National Instruments Corp (NATI) 2008 Q4 法說會逐字稿

Good day, everyone, and welcome to the National Instruments fourth quarter 2008 earnings conference call. (Operator's Instructions). With us today are Mr. David Hugley, VP, Corporate Counsel; Mr. James Truchard, Chief Executive Officer, and Mr. Alex Davern, Chief Financial Officer. For opening remarks, I now would like to turn the call over to Mr. David Hugley, Vice President, Corporate Counsel. Please go ahead, sir.

Good afternoon. During the course of this conference call, we shall make forward-looking statements regarding the future financial performance of the Company, including statements regarding the following. Our expected expenses for the first quarter and for 2009, improving revenue and profit in the second quarter compared to the first quarter, revenue and profit following a normal seasonal pattern, a decline in inventories, effective tax rate, and gaining market share.

We wish to caution you that such statements are just predictions and actual events or results may differ materially. We refer you to the documents the Company files regularly with the Securities and Exchange Commission, including the Company's annual report on Form 10-K for the year ended December 31, 2007, and our quarterly report on Form 10-Q filed in November 7, 2008. These documents contain and identify important factors that could cause our actual results to differ materially from those contained in our forward-looking statements. With that, I will now turn it over to the President and CEO of National Instruments Corporation, Dr. JamesTruchard.

Thank you, David. Good afternoon, and thank you for joining us. Our key points today are 11% year-over-year revenue growth in 2008, record annual revenue in key product areas, including software, data acquisition, PXI, and module instrumentation and distributed IO and continued validation of the advantages of our software-based approach in a tough economic environment.

Despite the 1% revenue decline in Q4, we turned in a relatively strong performance when you considered the historic weakness in an economy that triggered a severe contraction in a test and measurement market. The strength of our operating business model was tested and validated in one of the most challenging periods in the history of the Company. The diversity and adaptability of our products and channels enabled us to find new business opportunity and growth areas in Q4. In our call today, Alex Davern, our CFO will review our financials, John Graff, our Vice President of Marketing will discuss our business and I will close with a few comments before we open up for your questions. Alex?

Good afternoon. Today we reported quarterly revenue of $202 million, a 1% year-over-year decline. For the full year, the Company reported record annual revenue of $821 million, an 11% increase over 2007. This represents the sixth consecutive annual revenue record for the Company. Given that the US economy was in recession throughout 2008 and that the global PMI averaged approximately 46 during the year indicating a global industrial recession, National Instruments' 11% year-over-year growth was a very good relative performance.

Net income for Q4 was $19.3 million with fully diluted earnings per share of $0.25. Non-GAAP net income was $24.2 million, with non-GAAP fully diluted earnings per share of $0.31. When comparing our results with our GAAP and non-GAAP fully diluted EPS in Q4 2007, please remember that in Q4 2007, NI recognized an $18.3 million tax credit, which had the impact of increasing our GAAP and non-GAAP EPS by $0.23 in Q4 2007. GAAP operating income for 2008 was $96 million, down from $102 million in 2007. Non-GAAP operating income for 2008 was $120 million, down 3% from 2007. Cash flow from operating activities was $122 million in 2008.

Now, looking at revenue in more detail. From a product point of view, our instrument control revenues saw a 29% year-over-year decline in Q4. With the rest of our products being up 2% year-over-year. Our instrument control products are the most economically sensitive portion of revenue and we expect the revenue trend and instrument control to continue to deteriorate in Q1.

Q4 represented the lowest quarterly revenue total for our instrument control products since 1994 and this data, plus the very negative news announced in the industry since October suggests a very severe contraction in the test and measurement industry during Q4, especially in the semiconductor ATE segment. The very modest growth of the rest of the business during Q4 was enabled by growth in the areas of modular instruments, PXI, software and CompactRIO which which performed very well in light of the industry contraction. Within modular instruments, our RF test products were a standout performer, with revenues up approximately 50% year-over-year for Q4. For the full year, our instrument control revenues were down 11% as a result of the contraction in the test market during 2008. Our virtual instrumentation and graphical system design products grew 13% for the year.

We saw the impact of the industrial recession on all regions. During Q4 year-over-year revenue growth was minus 2% in Europe, minus 8% in Asia and up 4% in the Americas, giving overall growth of minus 1%. We believe that our performance in the US was helped by the fact that it had lower growth than the other regions in Q4 2007, as the US economy weakened first, with a PMI averaging below 50 in Q4 of 2007.

On another note, in the earnings release today, we have separately disclosed our maintenance, software maintenance revenue for the first time. We've added this disclosure due to the increasing percentage of our revenues coming from the software maintenance and the interest of shareholders' invisibility into this revenue stream. All future earnings releases and regulatory filings will include this expanded revenue disclosure. As part of this expanded disclosure, some technical support costs previously included in sales and marketing expenses are now accounted for as part of costs of goods sold. All prior year amounts have been reclassified to conform with this presentation. This change will have the impact of reducing our gross margins by approximately 40 basis points, with a corresponding reduction in sales or marketing expenses as a percentage of sales.

