                                                  
24
     
Quantitative and Qualitative Disclosures about Market Risk                                                                                                  
33
     
Controls and Procedures                                                                                                  
35
     
     
PART II.  OTHER INFORMATION
 
     
     
Legal Proceedings                                                                                                  
37
     
Risk Factors                                                                                                  
37
     
Unregistered Sales of Equity Securities and Use of Proceeds                                                                                                  
44
     
44
     
Other Information                                                                                                  
45
     
Exhibits                                                                                                  
46
     
 
Signatures and Certifications                                                                                                  
47
 

 
 

 

PART I - FINANCIAL INFORMATION

ITEM 1.
Financial Statements

NATIONAL INSTRUMENTS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)


   
June 30,
2009
   
December 31,
2008
 
Assets
 
(unaudited)
       
Current assets:
           
Cash and cash equivalents                                                                                     
  $ 221,723     $ 229,400  
Short-term investments                                                                                     
    28,991       6,220  
Accounts receivable, net                                                                                     
    91,393       121,548  
Inventories, net                                                                                     
    95,269       107,358  
Prepaid expenses and other current assets                                                                                     
    43,496       43,062  
Deferred income taxes, net                                                                                     
    23,989       21,435  
Total current assets                                                                                 
    504,861       529,023  
Long-term investments                                                                                          
    10,500       10,500  
Property and equipment, net                                                                                          
    150,620       154,477  
Goodwill, net                                                                                          
    64,610       64,561  
Intangible assets, net                                                                                          
    46,719       41,915  
Other long-term assets                                                                                          
    32,028       32,115  
Total assets                                                                                 
  $ 809,338     $ 832,591  
Liabilities and Stockholders' Equity
               
Current liabilities:
               
Accounts payable                                                                                     
  $ 24,378     $ 30,876  
Accrued compensation                                                                                     
    18,387       22,012  
Deferred revenue                                                                                     
    47,692       45,514  
Accrued expenses and other liabilities                                                                                     
    12,333       18,848  
Other taxes payable                                                                                     
    11,855       13,481  
Total current liabilities
    114,645       130,731  
Deferred income taxes                                                                                          
    24,488       25,157  
Other long-term liabilities                                                                                          
    12,784       12,265  
Total liabilities
    151,917       168,153  
Commitments and contingencies
               
Stockholders' equity:
               
Preferred stock:  par value $0.01; 5,000,000 shares authorized;
none issued and outstanding                                                                                     
           
Common stock:  par value $0.01; 180,000,000 shares authorized;
77,567,862 and 77,193,063 shares issued and outstanding,
respectively                                                                                     
      775         772  
Additional paid-in capital                                                                                     
    45,964       39,673  
Retained earnings                                                                                     
    599,681       613,510  
Accumulated other comprehensive income                                                                                     
    11,001       10,483  
Total stockholders’ equity
    657,421       664,438  
Total liabilities and stockholders’ equity
  $ 809,338     $ 832,591  


The accompanying notes are an integral part of these financial statements.

 
 

 

NATIONAL INSTRUMENTS CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
(unaudited)


   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Net sales:
                       
Product
  $ 139,792     $ 195,562     $ 283,242     $ 377,351  
Software maintenance
    12,371       14,912       26,720       26,041  
Total net sales
    152,163       210,474       309,962       403,392  
                                 
Cost of sales:
                               
Product
  $ 39,202     $ 51,863     $ 78,758     $ 99,530  
Software maintenance
    1,284       1,577       2,611       2,979  
Total cost of sales
    40,486       53,440       81,369       102,509  
                                 
Gross profit
    111,677       157,034       228,593       300,883  
                                 
Operating expenses:
                               
Sales and marketing
  $ 65,137     $ 78,729     $ 133,963     $ 152,246  
Research and development
    29,447       33,188       64,236       68,792  
General and administrative
    14,752       17,283       30,532       33,945  
Total operating expenses
    109,336       129,200       228,731       254,983  
                                 
Operating income (loss)
    2,341       27,834       (138 )     45,900  
                                 
Other income (expense):
                               
Interest income
  $ 407     $ 1,514     $ 996     $ 3,651  
Net foreign exchange gain (loss)
    1,063       (313 )     361       1,235  
Other income (expense), net
    334       (129 )     497       (68 )
Income before income taxes
    4,145       28,906       1,716       50,718  
Provision for (benefit from) income taxes
    (285 )     4,172       (3,072 )     8,368  
                                 
Net income
  $ 4,430     $ 24,734     $ 4,788     $ 42,350  
                                 
Basic earnings per share
  $ 0.06     $ 0.32     $ 0.06     $ 0.54  
                                 
Weighted average shares outstanding – basic
    77,556       78,484       77,417       78,662  
                                 
Diluted earnings per share
  $ 0.06     $ 0.31     $ 0.06     $ 0.53  
                                 
Weighted average shares outstanding – diluted
    77,824       79,549       77,596       79,691  
                                 
Dividends declared per share
  $ 0.12     $ 0.11     $ 0.24     $ 0.22  


The accompanying notes are an integral part of these financial statements.


 
 

 

NATIONAL INSTRUMENTS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)


   
Six Months Ended
 
   
June 30,
 
   
2009
   
2008
 
Cash flow from operating activities:
           
Net income                                                                                             
  $ 4,788     $ 42,350  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization                                                                                    
    19,569       19,852  
Stock-based compensation                                                                                    
    10,036       9,662  
Benefit from deferred income taxes                                                                                    
    (2,610 )     (3,585 )
Tax expense (benefit from) stock option plans                                                                                    
    1,379       (492 )
Changes in operating assets and liabilities:
               
Accounts receivable                                                                                    
    30,155       3,524  
Inventories                                                                                    
    12,089       (12,894 )
Prepaid expenses and other assets                                                                                    
    (624 )     (839 )
Accounts payable                                                                                    
    (6,498 )     2,425  
Deferred revenue                                                                                    
    2,178       5,316  
Taxes and other liabilities                                                                                    
    (11,922 )     3,008  
Net cash provided by operating activities                                                                                         
    58,540       68,327  
                 
Cash flow from investing activities:
               
Capital expenditures                                                                                             
    (7,706 )     (12,382 )
Capitalization of internally developed software                                                                                             
    (9,936 )     (7,585 )
Additions to other intangibles                                                                                             
    (2,420 )     (1,072 )
Acquisition, net of cash received                                                                                             
          (17,310 )
Purchases of short-term and long-term investments                                                                                             
    (23,989 )     (17,245 )
Sales and maturities of short-term and long-term investments
    1,218       74,682  
Purchases of foreign currency option contracts                                                                                         
          (2,784 )
Net cash (used by) provided by investing activities                                                                                         
    (42,833 )     16,304  
                 
Cash flow from financing activities:
               
Proceeds from issuance of common stock                                                                                             
    11,520       17,077  
Repurchase of common stock                                                                                             
    (14,908 )     (57,644 )
Dividends paid                                                                                             
    (18,617 )     (17,370 )
Tax expense (benefit from) stock option plans                                                                                             
    (1,379 )     492  
Net cash (used by) financing activities                                                                                         
    (23,384 )     (57,445 )
                 
Net change in cash and cash equivalents                                                                                                  
    (7,677 )     27,186  
Cash and cash equivalents at beginning of period                                                                                                  
    229,400       194,839  
Cash and cash equivalents at end of period                                                                                                  
  $ 221,723     $ 222,025  



The accompanying notes are an integral part of these financial statements.

