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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended: September 30, 2003 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 CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 74-1871327
- ---------------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
11500 North MoPac Expressway
Austin, Texas 78759
- ---------------------------------------- -----------------------------------
(address of principal executive (zip code)
offices)
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 [X] No [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [_]
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 October 21, 2003
Common Stock - $0.01 par value 51,993,669
NATIONAL INSTRUMENTS CORPORATION
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1 Financial Statements:
Consolidated Balance Sheets
September 30, 2003 (unaudited) and December 31, 2002...... 3
Consolidated Statements of Income (unaudited)
Three months and nine months ended September 30, 2003
and 2002.................................................. 4
Consolidated Statements of Cash Flows (unaudited)
Nine months ended September 30, 2003 and 2002............. 5
Notes to Consolidated Financial Statements................ 6
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations......................... 11
Item 3 Quantitative and Qualitative Disclosures About Market Risk.. 19
Item 4 Controls and Procedures..................................... 19
PART II. OTHER INFORMATION
Item 1 Legal Proceedings........................................... 20
Item 6 Exhibits and Reports on Form 8-K............................ 21
Signatures.................................................. 22
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
NATIONAL INSTRUMENTS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
September 30, December 31,
2003 2002
------------- ------------
Assets (unaudited)
Current assets:
Cash and cash equivalents..................... $ 34,015 $ 40,240
Short-term investments........................ 138,210 113,638
Accounts receivable, net...................... 68,313 62,981
Inventories, net.............................. 38,448 39,247
Prepaid expenses and other current assets..... 9,918 13,756
Deferred income tax, net...................... 8,281 8,104
------------- ------------
Total current assets........................ 297,185 277,966
Property and equipment, net..................... 151,126 152,133
Intangibles and other assets.................... 40,365 28,615
------------- ------------
Total assets................................ $ 488,676 $ 458,714
============= ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable.............................. $ 26,108 $ 25,578
Accrued compensation.......................... 12,176 9,555
Accrued expenses and other liabilities........ 15,279 13,507
Income taxes payable.......................... 264 6,153
Other taxes payable........................... 8,302 11,720
------------- ------------
Total current liabilities................... 62,129 66,513
Deferred income taxes........................... 5,402 5,738
------------- ------------
Total liabilities........................... 67,531 72,251
------------- ------------
Commitments and contingencies -- --
Stockholders' equity:
Common Stock: par value $0.01; 180,000,000
shares authorized; 51,837,423 and 51,074,607
shares issued and outstanding, respectively... 518 511
Additional paid-in capital...................... 86,097 72,063
Retained earnings............................... 341,349 321,813
Accumulated other comprehensive loss............ (6,819) (7,924)
------------- ------------
Total stockholders' equity.................. 421,145 386,463
------------- ------------
Total liabilities and stockholders' equity.. $ 488,676 $ 458,714
============= ============
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 Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net sales.............................. $ 104,644 $ 96,020 $ 303,983 $ 284,264
Cost of sales.......................... 27,434 25,196 80,598 77,157
---------- ---------- ---------- ----------
Gross profit......................... 77,210 70,824 223,385 207,107
---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing................. 40,282 36,679 116,951 105,653
Research and development............ 18,370 16,095 50,497 47,762
General and administrative.......... 8,800 9,444 29,040 26,072
---------- ---------- ---------- ----------
Total operating expenses......... 67,452 62,218 196,488 179,487
---------- ---------- ---------- ----------
Operating income................. 9,758 8,606 26,897 27,620
Other income (expense):
Interest income, net................ 570 785 1,876 2,419
Net foreign exchange gain (loss).... (209) (612) 116 (1,288)
Other income........................ 486 506 606 1,028
---------- ---------- ---------- ----------
Income before income taxes............. 10,605 9,285 29,495 29,779
Provision for income taxes............. 2,651 2,600 7,374 8,338
---------- ---------- ---------- ----------