Looking at this breakdown for Q4, product revenue was $187 million, down 4% from Q4 2007 and software maintenance revenue was $15 million, up 42% year-over-year. For the full year, product revenue was $765 million and software and maintenance revenue was $55 million, representing 9% and 42% year-over-year revenue growth respectively.

Now, looking at the non-GAAP income statement in more detail. Non-GAAP gross margin in Q4 was 75.8% compared to 75.7% in Q4 2007. Both these data points have been adjusted for the software maintenance reclassification discussed earlier. R&D expenses were up 7% year-over-year in Q4. Software development expenses capitalized in the quarter amounted to $800,000, down from $1.1 million in Q3, and also during the quarter, $2.5 million in previously capitalized software development costs were amortized to cost of goods sold.

Now, turning to the balance sheet. Inventory increased by 8% during the quarter. The increase is a result of the demand in Q4 falling short of our original expectations. We have adjusted our production schedules and we expect that the inventories decline in Q1. Accounts receivable days outstanding were flat with Q4 2007.

As of December 31, the Company had $236 million in cash and short-term investments. This cash balance is net of $9 million in dividends paid during the quarter and $45 million used to repurchase 1,989,000 shares of NI's common stock at an average price of $22.86 per share. For the full year, the Company paid $35 million in dividends and used $104 million to repurchase 4.1 million shares, or 5% of its common stock at an average price of $25.23 per share. In January, the board of directors increased the Company's stock repurchase authorization to 3 million shares of NI's common stock. We also announced today that the board of directors approved an increase in the Company's quarterly dividend from $0.11 per share to $0.12 per share payable on March 2 to shareholders of record on February 9.

Now, looking forward into 2009. Business conditions, which had deteriorated significantly in December, have continued to be challenging in January. The current economic uncertainty, coupled with extended holiday shutdowns at many of our customers, and the shift to the Chinese new year into January of this year from February last year has limited our visibility for Q1. As a result, we have decided to delay giving revenue and earnings per share guidance for the first quarter until our business update call scheduled for Thursday, March 5, when we expect to have a clearer picture of Q1. Historically, NI's revenue has declined sequentially in Q1 and Q1 has been the lowest revenue and profit quarter for the year. We expect these patterns to continue this year.

Looking out to Q2 and beyond, we expect our normal seasonal pattern to start to re-emerge and to see revenue and profit improve sequentially in Q2 from the base level in Q1. On the expense side, we will continue to be very prudent in managing our expenses. We will continue to increase investments in R&D and field sales, plus significantly limiting expense growth elsewhere. Since the update call on January 2, the Company has reduced its spending plans for the full year of 2009 by a further $30 million in order to better position the Company to deal with the extended economic uncertainty. As a result, for the full year of 2009, we are now budgeting for 3% year-over-year reduction in non-GAAP operating expenses compared to a 14% increase in 2008. For Q1, we are currently budgeting for a year-over-year increase of approximately 1% in total non-GAAP operating expenses.

In other items, we expect non-GAAP gross margins adjusted for software maintenance change discussed earlier to be between 74.8% and 75.3% for Q1 and we are guiding to a 15% non-GAAP effective tax rate for the full year of 2009. As these are forward-looking statements, I must caution you that actual revenues, expenses and earnings could be negatively effected by numerous factors such as any further decline in the global economy, delays in new product leases, rescheduling customer orders, expense overruns, manufacturing inefficiencies, effective tax rates and foreign exchange fluctuations.

So in closing, despite a global industrial recession, we successfully grew our business 11% in 2008, effectively maintained our operating profit, and generated $122 million in cash flow from operations. I believe we have been both strategic and prudent in our business planning and our reaction and execution in this downturn is once again demonstrated that our business model is solid. And with that, I'll turn it over to John Graff, Vice President of Marketing.

Thank you, Alex. The historically low global PMI rating in December of 33.2, suggests that Q4 2008 was the most challenging global economic environment in the 32-year history of National Instruments. The instrument control portion of our business was down 29% in the quarter, suggesting a significant contraction of the test measurement industry in Q4. While we were ultimately unable to sustain growth in Q4 in the face of these downward forces, we believe that we have weathered this economic storm better than our peers and continued to drive market share gains throughout 2008.

For the full year, we delivered record revenue, up 11%, our 31st year of revenue growth in our 32 year history. Our operating model proved its strength and resilience as strong margins helped fund strategic investments in R&D and field sales in 2008. The diversity of our business has proven again to be a powerful asset in this harsh environment. Since the last downturn, we have transformed from a transaction-focused PC peripheral company to a platform-based business that closes large system sales to high end test, industrial, and embedded applications. Sales of distributed IO products, including compact Rio more than tripled since the end of 2003 and sales of PXI modular instrumentation increased more than 6 X in that same five-year period. The success of these system level platforms has led to a shift in our business and sales model, as evidenced by our average order size increasing to $3700 at the end of 2008, a 35% increase compared to the end of 2003.