 
 

 

NATIONAL INSTRUMENTS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 – Basis of Presentation

The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2008, included in our annual report on Form 10-K, filed with the Securities and Exchange Commission. In our opinion, the accompanying consolidated financial statements reflect all adjustments (consisting only of normal recurring items) considered necessary to present fairly our financial position at June 30, 2009 and December 31, 2008, and the results of our operations for the three month and six month periods ended June 30, 2009 and June 30, 2008 and the cash flows for the six month periods ended June 30, 2009 and 2008. Operating results for the three-month and six-month periods ended June 30, 2009, are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

Certain prior year amounts have been reclassified to conform to the 2009 presentation as shown in the following tables:
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30, 2008
   
June 30, 2008
 
   
(unaudited)
   
(unaudited)
 
             
Cost of sales as previously reported                                                                                     
  $ 52,443     $ 100,690  
Technical support costs previously reported as sales and marketing (a)
    997       1,819  
Cost of sales adjusted for reclassification                                                                                     
  $ 53,440     $ 102,509  
                 
Sales and marketing as previously reported                                                                                     
  $ 79,726     $ 154,065  
Technical support costs as previously reported as sales and marketing (a)
    (997 )     (1,819 )
Sales and marketing adjusted for reclassification                                                                                     
  $ 78,729     $ 152,246  

 
(a)  
Since December 31, 2008, we have been separately reporting software maintenance revenue and cost of software maintenance revenue in our Consolidated Statements of Income. We added this disclosure due to the increasing percentage of our revenue coming from software maintenance. As part of this expanded disclosure, some technical support costs previously reported as a component of sales and marketing expense are reported as cost of software maintenance. This change has had no impact on our operating income, net income or earnings per share.
 
We have historically recorded the excess of the purchase price over par or stated value of retired shares of common stock as a reduction of additional paid-in capital. We are evaluating whether a portion of the excess of the purchase price over par or stated value associated with the retirement of shares of common stock is required to be charged to retained earnings in accordance with Accounting Research Bulletin ("ARB") No.43. We are currently evaluating whether we will need to make an adjustment to our consolidated statements of stockholders’ equity to reflect this reclassification. Any resulting reclassification will have no impact on previously reported statements of income, earning per share amounts, statements of cash flows or total stockholders’ equity.
 
NOTE 2 – Earnings Per Share

Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding during each period. Diluted EPS is computed by dividing net income by the weighted average number of common shares and common share equivalents outstanding (if dilutive) during each period. The number of common share equivalents, which include stock options and restricted stock units, is computed using the treasury stock method.

The reconciliation of the denominators used to calculate basic EPS and diluted EPS for the three month and six month periods ended June 30, 2009 and 2008, respectively, are as follows (in thousands):

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
(unaudited)
   
(unaudited)
 
   
2009
   
2008
   
2009
   
2008
 
Weighted average shares outstanding-basic
    77,556       78,484       77,417       78,662  
Plus: Common share equivalents
                               
Stock options, restricted stock units                                                           
    268       1,065       179       1,029  
Weighted average shares outstanding-diluted
    77,824       79,549       77,596       79,691  

Stock options to acquire 3,696,000 shares and 2,318,000 shares for the three month periods ended June 30, 2009 and 2008, respectively, and 4,973,000 and 2,678,000 shares for the six month periods ended June 30, 2009 and 2008, respectively, were excluded in the computations of diluted EPS because the effect of including the stock options would have been anti-dilutive.

NOTE 3 – Cash, Cash Equivalents, Short-Term and Long-Term Investments

Cash, cash equivalents, short-term and long-term investments consist of the following (in thousands):

   
As of
June 30, 2009
   
As of
December 31, 2008
 
   
(unaudited)
       
Cash and cash equivalents:
           
Cash                                                                                 
  $ 61,683     $ 100,967  
Cash equivalents:
               
Debt securities                                                                               
           
Time deposits                                                                               
          73,400  
Money market accounts                                                                               
    160,040       55,033  
Total cash and cash equivalents                                                                            
  $ 221,723     $ 229,400  
Short-term investments:
               
Debt securities                                                                                 
  $ 28,991     $ 6,220  
Auction rate securities                                                                                 
           
Long-term investments:
               
Auction rate securities                                                                                 
    8,190       6,964  
Auction rate securities put option                                                                                 
    410       1,636  
Other long-term investments                                                                                 
    1,900       1,900  
Total investments                                                                               
  $ 39,491     $ 16,720  
Total cash, cash equivalents and investments                                                                            
  $ 261,214     $ 246,120  

The following table summarizes unrealized gains and losses related to our investments designated as available-for-sale (in thousands):

   
As of June 30, 2009
 
   
(unaudited)
 
                         
   
 
Adjusted Cost
   
Gross Unrealized Gain
   
Gross Unrealized Loss
   
 
Fair Value
 
Debt securities                                                                 
  $ 28,943     $ 77     $ (29 )   $ 28,991  
Auction rate securities                                                                 
    8,600             (410 )     8,190  
Auction rate securities put option                                                                 
          410             410  
Other long-term investments                                                                 
    1,900                   1,900  
Total investments                                                            
  $ 39,443     $ 487     $ (439 )   $ 39,491  
 
   
As of December 31, 2008
 
   
 
Adjusted Cost
   
Gross Unrealized Gain
   
Gross Unrealized Loss
   
 
Fair Value
 
Debt securities                                                                 
  $ 6,199     $ 28     $ (7 )   $ 6,220  
Auction rate securities                                                                 
    8,600             (1,636 )     6,964  
Auction rate securities put option                                                                 
          1,636             1,636  
Other long-term investments                                                                 
    1,900                   1,900  
Total investments                                                            
  $ 16,699     $ 1,664     $ (1,643 )   $ 16,720  
 
NOTE 4 – Fair Value Measurements

Effective January 1, 2008, we adopted Statement of Financial Accounting Standards (“SFAS”) 157, Fair Value Measurements (SFAS 157). SFAS 157 clarifies the definition of fair value, prescribes methods for measuring fair value, establishes a fair value hierarchy based on the inputs used to measure fair value and expands disclosures about the use of fair value measurements. Effective January 1, 2009, in accordance with Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) FAS 157-2, Effective Date of FASB Statement 157, we adopted SFAS 157 for our nonfinancial assets and nonfinancial liabilities, except those items recognized or disclosed at fair value on an annual or more frequently recurring basis. The adoption of FSP FAS 157-2 did not have a material impact on our fair value measurements as we did not have any items that were measured at fair value on a nonrecurring basis for the six months ended June 30, 2009.  Effective April 1, 2009, we adopted FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, which provides additional guidance for estimating fair value in accordance with FASB Statement No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. The adoption of FSP FAS 157-4 did not have a material impact on our fair value measurements.

The following tables present our assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy. The fair value hierarchy has three levels based on the reliability of the inputs used to determine fair value (in thousands).

         
Fair Value Measurements at Reporting Date Using (unaudited)
 
 
 
 
Description
 
 
June 30, 2009
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Assets
                       
Money Market Funds                                                 
  $ 160,040     $ 160,040     $      
Available for sale securities:
                               
Short-term debt securities                                            
    28,991       28,991              
Long-term debt securities                                            
    8,600                   8,600  
Derivatives                                                 
    14,509             14,509        
Total Assets                                                    
  $ 212,140     $ 189,031     $ 14,509     $ 8,600  
                                 
Liabilities
                               
Derivatives                                                 
    (2,901 )           (2,901 )      
Total Liabilities                                                    
  $ (2,901 )   $     $ (2,901 )   $  

   
Fair Value Measurements Using Significant Unobservable Inputs
(Level 3)
 
   
Long-term investments available for sale
 
   
(unaudited)
 
       
Beginning Balance at December 31, 2008                                                                         
  $ 8,600  
Total gains or (losses) (realized/unrealized)
       
Included in earnings                                                                    
    410  
Included in other comprehensive income                                                                    
     
Total losses (realized/unrealized)
       
Included in earnings
    (410 )
Included in other comprehensive income
     
Purchases, issuances and settlements
     
Transfer in and/or out of Level 3
     
Ending Balance at June 30, 2009                                                                         
  $ 8,600  
         
The amount of total gains or (losses) for the period included in earnings (or changes in net assets) attributable to the change in unrealized gains or losses relating to assets still held at the reporting date
       
    $  

Short-term debt securities available-for-sale are valued using a market approach (Level 1) based on the quoted market prices of identical instruments when available or other observable inputs such as trading prices of identical instruments in inactive markets. Short-term investments available-for-sale consist of debt securities issued by states of the U.S. and political subdivisions of the states, corporate debt securities and debt securities issued by U.S. government corporations and agencies. All short-term investments available-for-sale have contractual maturities of less than 24 months.

Derivatives include foreign currency forward and option contracts. Our foreign currency forward contracts are valued using an income approach (Level 2) based on the spot rate less the contract rate multiplied by the notional amount. Our foreign currency option contracts are valued using a market approach based on the quoted market prices which are derived from observable inputs including current and future spot rates, interest rate spreads as well as quoted market prices of identical instruments.