Net income....................... $ 7,954 $ 6,685 $ 22,121 $ 21,441
========== ========== ========== ==========
Basic earnings per share............... $ 0.15 $ 0.13 $ 0.43 $ 0.42
========== ========== ========== ==========
Weighted average shares
outstanding-basic...................... 51,532 51,195 51,468 51,286
========== ========== ========== ==========
Diluted earnings per share............. $ 0.15 $ 0.13 $ 0.41 $ 0.40
========== ========== ========== ==========
Weighted average shares
outstanding-diluted.................... 53,932 52,906 53,719 53,603
========== ========== ========== ==========
Dividends declared per share........... $ 0.05 $ -- $ 0.05 $ --
========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
NATIONAL INSTRUMENTS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended
September 30,
----------------------
2003 2002
---------- ----------
Cash flow from operating activities:
Net income.......................................... $ 22,121 $ 21,441
Adjustments to reconcile net income to net cash
provided by operating activities:
Charges to income not requiring cash outlays:
Depreciation and amortization.................. 18,787 14,862
Benefit from deferred income taxes............. (514) (3,769)
Tax benefit from stock option plans............ 2,565 1,164
Changes in operating assets and liabilities:
Increase in accounts receivable................ (5,332) (1,894)
Decrease (increase) in inventory............... 799 (7,015)
Decrease in prepaid expense and other assets... 4,071 3,154
(Decrease) increase in current liabilities..... (4,384) 5,677
---------- ----------
Net cash provided by operating activities........ 38,113 33,620
---------- ----------
Cash flow from investing activities:
Payment for acquisitions, net of cash received...... (5,316) --
Capital expenditures................................ (12,870) (24,753)
Capitalization of internally developed software..... (9,449) (3,025)
Additions to other intangibles...................... (1,022) (2,214)
Purchases of short-term investments................. (105,626) (106,294)
Sales/maturities of short-term investments.......... 81,054 130,531
---------- ----------
Net cash used in investing activities............ (53,229) (5,755)
---------- ----------
Cash flow from financing activities:
Proceeds from issuance of common stock.............. 11,476 6,666
Repurchase of common stock.......................... -- (17,420)
Dividends paid...................................... (2,585) --
---------- ----------
Net cash provided by (used in) financing
activities....................................... 8,891 (10,754)
---------- ----------
Net increase (decrease) in cash and cash equivalents... (6,225) 17,111
Cash and cash equivalents at beginning of period....... 40,240 49,089
---------- ----------
Cash and cash equivalents at end of period............. $ 34,015 $ 66,200
========== ==========
Non-cash financing activities:
Accrued liability for repurchase of common stock.... $ -- $ 2,203
========== ==========
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, 2002, included in the Company's annual report on Form
10-K, filed with the Securities and Exchange Commission. In the opinion of
management, the accompanying consolidated financial statements reflect all
adjustments (consisting only of normal recurring items) considered necessary to
present fairly the financial position of National Instruments Corporation and
its consolidated subsidiaries at September 30, 2003 and December 31, 2002, and
the results of operations for the three-month and nine-month periods ended
September 30, 2003 and 2002, and the cash flows for the nine-month periods ended
September 30, 2003 and 2002. Operating results for the three-month and
nine-month periods ended September 30, 2003 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2003.
Certain prior year amounts have been reclassified to conform with the 2003
presentation.
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. Common share equivalents include stock options. The number of common
share equivalents outstanding relating to stock options 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 nine-month periods ended September 30, 2003 and
2002, respectively, are as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
(unaudited) (unaudited)
2003 2002 2003 2002
---------- ---------- ---------- ----------
Weighted average shares
outstanding-basic............... 51,532 51,195 51,468 51,286
Plus: Common share equivalents
Stock options................ 2,400 1,711 2,251 2,317
---------- ---------- ---------- ----------
Weighted average shares
outstanding-diluted............. 53,932 52,906 53,719 53,603
========== ========== ========== ==========
Stock options to acquire 1,386,000 and 3,071,000 shares for the quarters ended
September 30, 2003 and 2002, respectively, and 1,503,000 and 1,545,000 shares
for the nine months ended September 30, 2003 and 2002, respectively, were not
included in the computations of diluted earnings per share because the effect of
including the stock options would have been anti-dilutive.