Additionally, orders over $20,000 were 38% of our business in 2008, compared to only 25% of our business in 2003. While the success of PXI and NI CompactRIO signal our further penetration in new application areas, National Instruments remains highly diversified across industries and applications. With no one industry accounting for more than 10% of revenues and no one customer accounting for more than 3%. As it did throughout 2008, software growth again outpaced the Company average in Q4, leading to record quarterly revenue. Growth was driven by strong sales of Developer Suite, a configurable bundle which packages LabVIEW with other NI software. We saw continued strength during the quarter of sales of volume license agreements for LabVIEW, which is a strong indicator that companies continue to see the value of investing in and standardizing on LabVIEW across a department or throughout the organization.

Continued growth of our LabVIEW user base has contributed to an uptick in paid customer training in 2008. In Q4, we saw a surge in customers attending our online training offerings, where customers attend a live internet session rather than traveling to a regional training site. Making customers more proficient with LabVIEW has been and will continue to be a key focus area for the Company, as it often leads to further adoption of other NI hardware and software. Our new family of Wi-Fi data acquisition devices released at NI week was a bright spot in Q4. Despite the challenges in the quarter, the Wi-Fi devices exceeded the sales targets that we set earlier in the year. The Wi-Fi capability has allowed us to win applications where cabling would be difficult or impossible, and we have had successes in application areas as diverse as agriculture, mining, and facility monitoring.

While we did see a slowdown in the growth rate of PXI and modular instrument products in Q4 after five consecutive quarters of record revenue, these products had year-over-year sales growth in Q4 well ahead of the Company average. Success of the new PXI Express 6.6 gigahertz RF modular instruments helped drive record RF product sales in Q4. The new modules, which were announced at NI week last year, extend the capabilities of PXI into new applications such as WiMAX and mylo testing that we were previously unable to address.

In addition to the new application areas, internal and customer benchmarks have shown improvements in measurement speed of up to 10 X compared to traditional RF instrumentation. This offers both significant reductions in testing time, as well as reduced number of test systems required for a given volume of production units, which makes our PXI RFsolutions especially attractive during periods of tightening capital spending.

In addition to wins in production tests, we also continued to see success of PXI Express and validation tests. One example during the quarter was a prominent LCD manufacturer who adopted PXI Express due to its high bandwidth data streaming capabilities. Their new system executes a complete video test profile in hours and replaced the manual process of testing each input source individually that took weeks to complete.

In Q4, CompactRIO saw continued growth and record revenue. Our new NI single board RIO products had another successful quarter, as our FPGA-based board level systems won out against custom signs in OEM applications such as medical devices and green energy.

In addition, starting January 3, approximately 50,000 high school students and 3000 engineering mentors in the first robotics competition began using CompactRIO. Students in the competition have only 6 weeks to design, prototype and deploy their complex robotic devices. The challenges they face are similar to those faced by many of our industry customers and first represents not only an opportunity to impact the engineers of tomorrow, but also expose the benefits of graphical system design to today's leaders in the engineering community. One team mentor who has been a seed programmer for the past 20 years, described his first experiences with LabVIEW by saying, "you don't really appreciate the depth and breadth of LabVIEW until you actually work with it. Now the kids can focus on problem solving. I'm very impressed and definitely converted."

In summary, we believe our continued focus on making our core customer base successful, in combination with the disciplined investments we have made in new product R&D and field sales to target new application areas, has enabled us to outperform the market even during economic contraction and provides a very strong position to take advantage of the eventual recovery. With that, I'll turn it over to Dr. T.

Thank you, John. Q4 was indeed the most challenging and turbulent period in the history of the Company. It's during these times that the strength and resilience of our business model truly shows its merit. Our field sales force again proved to be a powerful asset, as their aptitude and adaptability enabled us to outperform the market in Q4. The breadth of customers in markets we serve enables our field sales engineers to continue to find and capitalize on areas where investment is flowing.

Two areas in particular were where we see continued focus from our customers are manufacturing cost reduction and R&D innovation. In manufacturing, customers continue to show significant caution in increasing production capacity, but also have an increased need for efficiency gains and cost reduction. Software-based test systems with PXI and modular instrumentation are well suited to meet this need, providing much faster bandwidth, faster test times, and greater flexibility than traditional instruments, which result in lower per-unit test costs.

In industrial and embedded applications, our ability with CompactRIO to run sophisticated control algorithms on the FPGA enables more efficient motor control, improved energy management, and reduced [graph]. In R&D, we see the opportunity and efforts to improve efficiency and reduce design times. For example, the ability to design application-specific code in LabVIEW deployed on reconfigurable FPGAs provide significant advantages and efficiency gains in prototyping and design validation of products ranging from advanced engine control units to next generation semi conductors. We are also in a good position to benefit from the increased capital flows into such areas as structural help monitoring, alternative energy research, and science and engineering at the high school and university level. For example, earlier this month, the National Institute of Standards and Technology announced a $3.4 million grant to fund the five-year research product between the University of Texas, National Instruments, and an Illinois-based engineering firm to develop sensor networks for bridge inspection. Further examples are found in research facilities such as National Renewable Energy Laboratory that are using LabVIEW and National Instruments technology to research and develop solutions for alternative energy, including solar, wind, and wave harvesting.