Long-term debt securities available-for-sale included in Level 3 are reported at their fair market value and consist of auction rate securities backed by education loan revenue bonds. One of our auction rate securities is from the Vermont Student Assistance Corporation and has a par value of $2.2 million. The other of our auction rate securities is from the New Hampshire Health and Education Facilities Authority and has a par value of $6.4 million. The ratings for these securities at June 30, 2009, were Baa3/A/AAA and Aaa/NR/AAA, respectively. We note that the bonds from the Vermont Student Assistance Corporation carried ratings of Aa3/A/AAA at December 31, 2008. Historically, we reported the fair market value of these securities at par as differences between par value and the purchase price or settlement value were historically comprised of accrued interest. Auction rate securities are variable rate debt instruments whose interest rates are typically reset approximately every 7 to 35 days. On July 24, 2009, and in prior auction periods beginning in February 2008, the auction process for these securities failed. Prior to the failure of the auction process, we had classified these investments as short-term but are now reporting them as long-term due to the fact that the underlying securities generally have longer dated contractual maturities which are in excess of the guidelines provided for in our corporate investment policy. The auction rate securities are classified as available-for-sale.

At June 30, 2009, we reported these long-term investments at their estimated fair market value of $8.2 million. In November 2008, we accepted the UBS Auction Rate Securities Rights (the "Rights”) agreement offered by UBS as a liquidity alternative to the failed auction process. This Rights agreement is related to the auction rates securities discussed above. The Rights agreement is a nontransferable right to sell our auction rate securities, at par value, back to UBS at any time during the period June 30, 2010, through July 2, 2012. At June 30, 2009, we reported the Rights agreement at its estimated fair market value of $0.4 million. We continue to have the ability to hold the debt instruments to their ultimate maturity and have not made a determination as to whether we will exercise our right under the Rights agreement described above. As such, we have recorded the unrealized loss related to the auction rate securities and the unrealized gain related to the Rights agreement as a component of other income (expense), in our Consolidated Statements of Income. The estimated fair market value of the Rights agreement is also included as a component of our long-term investments.

The estimated fair market value of both the auction rate securities and the Rights agreement was determined using significant unobservable inputs (Level 3) as prescribed by SFAS 157, Fair Value Measurements. We considered many factors in determining the fair market value of the auction rate securities as well as our corresponding Rights agreement at June 30, 2009, including the fact that the debt instruments underlying the auction rate securities have redemption features which call for redemption at 100% of par value, current credit curves for like securities and discount factors to account for the illiquidity of the market for these securities. During the three months ended June 30, 2009, we did not make any changes to our valuation techniques or related inputs.

NOTE 5 – Derivative Instruments and Hedging Activities

SFAS 133, Accounting for Derivative Instruments and Hedging Activities, as amended (SFAS 133(R),) requires companies to recognize all of their derivative instruments as either assets or liabilities in the statement of financial position at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation.

We have operations in over 40 countries. Sales outside of the Americas, as a percentage of consolidated sales were 55% and 58% in each of the three month periods ended June 30, 2009 and 2008, respectively, and 56% and 57% in each of the six month periods ended June 30, 2009 and 2008, respectively. Our activities expose us to a variety of market risks, including the effects of changes in foreign-currency exchange rates. These financial risks are monitored and managed by us as an integral part of our overall risk management program.

We maintain a foreign-currency risk management strategy that uses derivative instruments (foreign currency forward and purchased options contracts) to help protect our earnings and cash flows from fluctuations caused by the volatility in currency exchange rates. Movements in foreign-currency exchange rates pose a risk to our operations and competitive position, since exchange rate changes may affect our profitability and cash flow, and the business or pricing strategies of our non-U.S. based competitors.

The vast majority of our foreign sales are denominated in the customers’ local currency. We purchase foreign currency forward and purchased options contracts as hedges of forecasted sales that are denominated in foreign currencies and as hedges of foreign currency denominated receivables. These contracts are entered into to protect against the risk that the eventual dollar-net-cash inflows resulting from such sales or firm commitments will be adversely affected by changes in exchange rates. We also purchase foreign currency forward contracts as hedges of forecasted expenses that are denominated in foreign currencies. These contracts are entered into to protect against the risk that the eventual dollar-net-cash outflows resulting from foreign currency operating and cost of revenue expenses will be adversely affected by changes in exchange rates.

In accordance with SFAS 133(R), we designate foreign currency forward and option contracts as cash flow hedges of forecasted revenues or forecasted expenses. In addition, we hedge our foreign currency denominated balance sheet exposures using foreign currency forward contracts. These derivatives are not designated as hedging instruments under SFAS 133(R). None of our derivative instruments contain a credit-risk-related contingent feature.

Cash flow hedges

To protect against the reduction in value caused by a fluctuation in foreign currency exchange rates of forecasted foreign currency cash flows resulting from international sales over the next one to two years, we have instituted a foreign currency cash flow hedging program. We hedge portions of our forecasted revenue and forecasted expenses denominated in foreign currencies with forward and option contracts. For forward contracts, when the dollar strengthens significantly against the foreign currencies, the change in the present value of future foreign currency cash flows may be offset by the change in the fair value of the forward contracts designated as hedges. For option contracts, when the dollar strengthens significantly against the foreign currencies, the change in the present value of future foreign currency cash flows may be offset by the change in the fair value of the option contracts net of the premium paid designated as hedges. Our foreign currency purchased option contracts are purchased “at-the-money” or “out-of-the-money”. We purchase foreign currency forward and option contracts for up to 100% of our forecasted exposures in selected currencies (primarily in Euro, Japanese yen, British pound sterling, South Korean won and Hungarian forint) and limit the duration of these contracts to 40 months or less.

For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income (“OCI”) and reclassified into earnings in the same line item (net sales, operating expenses, or cost of sales) associated with the forecasted transaction and in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings or expenses during the current period and are classified as a component of “net foreign exchange gain (loss)”. Hedge effectiveness of foreign currency forwards and option contracts designated as cash flow hedges are measured by comparing the hedging instrument’s cumulative change in fair value from inception to maturity to the forecasted transaction’s terminal value.

We held forward contracts with a notional amount of $28.6 million dollar equivalent of Euro, $6.1 million dollar equivalent of British pound sterling, $28.5 million dollar equivalent of Japanese yen, and $30.3 million dollar equivalent of Hungarian forint at June 30, 2009. These contracts are for terms up to 24 months. At December 31, 2008, we held forward contracts with a notional amount of $54.9 million dollar equivalent of Euro, $6.2 million dollar equivalent of British pound sterling, $18.9 million dollar equivalent of Japanese yen, $4.7 million dollar equivalent of South Korean won and $21.7 million dollar equivalent of Hungarian forint.

We held option contracts with a notional amount of $77.3 million dollar equivalent of Euro at June 30, 2009. These contracts are for terms up to 24 months. At December 31, 2008, we held option contracts with a notional amount of $111.3 million dollar equivalent of Euro.

At June 30, 2009, we expect to reclassify $3.3 million of gains and $128,000 of losses on derivative instruments from accumulated other comprehensive income to net sales during the next twelve months when the hedged international sales occur. At June 30, 2009, we expect to reclassify $2.1 million of gains on derivative instruments from accumulated OCI to cost of sales and $1.4 million of gains on derivative instruments from accumulated OCI to operating expenses during the next twelve months when the hedged international expenses occur. Expected amounts are based on derivative valuations at June 30, 2009. Actual results may vary as a result of changes in the corresponding exchange rate subsequent to this date.

During the six months ended June 30, 2009, hedges with a notional amount of $14.4 million were determined to be ineffective. As a result, we recorded a net gain of $512,000 related to these hedges as a component of “net foreign exchange gain (loss)” during the six months ended June 30, 2009. We did not record any gains or losses due to the ineffectiveness of our hedges during the six months ended June 30, 2008.

Other Derivatives

Other derivatives not designated as hedging instruments under SFAS 133(R) consist primarily of foreign currency forward contracts that we use to hedge our foreign denominated net receivable or net payable positions to protect against the change in value caused by a fluctuation in foreign currency exchange rates. We typically hedge up to 90% of our outstanding foreign denominated net receivables or net payables and typically limit the duration of these foreign currency forward contracts to approximately 90 days. The gain or loss on the derivatives as well as the offsetting gain or loss on the hedge item attributable to the hedged risk is recognized in current earnings under the line item “net foreign exchange gain (loss)”. As of June 30, 2009 and December 31, 2008, we held forward contracts with a notional amount of $33.2 million and $67.1 million, respectively.