NOTE 3 - Inventories
Inventories, net consist of the following (in thousands):
September 30, December 31,
2003 2002
(unaudited)
------------- ------------
Raw materials.................... $ 17,842 $ 21,127
Work-in-process.................. 1,518 1,324
Finished goods................... 19,088 16,796
------------- ------------
$ 38,448 $ 39,247
============= ============
NOTE 4 - Comprehensive Income
Total comprehensive income for the quarters ended September 30, 2003 and 2002 is
$8.3 million and $6.5 million, respectively, and includes other comprehensive
income of $361,000 and other comprehensive loss of $235,000, respectively. For
the first nine months of 2003 and 2002, comprehensive income is $23.2 million
and $18.8 million, respectively, and includes other comprehensive income of $1.1
million and other comprehensive loss of $2.7 million, respectively. The
Company's other comprehensive income is from foreign currency translation and
unrealized gains and losses on the Company's forward and option contracts and
securities available for sale.
NOTE 5 - Stock-Based Compensation Plans
The Company has two active stock-based compensation plans and one inactive plan.
The two active stock-based compensation plans are the 1994 Incentive Stock
Option Plan and the Employee Stock Purchase Plan. The Company follows the
disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. As allowed by SFAS No. 123, the
Company continues to apply the provisions of Accounting Principles Board Opinion
No. 25, Accounting for Stock issued to Employees, and related interpretations in
accounting for its plans. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the quoted market price of the Company's
stock at the date of the grant over the amount an employee must pay to acquire
the stock. No compensation cost has been recognized in the Company's financial
statements for the stock option plan and the stock purchase plan. If
compensation cost for the Company's two active stock-based compensation plans
were determined based on the fair value at the grant date for awards under those
plans consistent with the method established by SFAS No. 123, the Company's net
income and earnings per share would approximate the pro-forma amounts below (in
thousands, except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
(unaudited) (unaudited)
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income, as reported................. $ 7,954 $ 6,685 $ 22,121 $ 21,441
Stock-based compensation included in
reported net income, net of related
tax effects............................. -- -- -- --
Total stock-based compensation expense
determined under fair value method for
all awards, net of related tax effects.. (2,084) (2,222) (6,323) (6,673)
---------- ---------- ---------- ----------
Pro-forma net income.................... $ 5,870 $ 4,463 $ 15,798 $ 14,768
---------- ---------- ---------- ----------
Earnings per share:
Basic - as reported..................... $ 0.15 $ 0.13 $ 0.43 $ 0.42
Basic - pro-forma....................... $ 0.11 $ 0.09 $ 0.31 $ 0.29
Diluted - as reported................... $ 0.15 $ 0.13 $ 0.41 $ 0.40
Diluted - pro-forma..................... $ 0.11 $ 0.08 $ 0.29 $ 0.28
NOTE 6 - Warranty Reserve
The Company offers a one-year limited warranty on most hardware products and a
90-day warranty on software products, which is included in the sales price of
many of its products. Provision is made for estimated future warranty costs at
the time of sale.