The adoption and usage of LabVIEW in the high school and university science and engineering classrooms and research labs should benefit NI [associate] additional funding for computers and instrumentation. As these opportunities and others present themselves, the skill and flexibility of our sales force lets us quickly respond and capitalize.

Finally, I would like to thank and congratulate our employees for National Instruments being named to Fortune 100 best places to work for a tenth consecutive year. Our employees are the life blood of the Company and continue to drive innovative culture that makes National Instruments a great place to work and a leader in the markets we serve. We remain dedicated to delivering highly differentiated new products to increase market share in our existing market and drive growth in new application areas. I see the current market condition as not only a challenge, but also as an opportunity as our customers focus on doing more with less, reducing risk, and sharpening design cycle.

We remain financially prudent and committed to tight spending control, but will maintain our strategic investments to find future growth. By striking this balance between long-term strategic priorities and short-term cost management National Instruments will be well positioned to emerge in an even stronger position in the next up cycle. This strategy has enabled National Instruments to be a model of consistent growth and profitability throughout our history and we remain committed as ever to the success of our customers, suppliers, employees, and shareholders. Thank you. We will now take your questions.

(Operator Instructions). Our first question comes from Antonio Antezano with Macquarie Capital.

Thank you, good afternoon.

Hi, Antonio, how are you?

Good. I wanted to ask you back in early January, the guidance -- preliminary guidance you provided for Q1 was a single-digit decline. So should we take that, or what should we think about that preliminary guidance you provided?

At this point in time, Antonio, we're rescinding that guidance and basically at a point where we're not going to give revenue guidance for the first quarter. The reason for that change in simple terms is that we had talked about Q4 as we went through the fourth quarter, October and November were slightly positive and then we saw a significant decline in very challenging conditions in December. January has turned out to be very similar to December at this point in time. It's also been a little bit confused by a significant number of our customers being shut down during the early part of January and then the shifting of the Chinese new year into January instead of February as it was last year. Those elements have confused the picture a little bit, made it more difficult.

I also think that the flood of kind of bad, negative news that's come out from many companies over the course of the last two weeks has probably made it likely that many of our customers themselves are going through a rebudgeting process. And it's quite likely they themselves at this point don't know exactly what their spending plans are going to be. Given that, it's most likely that the biggest variable influencing the outcome of Q1 for NI will be the broader based economy in the next couple of months. And given that that's not a factor that we control, I think the sensible thing for us to do at this point is wait until the picture is a little clearer and hence, we're going to do a business update call in early March. I think at that point we'll have a very clear idea of how things are going to play out.

And a follow-up, the 3%, I guess decline, operating and spending. If you could expand, what actions are you taking to get to that and what should we expect on a quarterly basis during the year?

Let me answer the second part first. So it's going to obviously, take a little bit of time to put fully into place. So while we are budgeting for minus 3% for the full year, we are budgeting for plus 1% in Q1. And then the change for the remaining three quarters will be largely consistent. So, the changes we're making, we expect to largely be in place for -- fully for Q2.

In terms of the changes we've made, I'm really proud of the organization and the business management around the world and the way that NI has reacted to this downturn. We've always been very focused on maintaining a strong and stable financial performance as you've seen over the last 20 years. As we saw strong growth in the first nine months of the year, we were spending aggressively and investing aggressively. We had increased our operating expenses on a non-GAAP basis, about 18% in the first nine months, in line with our revenue growth in the second and third quarters. And then we adjusted rapidly, bringing our operating expense growth down to less than 6% in Q4. We're now guiding to 1% in Q1 and minus 3% for all of '09.

So the Company's done an extremely good job of reacting to this downturn, but while at the same time we are going to increase our investment in terms of hiring and head count in R&D and into field sales. So we will be continuing to expand our head count in those two domains.

In terms of the main changes that have happened, primarily they relate around to obviously variable compensation, which we have adjusted. Also, significant reduction in hiring expectations, so we're now expecting to only hire about 100 people this year in 2009. That's a significant reduction from our original expectation.

We're also using this as an opportunity from a renegotiating point of view. We feel like the steady business that NI has provided our vendors over many years gives us a very good bargaining position and we have launched an initiative to reduce our costs from our suppliers by renegotiating pricing, which is paying some early dividends and we're confident we'll see some benefits on that front. And so it's been a combination of areas. I said at the beginning, related to compensation, related to hiring, and related to vendor pricing contracts.

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

Thank you.

And next we'll go to Mark Moskowitz with JPMorgan.

Thank you, good afternoon. Couple questions here. Alex, could you talk a little more about the revenue profile in the fourth quarter in terms of the commentary around a healthy dose of new customers in terms of revenues or benefiting from investments are still flowing. Just want to get a sense how much of your revenues came from those new customers, and if that's what is also is lending to some of the uncertainty around your outlook for the first quarter in terms of, hey, they popped up in the fourth quarter, great, but we don't really know how sustainable the revenues are?

Mark, this is John. Maybe I'll start and then Alex will fill in.

Hi, John.