The following table presents the fair value of derivative instruments on our consolidated balance sheets and the effect of derivative instruments on our Consolidated Statements of Income.

Fair Values of Derivative Instruments (in thousands):

In thousands
Asset Derivatives
 
 
June 30, 2009
 
December 31, 2008
 
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
 
     
(unaudited)
         
Derivatives designated as hedging
instruments under Statement 133(R)
               
                 
Foreign exchange contracts – ST forwards
Prepaid expenses and
other current assets
  $ 5,860  
Prepaid expenses and
other current assets
  $ 5,260  
                     
Foreign exchange contracts – LT forwards
Other long-term assets
    3,641  
Other long-term assets
    2,654  
                     
Foreign exchange contracts – ST options
Prepaid expenses and
other current assets
    3,122  
Prepaid expenses and
other current assets
    5,705  
                     
Foreign exchange contracts – LT options
Other long-term assets
    1,514  
Other long-term assets
    3,838  
                     
Total derivatives designated as
hedging instruments under Statement 133(R)
    $ 14,137       $ 17,457  
                     
Derivatives not designated as
hedging instruments under Statement 133(R)
                   
                     
Foreign exchange contracts – ST forwards
Prepaid expenses and
other current assets
  $ 372  
Prepaid expenses and
other current assets
  $ 2,745  
                     
Total derivatives not designated as
hedging instruments under Statement 133(R)
    $ 372       $ 2,745  
                     
Total derivatives
    $ 14,509       $ 20,202  
 
 
 
Liability Derivatives
 
 
June 30, 2009
 
December 31, 2008
 
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
 
     
(unaudited)
         
Derivatives designated as hedging
instruments under Statement 133(R)
               
                 
Foreign exchange contracts – ST forwards
Accrued expenses
and other liabilities
  $ (272 )
Accrued expenses
and other liabilities
  $ (1,803 )
                     
Foreign exchange contracts – LT forwards
Other long-term liabilities
     
Other long-term liabilities
     
                     
Foreign exchange contracts – ST options
Accrued expenses
and other liabilities
     
Accrued expenses
and other liabilities
     
                     
Foreign exchange contracts – LT options
Other long-term liabilities
     
Other long-term liabilities
     
                     
Total derivatives designated as
hedging instruments under Statement 133(R)
    $ (272 )     $ (1,803 )
                     
Derivatives not designated as
hedging instruments under Statement 133(R)
                   
                     
Foreign exchange contracts – ST forwards
Accrued expenses
and other liabilities
  $ (2,629 )
Accrued expenses
and other liabilities
  $ (3,280 )
                     
Total derivatives not designated as
hedging instruments under Statement 133(R)
    $ (2,629 )     $ (3,280 )
                     
Total derivatives
    $ (2,901 )     $ (5,083 )

The following unaudited table shows the effect of derivative instruments on the Consolidated Statements of Income for the three months ended June 30, 2009 (in thousands):
 
 
 
 
 
 
 
Derivatives in Statement 133(R) Cash Flow Hedging Relationship
 
 
 
Amount of Gain or (Loss) Recognized in OCI on Derivative (Effective Portion) (in thousands)
 
 
 
 
 
Location of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) (in thousands)
 
 
 
 
 
 
Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
 
Amount of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
 
   
2009
     
2009
     
2009
 
Foreign exchange contracts – forwards and options
  $ (7,581 )
 
 
Net sales
  $  346  
 
Net foreign exchange gain (loss)
  $  11  
                             
Foreign exchange contracts – forwards and options
      4,057  
 
 
Cost of sales
    (413 )
 
Net foreign exchange gain (loss)
      84  
                             
Foreign exchange contracts – forwards and options
      2,553  
 
Operating expenses
      70  
 
Net foreign exchange gain (loss)
       
                             
Total
  $ (971 )     $ 3       $ 95  

 
 
 
Derivatives not Designated as Hedging Instruments under Statement 133(R)
 
Location of Gain (Loss) Recognized in Income on Derivative
 
Amount of Gain (Loss) Recognized in Income on Derivative
 
     
2009
 
Foreign exchange contracts – forwards
Net foreign exchange gain/(loss)
  $ (3,273 )
           
Total
    $ (3,273 )
 
The following unaudited table shows the effect of derivative instruments on the Consolidated Statements of Income for the six months ended June 30, 2009 (in thousands):
 
 
 
 
 
 
 
 
Derivatives in Statement 133(R) Cash Flow Hedging Relationship
 
 
 
Amount of Gain or (Loss) Recognized in OCI on Derivative (Effective Portion) (in thousands)
 
 
 
 
 
Location of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) (in thousands)
 
 
 
 
 
 
Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
 
Amount of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
 
   
2009
     
2009
     
2009
 
Foreign exchange contracts – forwards and options
  $ (3,785 )
 
 
Net sales
  $  2,979  
 
Net foreign exchange gain (loss)
  $  951  
                             
Foreign exchange contracts – forwards and options
      1,311  
 
 
Cost of sales
    (668 )
 
Net foreign exchange gain (loss)
    (439 )
                             
Foreign exchange contracts – forwards and options
      1,665  
 
Operating expenses
    (196 )
 
Net foreign exchange gain (loss)
       
                             
Total
  $ (809 )     $ 2,116       $ 512  
 

 
 
Derivatives not Designated as Hedging Instruments under Statement 133(R)
 
Location of Gain (Loss) Recognized in Income on Derivative
 
Amount of Gain (Loss) Recognized in Income on Derivative
 
     
2009
 
Foreign exchange contracts – forwards
Net foreign exchange gain/(loss)
  $ (184 )
           
Total
    $ (184 )
 
NOTE 6 – Inventories

Inventories, net consist of the following (in thousands):

   
June 30,
   
December 31,
 
   
2009
   
2008
 
   
(unaudited)
       
             
Raw materials                                                         
  $ 42,696     $ 48,004  
Work-in-process                                                         
    2,087       4,150  
Finished goods                                                         
    50,486       55,204  
    $ 95,269     $ 107,358  
 
NOTE 7 – Intangibles

Intangibles at June 30, 2009 and December 31, 2008 are as follows:

   
June 30, 2009
   
December 31, 2008
 
   
(unaudited)
                   
   
Gross Carrying Amount
   
Accumulated Amortization
   
Net Carrying Amount
   
Gross Carrying Amount
   
Accumulated Amortization
   
Net Carrying Amount
 
Capitalized software development costs
  $ 35,547     $ (15,517 )   $ 20,030     $ 25,610     $ (11,344 )   $ 14,266  
Acquired technology                                                
    27,412       (18,626 )     8,786       27,503       (16,804 )     10,699  
Patents                                                
    17,981       (4,918 )     13,063       16,068       (4,506 )     11,562  
Leasehold equipment and other
    11,941       (7,101 )     4,840       11,401       (6,013 )     5,388  
    $ 92,881     $ (46,162 )   $ 46,719     $ 80,582     $ (38,667 )   $ 41,915  

Software development costs capitalized during the three month periods ended June 30, 2009 and 2008, were $6.8 million and $6.1 million, respectively. Capitalized software amortization expense was $2.1 million and $2.5 million during the three month periods ended June 30, 2009 and 2008, respectively. During the six month periods ended June 30, 2009 and 2008, we capitalized software development costs of $9.9 million and $7.6 million, respectively. During the six month periods ended June 30, 2009 and 2008, capitalized software amortization expense was $4.2 million and $5.0 million, respectively. Amortization of capitalized software development costs is computed on an individual product basis for those products available for market and is recognized based on the product’s estimated economic life, generally three years. Patents are amortized using the straight-line method over their estimated period of benefit, generally ten to seventeen years. Total intangible assets amortization expenses were $3.9 million and $4.0 million during the three month periods ended June 30, 2009 and 2008, respectively, and $7.5 million and $8.0 million during the six month periods ended June 30, 2009 and 2008, respectively.