The warranty reserve was as follows (in thousands):
Nine Months Ended Year Ended
September 30, December 31,
2003 2002
(unaudited)
----------------- ------------
Balance at the beginning of the period....... $ 715 $ 865
Accruals for warranties issued during the
period....................................... 805 988
Settlements made (in cash or in kind) during
the period................................... (805) (1,138)
----------------- ------------
Balance at the end of the period............. $ 715 $ 715
================= ============
NOTE 7 - Segment Information
While the Company sells its products to many different markets, its management
has chosen to organize the Company by geographic areas, and as a result has
determined that it has one reportable segment. Substantially all of the interest
income, interest expense, depreciation and amortization is recorded in North
America. Net sales, operating income and identifiable assets, classified by the
major geographic areas in which the Company operates, are as follows (in
thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
(unaudited) (unaudited)
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net sales:
Americas:
Unaffiliated customer sales... $ 50,828 $ 50,432 $ 147,049 $ 147,620
Geographic transfers.......... 15,803 15,087 42,933 42,329
---------- ---------- ---------- ----------
$ 66,631 $ 65,519 $ 189,982 $ 189,949
---------- ---------- ---------- ----------
Europe:
Unaffiliated customer sales... $ 31,701 $ 27,065 $ 94,154 $ 85,430
Geographic transfers.......... 14,195 13,052 37,212 35,121
---------- ---------- ---------- ----------
$ 45,896 $ 40,117 $ 131,366 $ 120,551
---------- ---------- ---------- ----------
Asia Pacific:
Unaffiliated customer sales... $ 22,115 $ 18,523 $ 62,780 $ 51,214
---------- ---------- ---------- ----------
Eliminations.................... (29,998) (28,139) (80,145) (77,450)
---------- ---------- ---------- ----------
$ 104,644 $ 96,020 $ 303,983 $ 284,264
========== ========== ========== ==========
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
(unaudited) (unaudited)
2003 2002 2003 2002
---------- ---------- ---------- ----------
Operating income:
Americas........................ $ 9,787 $ 7,625 $ 25,022 $ 25,778
Europe.......................... 9,695 7,337 27,304 24,149
Asia Pacific.................... 8,646 9,739 25,068 25,455
Unallocated:
Research and development
expenses........................ (18,370) (16,095) (50,497) (47,762)
---------- ---------- ---------- ----------
$ 9,758 $ 8,606 $ 26,897 $ 27,620
========== ========== ========== ==========
September 30, December 31,
2003 2002
(unaudited)
------------- ------------
Identifiable assets:
Americas........................ $ 415,569 $ 373,066
Europe.......................... 45,267 63,600
Asia Pacific.................... 27,840 22,048
------------- ------------
$ 488,676 $ 458,714
============= ============
Total sales outside the United States for the quarter and nine months ended
September 30, 2003 were $58.3 million and $170.4 million, respectively, and for
the quarter and nine months ended September 30, 2002 were $49.4 million and
$149.2 million, respectively.
NOTE 8 - Recently Issued Accounting Pronouncement
In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity. This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances) because that
financial instrument embodies an obligation of the issuer. This Statement is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. It is to be implemented by reporting the
cumulative effect of a change in an accounting principle for financial
instruments created before the issuance date of the Statement and still existing
at the beginning of the interim period of adoption. The adoption of SFAS No. 150
did not have a material effect on the Company's financial position or results of
operations as the Company has no debt.
NOTE 9 - Litigation
As reported in the two previous Form 10Q's of 2003, the Company has filed two
complaints against The MathWorks, Inc. ("Defendant") for patent infringement. In
both complaints, the Company claimed the Defendant infringes certain of its U.S.
patents and the Defendant challenged the validity and enforceability of those
patents and asserts that it does not infringe the claims of those patents.
The first complaint was filed on January 25, 2001 in the U.S. District Court,
Eastern District of Texas (Marshall Division). On January 30, 2003, the jury
found infringement by the Defendant of three of the patents involved and awarded
the Company specified damages. On June 23, 2003, the Court entered final
judgement in favor of the Company in an amount of approximately $4 million and
entered an injunction against Defendant's sale of its Simulink and related
products. The Court stayed the injunction pending appeal of the case and
required the Defendant to pay a specified royalty on its U.S. sales of the same
products during the pendency of appeal. On July 22, 2003, Defendant filed its
Notice of Appeal and the case is currently pending on appeal before the U.S.
Court of Appeals for the Federal Circuit. The final judgement has not been
recorded in the financial statements of the Company pending the disposition of
the appeal.
The second complaint was filed October 21, 2002, also in the U.S. District
Court, Eastern District of Texas (Marshall Division) and on August 27, 2003, the
complaint was dismissed by agreement of the parties.
On January 15, 2003, SoftWIRE Technology, LLC ("SoftWIRE") and Measurement
Computing Corporation ("MCC") filed a complaint against the Company in the U.S.