Terms of the new areas, we actually were continuing to be extremely pleased with the results and the growth and success of our new products. As you recall back at NI week, we had some very significant product introductions from the latest version of LabVIEW to new RF instruments, to new versions of our RIO FPGA platform, new Wi-Fi data acquisition products. All of these areas and more have seen very strong growth through the second half of the year and that trend continued. So this is one of the reasons why we continued to be optimistic in the payoff of this investment in R&D. With that, I'll turn it over to Alex.

Yes, in terms of -- I don't think there was a particular shift in the customer profile in Q4, so maybe I need to correct that if we allowed that misperception. As John said around the new products selling, largely existing customers, some new customers and new application areas, but it's not that there was one or two big new customers that came in the fourth quarter that we're concerned about. I guess looking at some of the caution on the expectations for Q1, Mark. The way I would kind of push it, it appears --certainly seems to be clear from what we're seeing that there's a general -- if you maybe back up and look at the industrial production numbers in the US, from what I saw in the paper today, looks like a 15% or 16% annualized drop in industrial production in the United States during the fourth quarter. A massive drop in capacity utilization in the United States in the fourth quarter, which looks highly probable to drag on into Q1.

What we've seen obviously in the third quarter, in Q4, we saw our instrument control business drop 30% year-over-year and as we indicated in the press release in the call, we expect that to deteriorate from a year-over-year point of view even further in Q1. So while we appear to be seeing is a collapse, if you like, in end of line production test business. And that is where we're getting most of our caution from. If you look at our business and you move away from a product line point of view and you move away from a geographic point of view and you think of it in terms of end markets, production test is a big portion of our business. Government, air space, defense, academic, national labs all wrapped up is another big portion of our business. R&D into commercial enterprises is another big portion of our business. In those areas, it looks to us like the government's area, defense, academic segment is likely to continue to be well funded and potentially with the increase in funding from multiple stimulus packages around the world may actually see an increase in funding in 2009. So that's likely to be stable.

R&D from a commercial point of view, is probably going to take some impact, but probably not that severe. The biggest shift and change that's happened quite rapidly, as we went through the last four months has really come in production tests.

Okay, and then the second question, I hear you on the cost savings that you're telegraphing for the coming year, but just want to get a sense in terms of the OpEx savings. How much could be reinvested to products if you don't get your bill material benefits from some of your renegotiations you're talking about right now? How much would you use to redeploy back in the pricing to move business?

I'm not sure I understand the question, Mark. If the billing material changes don't come back?

That's right.

Okay, so maybe perhaps to reflect that. What we're including in our budget at this point in time is only changes that we have agreed, so we do not have included in our spending budget assumptions of future pricing changes to come. We do have a project team working on that, but in terms of the budget thatwe're communicating today, minus 3%, that only includes cost changes where we already have agreement on those cost changes from our vendors.

Okay, thank you. I'll jump back in the queue.

Okay. Thank you, Mark.

Next we'll go to William Stein with Credit Suisse.

Thanks. First, just a clarification, guys. Am I getting this right -- that you are not providing revenue guidance for Q1 but you are providing margin guidance, is that correct?

Within a range, Mark yes, that's correct.

Okay, great. Couple other quick ones, software maintenance you're disclosing now. What about software license sales, is that meaningful? Are you disclosing that going forward?

Let's me reconcile a little bit if that will help you. Typically over the last number of years, we've communicated that overall software revenue is approximately 20% of the company's revenue. When we've talked in terms of that software revenue, we haven't included this maintenance revenue as part of that overall chunk of business. Due to the very different nature of the maintenance revenue and its recurring nature, I've gotten a lot of questions from investors about the scale of that number, they would like to see visibility into it. And as our user install base has increased over time, the scale of it as a percentage of our overall revenue has also increased. So for that reason, we've chosen it break it out because it's such a different revenue stream. At this point, we don't intend to break out software license revenue as a separate line item.

Okay, great. And then one other quick one. Can you tell us what gives you the confidence to suggest that you would start seeing normal seasonality in Q2?

Okay, so it's a good question. Obviously we don't know where Q1 is going to fall at this point in time, but when I take a look at where we stand, I think it's likely that it may form the base point. That's I will caveat that -- that that's an expectation we have at this point in time and we could be wrong in that. But when I look at it, the reasons that I see this as a likely case is number one, we've had a collapse in, I think in industrial production in the United States in Q4. We've seen significant impact from customer shutdowns through the first half of January. We have, I believe, most companies going through a fairly major rebudgeting exercise right now, and I think there's a fair degree of paralysis as a result of that.

And then the other issue I will put in is I think we've seen a fairly dramatic drop already in that portion of our business that's related to production tests. And so those are the primary reasons that I feel we'll start to see our seasonal pattern start to re-emerge. Now, I wouldn't want to promise that it will be the exact average of the last six-year increase in Q2 is what we're going to see in Q2, so I wouldn't want to be that specific. But I think in directional terms, it's likely that we will see some year-over-year -- some sequential increase in the second quarter. That's somewhat reinforced by what I see happening in instrument control. We saw a dramatic falloff in instrument control from a year-over-year point of view in Q4, while we expect it to be worse in Q1, the rate of incremental decline has certainly slowed down from Q4. And that's another indicator that I think, however Q1 shakes out, I think Q2 will very likely sequentially be better.

Okay, great. I'll get back in queue. Thank you.