Acquired core technology and intangible assets are amortized over their useful lives, which range from three to eight years. Amortization expense for intangible assets acquired was approximately $1.0 million and $1.1 million for the three month periods ended June 30, 2009 and 2008, respectively, of which approximately $853,000 and $937,000 was recorded in cost of sales, respectively, and approximately $126,000 and $161,000 was recorded in operating expenses, respectively. For the six month periods ended June 30, 2009 and 2008, amortization expense for intangible assets acquired was approximately $2.0 million and $2.1 million, respectively, of which approximately $1.7 million and $1.8 million was recorded in cost of sales, respectively, and approximately $252,000 and $310,000 was recorded in operating expenses, respectively. The estimated amortization expense of intangible assets acquired for the current fiscal year and in future years will be recorded in the consolidated statements of income as follows (in thousands):

 
 
Fiscal Year
 
Cost of Sales
   
Acquisition related costs and amortization, net
   
 
Total
 
                   
2009
  $ 3,300     $ 502     $ 3,802  
2010
    2,765       341       3,106  
2011
    2,121       214       2,335  
2012
    1,212       282       1,494  
Thereafter
                       
Total
  $ 9,398     $ 1,339     $ 10,737  

NOTE 8 – Goodwill

The carrying amount of goodwill for 2009 is as follows:

   
Amount
(in thousands)
 
Balance as of December 31, 2008                                                                                                     
  $ 64,561  
Acquisitions                                                                                                     
     
Divestitures                                                                                                     
     
Foreign currency translation impact                                                                                                     
    49  
Balance as of June 30, 2009                                                                                                     
  $ 64,610  

The excess purchase price over the fair value of assets acquired is recorded as goodwill. As we have one operating segment, we allocate goodwill to one reporting unit for goodwill impairment testing. In accordance with SFAS 142, Goodwill and Other Intangible Assets, goodwill is tested for impairment on an annual basis, and between annual tests if indicators of potential impairment exist, using a fair-value-based approach based on the market capitalization of the reporting unit. Our annual impairment test was performed as of February 28, 2009. No impairment of goodwill has been identified during the period presented. Goodwill is deductible for tax purposes in certain jurisdictions.

NOTE 9 – Income Taxes

In July 2006, the FASB issued FASB Interpretation (“FIN”) 48, Accounting for Uncertainty in Income Taxes – an interpretation of Statement of Financial Accounting Standards 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements and prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. We had $9.7 million and $9.3 million of unrecognized tax benefits at June 30, 2009 and June 30, 2008, respectively, all of which would affect our effective income tax rate if recognized. As of June 30, 2009, it is deemed reasonable that we will recognize tax benefits in the amount of $1.6 million in the next twelve months due to the closing of open tax years. The nature of the uncertainty is related to deductions taken on returns that have not been examined by the applicable tax authority. Our continuing policy is to recognize interest and penalties related to income tax matters in income tax expense. As of June 30, 2009, we had approximately $541,000 accrued for interest related to uncertain tax positions. We recognized no material adjustment to the liability for unrecognized income tax benefits. The tax years 2002 through 2008 remain open to examination by the major taxing jurisdictions to which we are subject.

Our provision for income taxes reflected an effective tax rate of (7%) and 14% for the three month periods ended June 30, 2009 and 2008, respectively and (179%) and 17% for the six month periods ended June 30, 2009 and 2008, respectively. For the three and six month periods ended June 30, 2009, our effective tax rate was lower than the U.S. federal statutory rate of 35% due to a partial release of a deferred tax asset valuation allowance and the research credit. These benefits were partially offset by non-deductible stock-based compensation expenses, losses in foreign jurisdictions with reduced income tax rates and a valuation allowance related to a deferred tax asset for which a tax benefit was previously recognized. The non-deductible stock-based compensation expenses were a greater percentage of net income in the three and six month periods ended June 30, 2009, than they were during the comparable periods in 2008. The decrease in our effective tax rate for the three and six month periods ended June 30, 2009, compared to the three and six month periods ended June 30, 2008, was due to the partial release of a deferred tax asset valuation allowance as a percentage of net income and the research credit. These benefits were partially offset by an increase in non-deductible stock-based compensation expenses as a percentage of net income, losses in foreign jurisdictions with reduced income tax rates and changes in the valuation allowance related to a deferred tax asset for which tax benefit was previously recognized. For the three and six month periods ended June 30, 2008, our effective tax rate was lower than the U.S. federal statutory rate of 35% as a result of lower tax rates in certain foreign jurisdictions, tax exempt interest and the partial release of a deferred tax asset valuation allowance.
 
The tax position of our Hungarian operation continues to benefit from assets created by the restructuring of our operations in Hungary which was effective on January 1, 2008. Partial release of the valuation allowance on these assets resulted in income tax benefits of $3.2 million and $4.1 million for the three month periods ended June 30, 2009 and 2008, respectively, and $4.2 million and $6.1 million for the six month periods ended June 30, 2009 and 2008, respectively. As of June 30, 2009 we had a net deferred tax asset of $19.5 million related to the tax benefit of these assets. This amount is based on estimated future earnings in Hungary that are deemed more likely than not to be realized as of June 30, 2009.

Our ability to predict our level of future profitability in Hungary is very limited due to significant and frequent changes in the corporate tax law, the unstable political environment, a restrictive labor code, the volatility of the Hungarian forint relative to the U.S. dollar and increasing labor costs. This view is also supported by the rapid and unexpected decline in the economy in 2008 and 2009, which has made historical results of operations unreliable evidence of the magnitude of future taxable income beyond a relatively short period. While we believe our historical operations are a fair indicator that our operations in Hungary will produce some level of profit in the future, we believe that quarterly reassessment of anticipated future taxable income is critical and that forecasting taxable income beyond two years is not viable at this point in time. We continue to reevaluate quarterly whether and to what extent we expect to generate future taxable income in Hungary as well as how far into the future we can project profitability.
 
NOTE 10 – Comprehensive Income

Our comprehensive income is comprised of net income, foreign currency translation, unrealized gains and losses on forward and option contracts and securities available for sale. Comprehensive income for the three month and six month periods ended June 30, 2009 and 2008, was as follows (in thousands):

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
(unaudited)
   
(unaudited)
 
   
2009
   
2008
   
2009
   
2008
 
Comprehensive income:
                       
Net income
  $ 4,430     $ 24,734     $ 4,788     $ 42,350  
Foreign currency translation gains (losses), net of taxes
    3,270       (775 )     495       4,927  
Unrealized gains (losses) on derivative instruments, net of taxes
    227       901       149       (1,206 )
Unrealized gains (losses) on available for sale securities, net of taxes
    54       (241 )     (126 )     (596 )
Total comprehensive income
  $ 7,981     $ 24,619     $ 5,306     $ 45,475  


NOTE 11 – Stock-Based Compensation Plans

Stock option plans

Our stockholders approved the 1994 Incentive Stock Option Plan (the “1994 Plan”) on May 9, 1994. At the time of approval, 9,112,500 shares of our common stock were reserved for issuance under this plan. In 1997, an additional 7,087,500 shares of our common stock were reserved for issuance under this plan, and an additional 750,000 shares were reserved for issuance under this plan, as amended, in 2004. The 1994 Plan terminated in May 2005, except with respect to outstanding awards previously granted thereunder. Awards under the plan were either incentive stock options within the meaning of Section 422 of the Internal Revenue Code or nonqualified options. The right to purchase shares vests over a five to ten-year period, beginning on the date of grant. Vesting of ten year awards may accelerate based on the Company’s previous year’s earnings and growth but shares cannot accelerate to vest over a period of less than five years. Stock options must be exercised within ten years from date of grant. Stock options were issued at the market price at the grant date. As part of the requirements of SFAS 123R, Share-Based Payment, we are required to estimate potential forfeitures of stock grants and adjust compensation cost recorded accordingly. The estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of stock compensation expense to be recognized in future periods.

Transactions under all stock option plans are summarized as follows:
 
   
Stock Options (unaudited)
 
 
 
Number of shares under option
   
Weighted average
Exercise price
 
Outstanding at December 31, 2008                                                                             
    4,272,567     $ 25.97  
Exercised                                                                      
    (267,487 )     12.99  
Canceled                                                                      
    (152,589 )     25.92  
Granted                                                                      
           
Outstanding at June 30, 2009                                                                             
    3,852,491     $ 26.78  
 
The aggregate intrinsic value of stock options at exercise, represented in the table above, was $1.6 million for the six months ended June 30, 2009. Total unrecognized stock-based compensation expense related to non-vested stock options was approximately $3.9 million as of June 30, 2009, related to approximately 294,000 shares with a per share weighted average fair value of $17.00. We anticipate this expense to be recognized over a weighted average period of approximately 3.6 years.