District Court for the District of Massachusetts asking the court to declare
that SoftWIRE does not infringe certain of the Company's U.S. patents and that
such patents are invalid and unenforceable. On February 21, 2003, the Company
filed a complaint against SoftWIRE and MCC in the U.S. District Court, Eastern
District of Texas (Marshall Division) claiming that both SoftWIRE and MCC
infringe the same and certain other of the Company's U.S. patents. SoftWIRE and
MCC challenge the validity and enforceability of these patents and assert that
they do not infringe any of these patents. In the Eastern District action, the
Company seeks monetary damages and injunction of the sale of certain products of
SoftWIRE and MCC as well as attorney's fees and costs. By order of the Court,
the Eastern District action was transferred to the U.S. District Court for the
District of Massachusetts on May 9, 2003, and the parties are seeking to
consolidate this action with the previously-filed SoftWIRE action. On June 12,
2003, SoftWIRE moved for leave to amend its complaint in order to allege that
the Company infringes two U.S. patents that SoftWIRE acquired by purchase on May
23, 2003. MCC joined SoftWIRE's motion to amend. With respect to the two U.S.
patents that SoftWIRE acquired, SoftWIRE seeks monetary damages and injunction
of the sale of certain products of the Company as well as attorney's fees and
costs. The Company opposes SoftWIRE's and MCC's motion for leave to amend. The
motion is currently pending before the Court. Should the Court permit amendment
to allow assertion of SoftWIRE's patents, the Company is prepared to vigorously
defend against SoftWIRE's claims and challenges the validity, enforceability and
alleged infringement of those patents.
NOTE 10 - Subsequent Event
The Company's Board of Directors declared on October 23, 2003, a quarterly cash
dividend of $0.05 per common share, payable November 24, 2003, to shareholders
of record November 3, 2003.
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 the future financial performance or operations of the Company
(including, without limitation, statements to the effect that the Company
"believes," "expects," "plans," "may," "will," "projects," "continues," or
"estimates" 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. For a discussion of
important factors that could affect the Company's results, please refer to the
Factors Affecting the Company's Business and Prospects section and financial
statement line item discussions below. Readers are also encouraged to refer to
the Company's Annual Report on Form 10-K for further discussion of the Company's
business and the risks attendant thereto.
Results of Operations
The following table sets forth, for the periods indicated, the percentage
of net sales represented by certain items reflected in the Company's
consolidated statements of income:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net sales:
Americas 48.6% 52.5% 48.4% 51.9%
Europe 30.3 28.2 31.0 30.1
Asia Pacific 21.1 19.3 20.6 18.0
-------- -------- -------- --------
Consolidated net sales 100.0 100.0 100.0 100.0
Cost of sales 26.2 26.2 26.5 27.2
-------- -------- -------- --------
Gross profit 73.8 73.8 73.5 72.8
-------- -------- -------- --------
Operating expenses:
Sales and marketing 38.5 38.2 38.5 37.2
Research and development 17.6 16.8 16.6 16.8
General and administrative 8.4 9.8 9.6 9.1
-------- -------- -------- --------
Total operating expenses 64.5 64.8 64.7 63.1
-------- -------- -------- --------
Operating income 9.3 9.0 8.8 9.7
Other income (expense):
Interest income, net 0.5 0.8 0.6 0.8
Net foreign exchange gain (loss) (0.2) (0.6) 0.1 (0.5)
Other income 0.5 0.5 0.2 0.4
-------- -------- -------- --------
Income before income taxes 10.1 9.7 9.7 10.4
Provision for income taxes 2.5 2.7 2.4 2.9
-------- -------- -------- --------
Net income 7.6% 7.0% 7.3% 7.5%
======== ======== ======== ========
Net Sales. Consolidated net sales increased by $8.6 million or 9% for the
three months ended September 30, 2003 to $104.6 million from $96.0 million for
the three months ended September 30, 2002, and increased $19.7 million or 7% to
$304.0 million for the nine months ended September 30, 2003 from $284.3 million
for the comparable period in the prior year. The increase in sales for the three
and nine months ended September 30, 2003 was primarily attributable to the
introduction of new and upgraded products, an early stage recovery in global
manufacturing and an increased market acceptance of the Company's products in
Asia. Sales in the Americas in the third quarter of 2003 increased by 1% from
the third quarter of 2002 and sales in the Americas for the nine months ended
September 30, 2003 were flat with sales from the nine months ended September 30,
2002.