Thank you, Will.

And next we'll go to Ajit Pai with Thomas Weisel Partners.

Yes, good afternoon.

Good afternoon, Ajit. How are you?

Good. Couple of quick questions. The first one is, looking at the software maintenance revenue, the -- you know you had 42% growth. That's really material relative to any other business you have. Could you give us some color what's driving that and also how long the software maintenance contracts are and on a go-forward basis also the margins of this business, is it lower gross margin but higher operating margin relative to the corporate average?

Ajit, this is John. So I think we've commented over the last few years that we've been seeing increased success in selling a service or maintenance program along with our software licenses. Again, this is a model pretty common in the software industry. You can really look at it in two ways. There's the maintenance programs we sell with our single seat, individual sales of LabVIEW, which is of course the volume part of our business. And then the other side would be these volume license agreements, where we're able to do some standardization within departments or complete organizations.

So in both areas, we're seeing good adoption and uptick, a higher percentage of people have an attach rate with these maintenance and license programs. And, again, that's reflected in the growth numbers you see in our release. So I believe today it's approximately 30% of our software now has an attach rate with these maintenance programs. The contracts are typically a year, but in some cases, are multi-year.

So addressing the second part of your question, Ajit, the gross margins for this business are higher. You'll see it in the -- you can do the math. I think it's about 89% gross margin for 2008, so definitely higher than the corporate average. We don't track operating income and operating margin by product line, but obviously this is a good business for us and one that we have been working hard to increase as an overall percentage of our profile. Also, you know, I've had a lot of investors ask me questions about this, just due to the increase they've seen in our deferred revenue balance sheet number over time and then to the fact that it has obviously slightly different characteristics in terms of the recognition and recurring nature of it relative to our other revenue profile.

And I just want to clarify one thing, Ajit. I meant to say our -- the maintenance revenue's about 30% of software revenue. Tax rates are actually much higher than that.

Right. If the attach rates are higher, that means that the potential to further penetrate is going to be lower, like the current kind of growth rate that you have over there. I mean it's not a sustainable growth rate, right?

Well, perhaps, you know, I wouldn't want to give a forecast on one element. We're not going to give a revenue forecast on it all. What I would say, Ajit, it more applies to the size of the overall user base. Obviously license revenue relates to new licenses being sold and maintenance relates to the whole install base, and so I think we still have quite a lot that we can do to improve this business over time.

Got it. And then the second question would be just about you are planning to set up a manufacturing operation somewhere in Asia and just given the kind -- the slowdown that you are seeing right now, do you have an update on that? Is that something you are pushing out or are you going to make use of the current weakness to actually set that up?

We have announced that we will be building a manufacturing facility in Panang in Malaysia and that is absolutely still our intent. This new facility will be the need for it is driven by capacity expansion and so we will adjust our plans as we need to in order to accommodate what we're seeing in the current environment. But we are very committed to going forward with our investment in Panang and we will be also doing other functions there such as R&D and those plans will continue pretty much regardless of the current economic condition.

And when will the CapEx demands be faced by the company as far as the Panang facility goes?

We will be looking at a land acquisition in '09 and then construction realistically, is going to be sometime in '10 or beyond.

Got it, thank you.

(Operator Instructions). Next, we'll go to David Yuschak with SMH Capital.

Good afternoon, guys.

Hi, David.

You guys have shown an amazing resiliency here in the last five quarters, producing $200 million in revenue even in this fourth quarter, as you described with the kind of industrial production collapse as we've seen. And you had said earlier, Alex that maybe in this first quarter that you are a little more concerned about being more sensitive to the economy in this quarter relative to any time in recent conference calls. The system side of it and the big dollar ticket numbers have really helped support that $20 million as you've seen -- $200 million, as other things have faded. Is there any concern on your part that that, whether it's the end of line production testing and audit, is some of these system sales things appear to be more vulnerable is why you're more cautious? That you reflect back on the economy maybe more important than what you've been able to do so far in last five quarters, kind of control your own destiny by, as you said in your press release, finding business wherever it is?

Yes, break it, rather than by product or by systems versus transactional, David, I really think it comes down to the end application. As I said a little bit earlier on, you hit the key point there of end of line production tests. We don't see a major shifts in and around the government defense, academic, national labs type area. Not that much even in commercial R&D. But I think most production managers right now are a little bit like deer in headlights and I think we have quite a bit of paralysis there. And until that paralysis starts to recover and people start to deal with the new situation as the economy resets, I think that it's going to be vulnerable.

This has been crystal clear in the semiconductor CapEx issue [sagae area]. Thankfully our business is very diversified and while semiconductor CapEx is a piece of our business, we're much more broad based than that. But when you see the broad base industrial production numbers drop on an annualized rate of 15%, you have to take that very seriously in terms of the impact it's going to have. And I think we're seeing a very rapid significant reset of production tests in a very short period of time and then we'll see where we go from there. And Dr. Truchard might care to comment on this from a longer term point of view as well.