     
Outstanding and Exercisable by Price Range as of June 30, 2009 (unaudited)
 
               
     
Options Outstanding
   
Options Exercisable
 
                                 
Range of Exercise prices
   
Number outstanding as of 6/30/2009
   
Weighted average remaining contractual life
   
Weighted average exercise price
   
Number exercisable as of 6/30/2009
   
Weighted average exercise price
 
$ 16.08 – $ 21.04       1,313,001       2.20     $ 20.69       1,230,068     $ 20.70  
$ 21.25 – $ 29.85       1,309,494       4.35     $ 27.98       1,107,211     $ 27.91  
$ 30.51 – $ 34.38       1,229,996       0.91     $ 32.02       1,221,317     $ 32.02  
$ 16.08 – $ 34.38       3,852,491       2.52     $ 26.78       3,558,596     $ 26.83  

The weighted average remaining contractual life of options exercisable as of June 30, 2009 was 3.6 years. The aggregate intrinsic value of options outstanding as of June 30, 2009 was ($16.3) million. The aggregate intrinsic value of options currently exercisable as of June 30, 2009 was ($15.2) million. No options were granted during the six months ended June 30, 2009 as our 1994 Plan terminated in May 2005.

Restricted stock plan

Our stockholders approved our 2005 Incentive Plan on May 10, 2005. At the time of approval, 2,700,000 shares of our common stock were reserved for issuance under this plan, as well as the number of shares which had been reserved but not issued under the 1994 Plan (our incentive stock option plan which terminated in May 2005), and any shares that returned to the 1994 Plan as a result of termination of options or repurchase of shares issued under such plan. The 2005 Plan, administered by the Compensation Committee of the Board of Directors, provides for granting of incentive awards in the form of restricted stock and restricted stock units (“RSUs”) to directors, executive officers and employees of the Company and its subsidiaries. Awards vest over a three, five or ten-year period, beginning on the date of grant. Vesting of ten year awards may accelerate based on the Company’s previous year’s earnings and growth but ten year awards cannot accelerate to vest over a period of less than five years. Shares available for grant at June 30, 2009 were 2,143,294. As part of the requirements of SFAS 123R, we are required to estimate potential forfeitures of RSUs and adjust compensation cost recorded accordingly. The estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of stock compensation expense to be recognized in future periods.

Transactions under the 2005 Incentive Plan are summarized as follows:

   
RSUs (unaudited)
 
   
Number of RSUs
   
Weighted Average Grant Price
 
Balance at December 31, 2008                                                                        
    2,165,228     $ 26.99  
Granted                                                                   
    530,858       20.91  
Earned                                                                   
    (407,156 )     22.04  
Canceled                                                                   
    (38,488 )     28.11  
Balance at June 30, 2009                                                                        
    2,250,442     $ 26.44  

Total unrecognized stock-based compensation expense related to non-vested RSUs was approximately $61.6 million as of June 30, 2009, related to 2,250,442 shares with a per share weighted average fair value of $26.44. We anticipate this expense to be recognized over a weighted average period of approximately 6.3 years.

Employee stock purchase plan

Our employee stock purchase plan permits substantially all domestic employees and employees of designated subsidiaries to acquire our common stock at a purchase price of 85% of the lower of the market price at the beginning or the end of the purchase period. The plan has quarterly purchase periods beginning on February 1, May 1, and November 1 of each year. At our annual shareholders meeting held on May 7, 2007, our shareholders approved an additional 3.0 million shares of common stock to be reserved for issuance under this plan. Employees may designate up to 15% of their compensation for the purchase of common stock under this plan. Common stock reserved for future employee purchases aggregated 2,145,996 shares at June 30, 2009. Shares issued under this plan were 447,611 in the three month period ended June 30, 2009. The weighted average fair value of the employees’ purchase rights was $18.25 and was estimated using the Black-Scholes model with the following assumptions:

   
2009
 
Dividend expense yield
    0.4 %
Expected life
 
3 months
 
Expected volatility
    46 %
Risk-free interest rate
    1.3 %

For the three month and six month periods ended June 30, 2009 and June 30, 2008, stock-based compensation recorded as a component of cost of sales, sales and marketing, research and development, and general and administrative was as follows:

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
(unaudited)
   
(unaudited)
 
   
2009
   
2008
   
2009
   
2008
 
Stock-based compensation
                       
Cost of sales
  $ 330     $ 270     $ 640     $ 515  
Sales and marketing
    2,231       2,084       4,416       4,090  
Research and development
    1,683       1,566       3,420       3,293  
General and administrative
    761       797       1,560       1,551  
                                 
Provision for income taxes
    (1,865 )     (1,141 )     (4,879 )     (2,224 )
Total
  $ 3,140     $ 3,576     $ 5,157     $ 7,225  

Authorized Preferred Stock and Preferred Stock Purchase Rights Plan

We have 5,000,000 authorized shares of preferred stock. On January 21, 2004, our Board of Directors designated 750,000 of these shares as Series A Participating Preferred Stock in conjunction with its adoption of a Preferred Stock Rights Agreement (the “Rights Agreement”) and declaration of a dividend of one preferred share purchase right (a “Right”) for each share of common stock outstanding held as of May 10, 2004 or issued thereafter. Each Right will entitle its holder to purchase one one-thousandth of a share of National Instruments’ Series A Participating Preferred Stock at an exercise price of $200, subject to adjustment, under certain circumstances. The Rights Agreement was not adopted in response to any effort to acquire control of National Instruments.

The Rights only become exercisable in certain limited circumstances following the tenth day after a person or group announces acquisitions of or tender offers for 20% or more of our common stock. In addition, if an acquirer (subject to certain exclusions for certain current stockholders of National Instruments, an “Acquiring Person”) obtains 20% or more of our common stock, then each Right (other than the Rights owned by an Acquiring Person or its affiliates) will entitle the holder to purchase, for the exercise price, shares of our common stock having a value equal to two times the exercise price. Under certain circumstances, our Board of Directors may redeem the Rights, in whole, but not in part, at a purchase price of $0.01 per Right. The Rights have no voting privileges and are attached to and automatically traded with our common stock until the occurrence of specified trigger events. The Rights will expire on the earlier of May 10, 2014 or the exchange or redemption of the Rights.

NOTE 12 – Commitments and Contingencies

We offer a one-year limited warranty on most hardware products, which is included in the sales price of many of our products. Provision is made for estimated future warranty costs at the time of sale pursuant to SFAS 5, Accounting for Contingencies, for the estimated costs that may be incurred under the basic limited warranty. Our estimate is based on historical experience and product sales during this period.

The warranty reserve for the six month periods ended June 30, 2009 and 2008, respectively, was as follows (in thousands):

   
Six Months Ended
 
   
June 30,
 
   
(unaudited)
 
   
2009
   
2008
 
Balance at the beginning of the period                                                                                
  $ 952     $ 750  
Accruals for warranties issued during the period                                                                                
    1,069       826  
Settlements made (in cash or in kind) during the period
    (1,099 )     (884 )
Balance at the end of the period                                                                                
  $ 922     $ 692  

As of June 30, 2009, we have outstanding guarantees for payment of foreign operating leases, customs and foreign grants totaling approximately $2.4 million.

As of June 30, 2009, we have non-cancelable purchase commitments with various suppliers of customized inventory and inventory components totaling approximately $7.1 million over the next twelve months.

NOTE 13 – Segment Information

In accordance with SFAS 131, Disclosures about Segments of an Enterprise and Related Information, we determine operating segments using the management approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of our operating segments. It also requires disclosures about products and services, geographic areas and major customers.

We have defined our operating segment based on geographic regions. We sell our products in three geographic regions. Our sales to these regions share similar economic characteristics, similar product mix, similar customers, and similar distribution methods. Accordingly, we have elected to aggregate these three geographic regions into a single operating segment. Revenue from the sale of our products which are similar in nature and software maintenance are reflected as total net sales in our Consolidated Statements of Income.