Sales outside of North America, as a percentage of consolidated sales for
the quarter ended September 30, 2003 increased to 51.4% from 47.5% over the
quarter ended September 30, 2002 as a result of stronger sales in Asia Pacific
and a stronger Euro. Sales outside of North America for the nine months ended
September 30, 2003 increased to 51.6% from 48.1% in the comparable 2002 period
as a result of stronger sales in Asia Pacific. Compared to the corresponding
periods in 2002, the Company's European sales increased by 18% to $31.7 million
for the quarter ended September 30, 2003 and increased by 11% to $94.2 million
for the nine months ended September 30, 2003. Sales in Asia Pacific increased by
18% to $22.1 million for the quarter ended September 30, 2003 compared to the
same period in 2002 and increased 22% to $62.8 million for the nine months ended
September 30, 2003 compared to the same period in 2002. The Company expects
sales outside of North America to continue to represent a significant portion of
its revenue.
Sales made by the Company's direct sales offices in Europe and Asia Pacific
are denominated in local currencies, and accordingly, the U.S. dollar equivalent
of these sales is affected by changes in the foreign currency exchange rates.
Between the third quarter of 2002 and the third quarter of 2003, net of hedging
results, the change in the exchange rates had the effect of increasing the
Company's consolidated sales by 2%; increasing European sales by 15% and
decreasing sales in Asia Pacific by 15%. The increase in sales as a result of
the change in exchange rates was more than offset by the decrease in local
currency product pricing in Europe. For 2003, year-to-date sales, net of hedging
results, the change in exchange rates had the effect of increasing the Company's
consolidated sales by 2%; increasing European sales by 13% and decreasing sales
in Asia Pacific by 15%. Since most of the Company's international operating
expenses are also incurred in local currencies, the change in exchange rates had
the effect of increasing operating expenses $5.2 million for the nine months
ended September 30, 2003 and by $1.5 million for the quarter ended September 30,
2003.
Gross Profit. As a percentage of net sales, gross profit for the third
quarter of 2003 remained constant at 73.8% compared to the third quarter of 2002
and increased to 73.5% for the first nine months of 2003 from 72.8% for the
comparable period a year ago. The gross margin in the third quarter of 2003
remained constant compared to the comparable prior year period primarily because
favorable foreign exchange rates and the impact of fixed charges relative to
higher sales volume totally offset the unfavorable effects of increased
amortization of capitalized software costs. The increase in the gross margin for
the first nine months of 2003 compared to the comparable prior year period is
primarily attributable to favorable foreign exchange rates and the favorable
impact of fixed charges relative to higher sales volume. There can be no
assurance that the Company will maintain its historical margins. The Company
believes its current manufacturing capacity is adequate to meet current needs.
Sales and Marketing. Sales and marketing expenses for the third quarter of
2003 increased to $40.3 million, a 9.8% increase, as compared to the third
quarter of 2002, and increased 10.7% to $117.0 million for the first nine months
of 2003 from the comparable 2002 period. As a percentage of net sales, sales and
marketing expenses were 38.5% and 38.2% for the quarters ended September 30,
2003 and 2002, respectively, and 38.5% and 37.2% for the nine months ended
September 30, 2003 and 2002, respectively. Approximately $1.6 million of the
increase in sales and marketing expenses for the quarter ended September 30,
2003, is attributable to the increase in international sales and marketing
personnel, and approximately $1.4 million of the increase is attributable to
increases in advertising and literature costs and special event activity.
Approximately 8% of the total increase in sales and marketing expenses in the
third quarter of the current year was offset by a decrease in employoee benefits
expense related to a reduction of the estimated health and medical insurance
liability resulting from the Company's additional focus on these costs.