Sure. First off, our current concern is, I think, everybody's concern, that we just don't have visibility about the economy. But in terms of systems, actually this is a strong area for us where we're taken on the applications that were very difficult to do with other technology and we can add a lot of value with the combination of FPGA and PXI with highly synchronized measurements and we're seeing good systems business in the areas like military, physics, and areas of research where the technology capability we have has a real good differentiation. So -- and systems business is strong relatively and we are continuing to focus on this area. Matter of fact, next week, I'll be at a seminar put on -- that we're putting on for big physics in France, so we are continuing to see nice opportunities there.

Then one last question. As far as -- you commented here about cutting some expenses and trying to deal with the current environment, but you still suggest that you're adding people. That compares very differently from what you're seeing in other test and measurement companies. At what point in time -- because you have been overspending on the field sales, R&D continues to be there. At what point in time -- is the cut in expenses here that hunker down mode or what do you think you would have to do to go another step down to cut expenses? What kind of conditions do you think you would need to take another drastic look at expenses?

Well, maybe, David, I'll break it into two parts. One just to address the expectations we have at this point in time is to add, as I said, about 100 people into the company next year, vast, vast majority which will be engineers. To be clear, these are almost all people with whom we've already extended offers to as part of our recruiting process. The vast majority of them are people who have committed start dates and we intend to honor those committed start dates and bring that talent into the company. I think it would do tremendous damage to our reputation if we were not to follow through, number one. And number two, as Dr. Truchard keeps reminding everybody, we've got an awful lot of very valuable work that needs to be done. So we have a long list of projects that are well defined, that we believe will be well received in the market and we want to go ahead and bring those projects to market. Certainly have them in market in preparation for the recovery when that comes and Dr. Truchard may care to comment on that in just a second.

In terms of conditions, it would require before we take another look, we will have a lot of time between now and early March, we'll be looking carefully at how the economy plays out. We're trying to take a very conservative approach right now. We've obviously seen a dramatic change in business conditions between September and today. We have reduced our planned hiring by about 75% or 80% from what we originally intended, so we pretty much -- dramatic reduction there and really focused on the long lead time hires where we can get very valuable long-term projects completed.

In terms of where we stand right now, I'm comfortable where we are at the moment. I think obviously, the Company would react pretty much, I think, in the same vein and from the same philosophy that we have so far were we to see a dramatically different situation that was much worse again. We would take the same philosophical approach to the question of cost reductions.

Yes, and this is a timeframe with which we are hoping to gain market share. And part of that gaining market share is about new products and part of it is about servicing the customer in a way, perhaps when our competitors are pulling back, we put that extra effort into it and make it possible for us to close business that we might have not otherwise. And we, of course, as we've talked about in the past, using the opportunity tracking system, so we're looking at actual customers with opportunity for us to close and sometimes taking more effort and we'll expend some of the effort to close that business.

Okay. Thank you.

Thank you, David.

And next we'll take a follow-up question from Antonio Antezano with Macquarie Capital.

Thank you. If you could expand -- I understand you don't have a lot of visibility in the near term, but whether you can comment on what you see by geography -- Asia, Europe, North America?

Sure. When we look at the regions at the moment, I think there's weakness has certainly spread throughout all regions. When we look at Q4, obviously we saw some modest growth in the US and I think it's pretty clear that the US entered this recession first. We saw some modest decline in Europe and obviously the economic news in Europe has not been getting better as we've gone over the last number of months. And then the biggest drop in Q4 was in Asia-Pacific region and significant impact there from our business in Japan and Asia will also continue to be challenged. But we look at it regionally, our take at the moment as we look out the next year or so, I think it's likely that the US will probably emerge from this downturn first, similar to how it led us into this downturn.

And just quick follow-up, you had a foreign exchange loss I think in Q4 and what should we assume for Q1?

At this point, as we talked before, Antonio, this is a notoriously difficult number for us to predict. Certainly it was a big swing in the fourth quarter when you look at our million dollar gain last year and the $2 million loss this year. We had guided in October to a $2 million loss approximately, given the volatility we had seen in currencies through the month of October. The currency markets have been a lot more stable so far, so if I had to give you guidance, I would say it's to a much smaller number in Q1. But again, currency markets are very difficult to predict. So as of now, my expectation would be a significantly smaller loss, but that could change between now and the end of March.

Thank you.

Thank you very much.

And next we have a follow he's up question from Mark Moskowitz with JPMorgan.

Thank you for the follow-ups. The first one, I apologize if I missed it, but did you say what the orders over $20,000 were as a percent of revenues and what the growth was year-over-year?

Yes, Mark, this is John. Orders over $20,000 came to 38% of revenue in the quarter, which was, I think flat with Q3, similar percentage. In terms of growth, we did see the impact of the deterioration in the economy on all parts of the business. We saw slight growth on the larger orders and we saw a decline in the single digits for the orders under $20,000.

Okay, and then within that high order bucket, any change in the deferrals or cancellation rates you're seeing there?

So we had talked, Mark, it's Alex here, in the call on January 2 that we saw about $5 million of orders push out right before Christmas. At this point, we have not seen any kind of repeat of that activity so far this quarter. Several of those orders have already shipped. Several are scheduled to ship out into March. But it's our expectation that that will probably happen as we move into March, that we'll see deferrals. We didn't really have much in the way of cancellations at all, but deferrals are likely I think to be as big a factor in Q1 as they were in Q4.