Total net sales, operating income, interest income and long-lived assets, classified by the major geographic areas in which we operate, are as follows (in thousands):

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
(unaudited)
   
(unaudited)
 
   
2009
   
2008
   
2009
   
2008
 
Net sales:
                       
Americas:
                       
Unaffiliated customer sales                                             
  $ 68,093     $ 88,922     $ 136,532     $ 172,506  
Geographic transfers                                             
    21,013       29,957       42,374       60,940  
      89,106       118,879       178,906       233,446  
                                 
Europe:
                               
Unaffiliated customer sales                                            
    46,863       72,089       96,343       131,233  
Geographic transfers                                            
    45,096       46,185       95,249       96,770  
      91,959       118,274       191,592       228,003  
                                 
Asia Pacific:
                               
Unaffiliated customer sales                                            
    37,207       49,463       77,087       99,653  
Eliminations                                              
    (66,109 )     (76,142 )     (137,623 )     (157,710 )
                                 
    $ 152,163     $ 210,474     $ 309,962     $ 403,392  

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
(unaudited)
   
(unaudited)
 
   
2009
   
2008
   
2009
   
2008
 
Operating income:
                       
Americas                                               
  $ 8,293     $ 16,834     $ 13,600     $ 32,087  
Europe                                               
    15,695       28,689       32,475       49,727  
Asia Pacific                                               
    7,800       15,499       18,023       32,878  
Unallocated:
                               
Research and development expenses
    (29,447 )     (33,188 )     (64,236 )     (68,792 )
    $ 2,341     $ 27,834     $ (138 )   $ 45,900  
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
(unaudited)
   
(unaudited)
 
   
2009
   
2008
   
2009
   
2008
 
Interest income:
                       
Americas                                               
  $ 226     $ 627     $ 520     $ 1,683  
Europe                                               
    162       867       436       1,917  
Asia Pacific                                               
    19       20       40       51  
    $ 407     $ 1,514     $ 996     $ 3,651  
 
 
 
June 30,
2009
   
December 31,
2008
 
   
(unaudited)
       
Long-lived assets:
           
Americas                                                     
  $ 104,547     $ 107,701  
Europe                                                     
    37,390       39,280  
Asia Pacific                                                     
    8,683       7,496  
    $ 150,620     $ 154,477  

Total sales outside the United States for the three month periods ended June 30, 2009 and 2008, were $90.9 million and $130.5 million, respectively. Total sales outside the United States for the six months ended June 30, 2009 and 2008, were $187.1 million and $247.2 million, respectively.

NOTE 14 – Acquisitions

On February 1, 2008, we acquired all of the outstanding shares of microLEX Systems A/S, a premier provider of virtual instrumentation-based video, audio and mixed-signal test solutions. This acquisition was accounted for as a business combination. The total purchase price of the acquisition, which included legal and accounting fees, was $17.8 million in cash. The allocation of the purchase price was determined using the fair value of assets and liabilities acquired as of February 1, 2008. We funded the purchase price from existing cash balances. Our consolidated financial statements include the operating results from the date of acquisition. Pro-forma results of operations have not been presented because the effects of those operations were not material. The following table summarizes the initial allocation of the purchase price of microLEX (in thousands):

Goodwill                                                        
  $ 10,818  
Acquired core technology                                                        
    5,201  
Non-competition agreements                                                        
    159  
Trademarks                                                        
    119  
Customer relationships                                                        
    354  
Current assets acquired                                                        
    3,057  
Long-term assets acquired                                                        
    20  
Current liabilities assumed                                                        
    (486 )
Deferred tax liabilities                                                        
    (1,458 )
Total equity acquired                                                        
  $ 17,784  

Goodwill is not deductible for tax purposes. Existing technology, non-competition agreements, trademarks and customer relationships have useful lives of 5 years, 3 years, 3 years, and 5 years, respectively, and will be amortized over these periods from the date of acquisition. These assets are not deductible for tax purposes.

NOTE 15 – Recently Issued Accounting Pronouncements

In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with FASB Statement 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. This FSP shall be effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. We adopted FSP FAS 157-4 on April 1, 2009 as required and concluded it did not have a material impact on our consolidated financial position or results of operations.

In December 2007, the FASB issued SFAS 141R, Business Combinations—a replacement of FASB Statement 141, which significantly changes the principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This statement is effective prospectively, except for certain retrospective adjustments to deferred tax balances, for fiscal years beginning after December 15, 2008. We adopted SFAS 161 on January 1, 2009, as required and concluded it did not have a significant impact on our consolidated financial position or results of operations.

In March 2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and Hedging Activities. This statement changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This statement is effective for fiscal years and interim periods beginning after November 15, 2008. We adopted SFAS 161 on January 1, 2009, as required and concluded it did not have a significant impact on our consolidated financial position or results of operations.

In April 2009, the FASB issued FSP FAS 115-2, Recognition and Presentation of Other-Than-Temporary Impairments. FSP FAS 115-2 amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The FSP shall be effective for interim and annual reporting periods ending after June 15, 2009. We adopted FSP FAS 115-2 on April 1, 2009, as required and concluded it did not have a material impact on our consolidated financial position or results of operations as we do not have material items within the scope of this standard.

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments. This FSP requires disclosures about the fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP shall be effective for interim reporting periods ending after June 15, 2009. We adopted FSP FAS 107-1 and APB 28-1 on April 1, 2009, as required and concluded it did not have a material impact on our consolidated financial position or results of operations as we do not have any significant financial instruments that are not already included in our fair value measurement disclosure under Note 4 of Notes to Consolidated Financial Statements.

In May 2009, the FASB issued SFAS 165, Subsequent Events. This standard establishes the principles and requirements for subsequent events. In particular, the standard sets forth the following: 1) the period after the balance sheet date during which management of a reporting entity shall evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, 2) the circumstances under which an entity shall recognize events or transactions occurring after the balance sheet date in its financial statements, and 3) the disclosures that an entity shall make about events or transactions that occurred after the balance sheet date. This statement is effective for interim and annual financial periods ending after June 15, 2009. We adopted FAS 165 on April 1, 2009, as required and concluded it did not have a material impact on our consolidated financial position or results of operations.
 
In June 2009, the FASB issued SFAS 168, The FASB Accounting Standards Codification and Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162. SFAS 168 establishes the FASB Standards Accounting Codification (“Codification”) as the source of authoritative U.S. generally accepted accounting principles (“GAAP”) recognized by the FASB to be applied to nongovernmental entities and rules and interpretive releases of the SEC as authoritative GAAP for SEC registrants. The Codification will supersede all then- existing non-SEC accounting and reporting standards. This statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. We are currently evaluating the requirements of SFAS 168 and have not yet determined the impact on our consolidated financial statements.

NOTE 16 – Litigation

We filed a patent infringement action on January 25, 2001, in the U.S. District Court, Eastern District of Texas (Marshall Division) claiming that The MathWorks, Inc. ("MathWorks") infringed certain of our U.S. patents. On January 30, 2003, a jury found infringement by MathWorks of three of the patents involved and awarded us specified damages. On June 23, 2003, the District Court entered final judgment in favor of us and entered an injunction against MathWorks' sale of its Simulink and related products and stayed the injunction pending appeal. Upon appeal, the judgment and the injunction were affirmed by the U.S. Court of Appeals for the Federal Circuit (September 3, 2004). Subsequently the stay of injunction was lifted by the District Court. In November 2004, the final judgment amount of $7.4 million which had been held in escrow pending appeal was released to us.