Approximately $6.5 million of the increase in sales and marketing expenses for
the nine months ended September 30, 2003 is attributable to the increase in
international sales and marketing personnel, and approximately $3.7 million of
the increase is attributable to increases in advertising and literature costs
and special event activity. The Company expects sales and marketing expenses in
future periods to increase in absolute dollars, and to fluctuate as a percentage
of sales based on recruiting, initial marketing and advertising campaign costs
associated with major new product releases and entry into new market areas,
investment in web sales and marketing efforts, increasing product demonstration
costs and the timing of domestic and international conferences and trade shows.
Research and Development. Research and development expenses increased to
$18.4 million for the quarter ended September 30, 2003, a 14.1% increase, as
compared to $16.1 million for the three months ended September 30, 2002, and
increased 5.7% to $50.5 million for the nine months ended September 30, 2003
from $47.8 million in the comparable 2002 period. As a percentage of net sales,
research and development expenses represented 17.6% and 16.8% for the third
quarters ended September 30, 2003 and 2002, respectively, and 16.6% and 16.8%
for the nine months ended September 30, 2003 and 2002, respectively. The
increase in research and development costs in absolute amounts in each period
and as a percentage of sales for the quarter ended September 30, 2003 is due to
increases in personnel costs from hiring of additional product development
engineers and from the decrease in capitalized software development costs.
Research and development personnel increased from 802 at September 30, 2002 to
869 at September 30, 2003. Approximately 14% of the total increase in resrarch
and development expenses in the third quarter of the current year was offset by
a decrease in employee benefits expense related to a reduction of the estimated
health and medical insurance liability resulting from the Company's additional
focus on these costs. The Company plans to continue making a significant
investment in research and development in order to remain competitive and
support revenue growth.
The Company capitalizes software development costs in accordance with SFAS
No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed. The Company amortizes such costs over the related product's
estimated economic useful life, generally three years, beginning when a product
becomes available for general release. Software amortization expense totaled
$1.8 million and $953,000 for the quarters ended September 30, 2003 and 2002,
respectively, and $4.0 million and $3.0 million during the nine months ended
September 30, 2003 and 2002, respectively. Software development costs
capitalized were $1.0 million and $1.5 million for the quarters ended September
30, 2003 and 2002, respectively, and $9.4 million and $3.0 million for the first
nine months of 2003 and 2002, respectively.
General and Administrative. General and administrative expenses for the
quarter ended September 30, 2003 decreased 7% to $8.8 million from $9.4 million
for the comparable prior year period. For the first nine months of 2003, general
and administrative expenses increased 11.4% to $29.0 million from $26.1 million
for the first nine months of 2002. As a percentage of net sales, general and
administrative expenses decreased to 8.4% for the quarter ended September 30,
2003 from 9.8% for the third quarter of 2002. During the first nine months of
2003, general and administrative expenses as a percentage of sales increased to
9.6% from 9.1% in the comparable prior year period. The decrease in general and
administrative expenses in absolute amounts and as a percentage of sales for the
quarter ended September 30, 2003, from the comparable prior year period is
attributable to decreased litigation costs of $860,000, associated with a legal
action by the Company brought against The MathWorks, Inc. in 2001 to enforce the
Company's intellectual property (See Note 9 - Litigation). The increase in
general and administrative expenses for the nine month period ended September
30, 2003 from the comparable prior year period is primarily attributable to
unfavorable foreign exchange rates, increased litigation costs and increased
international personnel costs. The Company expects that general and
administrative expenses in future periods will increase in absolute amounts and
will fluctuate as a percentage of revenue.
Interest Income, Net. Net interest income in the third quarter of 2003
decreased to $570,000 from $785,000 in the third quarter of 2002 and decreased
to $1.9 million for the first nine months of 2003 from $2.4 million for the
comparable 2002 period. The decrease in interest income for the quarter and nine
months ended September 30, 2003 were due to lower yields on the Company's
investments. The primary source of interest income is from the investment of the
Company's cash.
Net Foreign Exchange Gain (Loss). The Company experienced net foreign
exchange losses of $209,000 in the third quarter of 2003 compared to losses of
$612,000 in the third quarter of 2002. Net foreign exchange gains of $116,000
were recognized for the first nine months of 2003 compared to losses of $1.3
million for the first nine months of 2002. These results are attributable to
movements between the U.S. dollar and the local currencies in countries in which
the Company's sales subsidiaries are located. The Company recognizes the local
currency as the functional currency of its international subsidiaries.