And then just lastly, on tax rate, can you comment more on why the tax rate's going to be so much lower for '09 versus '08?

Well, when we look at our profile, we've been continuing to grow at a percentage of our revenue that's coming from foreign sources, especially in Hungary. As we look at that as a proportion of our business long-term moving forward, we see the opportunity for that tax rate to come down as we look at '09.

Thank you.

And next we do have another follow-up with William Stein from Credit Suisse.

Great, thanks. I think in the last downturn, you used some cash to acquire other businesses to support the revenue. Can you give us any update in that -- in that potential strategy for the Company.

Sure will. That's a good question. It's interesting, in the last downturn, we really set a goal in going into '01 coming out in '03 to shift the leadership between companies in the overall test and measurement space in the course of the downturn and I think we really achieved that goal. We're in a much, much stronger leadership position because of our investments and because of some of our acquisition decisions during that timeframe relative to the competition than we were at that point. Our goal through this downturn is to repeat that. We intend to be aggressive in investing not only in R&D and field sales force, but we will be looking for acquisition opportunities. We do want to use this downturn, which has been quite severe so far, as an opportunity to take another step up in terms of leadership in this industry.

However, from a pricing point of view, I'm not sure that reality has hit home yet in terms of most management teams. My own expectation, I think I said it in January as well, early January, I think it's going to take probably till the April-May timeframe before people come to accept resetting of the economy and the new evaluation dynamics. So at this point I would tell you that we are looking hard, but don't have any eminent decisions relative to acquisitions.

Would the strategy be more to buy, like I think you've done in the past, customers or companies that add technology to your products, or would they be companies that are in adjacent areas?

So you know, I think our strategy, we're not really going to be that interested in buying revenue per se or buying customers. We're going to be a lot more focused on the technology side and perhaps I'll ask Dr. Truchard to comment on that.

Sure. Because we have a platform-based solution, we do have partners that we from time to time acquire technologies, sometimes at a lower cost and sometimes more. And that could happen again. We don't have any specific things that we could talk about at this point. But we will be looking, because this is certainly a good time to keep our eyes open for any potential opportunities. Technology could be interesting as well, so those will be things we will keep our eye on.

Yes, I think people will be grappling pretty quickly with reality here in the next few months.

Okay, great, thank you.

We do have time for one more follow-up question from David Yuschak with SMH Capital.

Help me if my logic is not correct here, guys. But it would seem in periods like this that companies, factory for solution and all that, would be more open to looking for new ways to bring efficiencies to the factory floor because they don't want -- it's downtime now, let's take a look at this stuff versus running full out and not wanting to take the chance of anything. Just curious as you look at -- as you said earlier, Alex, you're kind of the deer in the headlight thing with the production people. But from a pipeline point of view, is there logic to what I suggested that you will see more things in a way of potential opportunities in this period of time because of what's happening in, kind of resetting the bar out there?

Exactly. We can see it in two places. First off, with our CompactRIO systems, maybe the design team is stretched on a budget and we can come in and provide a much quicker solution for them, so they can save a lot of cash in this timeframe. The second part is on the production floor and we are working on opportunities where we're demonstrating our equipment that perhaps can use less floor space, use less people to run it and so definitely, those are things that our customers are doing.

And I might just emphasize the point is that you heard Alex talk at a macro level the slowdown focused in the kind of production test area. Yet if you look at what we commented on this afternoon, we delivered record revenues for PXI and modular instruments and I think that's just one reflection of this opportunity, as you put it, for us to go in and gain market share.

Would that pipeline then, would you say that pipeline as you look into the first quarter as good as it was in the fourth quarter or third quarter or any kind of shifts in that kind of a pipeline?

I think from a design activity and end of line production test, it hasn't really changed. From a buying activity, it's clearly changed. But I think what we're seeing is one of the reasons we're pushing forward on not only R&D, but on the sales front as well. We have our sales marketing, our system engineering guys working with a fair number of customers right now who are in the design phase of test systems who told us they may not buy anything for three or six months. But if we don't get designs in now, we won't have the opportunity when they do turn around. And this is in the vein of what you talked earlier on. It's very wise, in my opinion, for us to continue to spend the engineering dollars and the sales dollars to get those designs in now, so that we can take advantage of greater market share when the economy turns.

But from a kind of quirky point of view, the slower the sale, the better opportunity you have in trying to do some more design work to get out in front of that potential opportunity.

That's what we're working on.

So you keep overspending to do it.

Well --

Thanks, guys.

We'll adjust our expenses as best we can.

With prudence. With prudence.

But you know you've done a good job in a tough environment, give you credit for that.

Thank you.

I would now like to turn the call back over to James Truchard for any additional comments or closing statements.

Yes. I'll be presenting at the Thomas Weisel Technology and Telecom Conference in San Francisco on February 10th, bright and early in the morning at 8:00 in the morning. So I would like to thank everybody for joining us today and taking the time. Thanks.

That does conclude today's conference. Thank you for participating, and have a wonderful day.