An action was filed by MathWorks against us on September 22, 2004, in the U.S. District Court, Eastern District of Texas (Marshall Division), claiming that on that day MathWorks had released modified versions of its Simulink and related products, and seeking a declaratory judgment that the modified products do not infringe the three patents adjudged infringed in the District Court's decision of June 23, 2003 (and affirmed by the Court of Appeals on September 3, 2004). On November 2, 2004, MathWorks served the complaint on us. We filed an answer to MathWorks' declaratory judgment complaint, denying MathWorks' claims of non-infringement and alleging our own affirmative defenses. On January 5, 2005, the Court denied a contempt motion by us to enjoin the modified Simulink products under the injunction in effect from the first case. On January 7, 2005, we amended our answer to include counterclaims that MathWorks' modified products are infringing three of our patents, and requested unspecified damages and an injunction. MathWorks filed its reply to our counterclaims on February 7, 2005, denying the counterclaims and alleging affirmative defenses. On March 2, 2005, we filed a notice of appeal regarding the Court's denial of the contempt motion. On March 15, 2005, the Court stayed MathWorks’ declaratory judgment action, pending a decision on the appeal by the Court of Appeals for the Federal Circuit. On February 9, 2006, the Court of Appeals for the Federal Circuit affirmed the District Court’s January 2005 order. On November 22, 2006, the District Court lifted the stay. The case schedule has yet to be set in this action. During the fourth quarter of 2004, we accrued $4 million related to our probable loss from this contingency, which consists entirely of anticipated patent defense costs that are probable of being incurred. In the fourth quarter of 2006, we accrued an additional $600,000 related to this contingency. We charged approximately $2,000 against this accrual during the six months ended June 30, 2009. To date, we have charged a cumulative total of $620,500 against this accrual.

NOTE 17 – Subsequent Event

We have evaluated subsequent events through August 4, 2009, the date the financial statements were issued.

On July 22, 2009, our Board of Directors declared a quarterly cash dividend of $0.12 per common share, payable August 31, 2009, to shareholders of record on August 10, 2009.


 
 

 

Item 2.              Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Any statements contained herein regarding our future financial performance or operations (including, without limitation, statements to the effect that we “believe,” "expect," "plan," "may," "will," "project," "continue," or "estimate" or other variations thereof or comparable terminology or the negative thereof) should be considered forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of important factors, including those set forth under the heading “Risk Factors” beginning on page 37, and the discussion below. Readers are also encouraged to refer to the documents regularly filed by us with the Securities and Exchange Commission, including our Annual Report on Form 10-K for further discussion of our business and the risks attendant thereto.


Overview

National Instruments Corporation (“we” or “our”) is a leading supplier of measurement and automation products that engineers and scientists use in a wide range of industries. These industries comprise a large and diverse market for design, control and test applications. We provide flexible application software and modular, multifunctional hardware that users combine with industry-standard computers, networks and third party devices to create measurement, automation and embedded systems, which we also refer to as “virtual instruments”. Our approach gives customers the ability to quickly and cost-effectively design, prototype and deploy unique custom-defined solutions for their design, control and test application needs. We sell to a large number of customers in a wide variety of industries. No single customer accounted for more than 3% of our sales during the three month and six month periods ended June 30, 2009, or in the years 2008, 2007 or 2006.

The key strategies that management focuses on in running our business are the following:

Expanding our broad customer base

We strive to increase our already broad customer base by serving a large market on many computer platforms, through a global marketing and distribution network. We also seek to acquire new technologies and expertise from time to time in order to open new opportunities for our existing product portfolio.

Maintaining a high level of customer satisfaction

To maintain a high level of customer satisfaction we strive to offer innovative, modular and integrated products through a global sales and support network. We strive to maintain a high degree of backwards compatibility across different platforms in order to preserve the customer’s investment in our products. In this time of intense global competition, we believe it is crucial that we continue to offer products with quality and reliability, and that these products provide cost-effective solutions for our customers.

Leveraging external and internal technology

Our product strategy is to provide superior products by leveraging generally available technology, supporting open architectures on multiple platforms and by leveraging our core technologies such as custom application specific integrated circuits (“ASICs”) across multiple products.

We sell into test and measurement (“T&M”) and industrial/embedded applications in a broad range of industries and as such are subject to the economic and industry forces which drive those markets. It has been our experience that the performance of these industries and our performance is impacted by general trends in industrial production for the global economy and by the specific performance of certain vertical markets that are intensive consumers of measurement technologies. Examples of these markets are semiconductor capital equipment, telecom, defense, aerospace, automotive and others. In assessing our business, we consider the trends in the Global Purchasing Managers Index (“PMI”) published by JP Morgan, global industrial production as well as industry reports on the specific vertical industries that we target. We believe that the global industrial economy continues to be in a recession. Many economists and other experts are predicting that this recession in the U.S. and global economies will likely continue through the remainder of 2009 and possibly beyond. We are unable to predict how long this recession will last. We expect our business to continue to be adversely impacted by this downturn in the U.S. and global economies.

We distribute our software and hardware products primarily through a direct sales organization. We also use independent distributors, OEMs, VARs, system integrators and consultants to market our products. We have sales offices in the U.S. and sales offices and distributors in key international markets. Sales outside of the Americas accounted for approximately 55% and 58% of our revenues in each of the three month periods ended June 30, 2009 and 2008, respectively, and 56% and 57% of our revenues in each of the six month periods ended June 30, 2009 and 2008, respectively. The vast majority of our foreign sales are denominated in the customers’ local currency, which exposes us to the effects of changes in foreign currency exchange rates. We expect that a significant portion of our total revenues will continue to be derived from international sales. (See Note 13 of Notes to Consolidated Financial Statements for details concerning the geographic breakdown of our net sales, operating income, interest income and identifiable assets).

We manufacture a substantial majority of our products at our facilities in Debrecen, Hungary. Additional production primarily of low volume or newly introduced products is done in Austin, Texas. Our product manufacturing operations can be divided into four areas: electronic circuit card and module assembly; chassis and cable assembly; technical manuals and product support documentation; and software duplication. We manufacture most of the electronic circuit card assemblies, and modules in-house, although subcontractors are used from time to time. We use subcontractors in Asia to manufacture a significant portion of our chassis. We manufacture some of our electronic cable assemblies in-house, but many assemblies are produced by subcontractors. We primarily subcontract our software duplication, our technical manuals and product support documentation.
 
In response to significant and frequent changes in the corporate tax law, the unstable political environment, a restrictive labor code, the volatility of the Hungarian forint relative to the U.S. dollar and increasing labor costs, we have significant doubts as to the long term viability of Hungary as a location for our manufacturing and warehousing operations. As such, we may need to look for an alternative location for a substantial majority of our manufacturing and warehousing activities which could have a material adverse effect on our ability to meet current customer demands, our ability to grow our business as well as our liquidity, capital resources and results of operations. Our long term manufacturing and warehousing capacity planning contemplates a third manufacturing and warehousing facility in Malaysia. Deployment of this facility could be accelerated in response to an unfavorable change in the corporate taxation, regulatory or economic environment in Hungary. We can give no assurance that we would be successful in accelerating the deployment of a new facility in Malaysia. Our failure to accelerate the deployment of our manufacturing and warehousing facility in Malaysia in response to changes in the corporate taxation, regulatory or economic environment in Hungary, could have a material adverse effect on our ability to meet current customer demands, our ability to grow our business as well as our liquidity, capital resources and results of operations.
 
We believe that our long-term growth and success depends on delivering high quality software and hardware products on a timely basis. Accordingly, we focus significant efforts on research and development. We focus our research and development efforts on enhancing existing products and developing new products that incorporate appropriate features and functionality to be competitive with respect to technology, price and performance. Our success also is dependent on our ability to obtain and maintain patents and other proprietary rights related to technologies used in our products. We have engaged in litigation and where necessary, will likely engage in future litigation to protect our intellectual property rights. In monitoring and policing our intellectual property rights, we have been and may be required to spend significant resources.

Current business outlook

Many of the industries we serve have historically been cyclical and have experienced periodic downturns. Our customers across almost all industries and geographic regions which we serve demonstrated reduced order patterns for our products beginning in the fourth quarter of 2008. Those reduced order patterns have continued during the six month period ended June 30, 2009. During this period, many of the world’s major industrial economies reported record or near record declines in industrial production, signaling severe contraction in the industrial economy. These difficult economic conditions have negatively impacted our order trends and revenue over this period.

The quarterly average of the global Purchasing Managers Index (PMI) was 44.7 for the second quarter of 2009 after reaching a record low of 36 during the first quarter of 2009. After reaching a record low monthly reading of 33.2 in December 2008, we have seen the monthly reading rise throughout the first six months of 2009. Although the PMI reading for the second quarter of 2009 continued to indicate that the global industrial economy was still declining through the end of June 2009, it also indicates that the rate of the decline eased over this same period. We have seen the effect of this PMI stabilization on our daily order rate which has stabilized in absolute dollars; however, we cannot predict when the overall contraction in the global industrial economy will end or when we will see readings that