The Company utilizes foreign currency forward contracts to hedge a majority
of its foreign currency-denominated receivables in order to reduce its exposure
to significant foreign currency fluctuations. The Company typically limits the
duration of its "receivables" foreign currency forward contracts to 90 days.
The Company also utilizes foreign currency forward contracts and foreign
currency purchased option contracts in order to reduce its exposure to
fluctuations in future foreign currency cash flows. The Company purchases these
contracts for up to 100% of its forecasted cash flows in selected currencies
(primarily the euro, yen and pound sterling) and limits the duration of these
contracts to 40 months. The foreign currency purchased option contracts are
purchased "at-the-money" or "out-of-the-money." As a result, the Company's
hedging activities only partially address its risks in foreign currency
transactions, and there can be no assurance that this strategy will be
successful. The Company does not invest in contracts for speculative purposes.
The Company's hedging strategy reduced the foreign exchange gains by $1.9
million during the quarter ended September 30, 2003, and reduced the foreign
exchange gains by $7.1 million for the nine months ended September 30, 2003.
Provision for Income Taxes. The provision for income taxes reflects an
effective tax rate of 25% for the three and nine months ended September 30, 2003
and 28% for the three and nine months ended September 30, 2002. The decrease in
the effective rate resulted from income tax benefits attributable to the
extraterritorial income exclusion and a change in the distribution of income
among taxing jurisdictions, particularly the impact of the Company's
manufacturing facility in Hungary. The Company's effective tax rate is lower
than the U.S. federal statutory rate of 35% primarily as a result of the
extraterritorial income exclusion, tax-exempt interest and reduced tax rates in
certain foreign jurisdictions.
Liquidity and Capital Resources
The Company is currently financing its operations and capital expenditures
through cash flow from operations. At September 30, 2003, the Company had
working capital of approximately $235.1 million compared to $211.5 million at
December 31, 2002. Net cash provided by operating activities for the nine months
ended September 30, 2003 totaled $35.5 million.
Accounts receivable increased to $68.3 million at September 30, 2003 from
$63.0 million at December 31, 2002. Days sales outstanding increased to 60 at
September 30, 2003 compared to 53 at September 30, 2002. Consolidated inventory
balances decreased to $38.4 million at September 30, 2003 from $39.2 million at
December 31, 2002. Inventory turns of 2.8 represent an increase from turns of
2.6 at September 30, 2002. Cash used in the first nine months of 2003 for the
purchase of property and equipment totaled $12.9 million, for the capitalization
of internally developed software costs totaled $9.4 million, acquisitions
totaled $5.3 million and additions to other intangibles totaled $1.0 million.
For the nine months ended September 30, 2003, cash provided by the issuance
of common stock totaled $11.5 million, and cash used for payment of dividends
totaled $2.6 million. The issuance of common stock was to employees under the
Employee Stock Purchase and Stock Option Plans.
The Company currently expects to fund expenditures for capital requirements
as well as liquidity needs created by changes in working capital from a
combination of available cash and short-term investment balances and internally
generated funds. As of September 30, 2003, the Company had no debt outstanding.
The Company believes that cash flow from operations, if any, existing cash
balances and short-term investments will be sufficient to meet its cash
requirements for at least the next twelve months. Cash requirements for periods
beyond the next twelve months will depend on the Company's profitability, its
ability to manage working capital requirements and its rate of growth.
Financial Risk Management
The Company's international sales are subject to inherent risks, including
fluctuations in local economies; difficulties in staffing and managing foreign
operations; greater difficulty in accounts receivable collection; costs and
risks of localizing products for foreign countries; unexpected changes in
regulatory requirements, tariffs and other trade barriers; difficulties in the
repatriation of earnings and burdens of complying with a wide variety of foreign
laws. The Company's sales outside of North America are denominated in local
currencies, and accordingly, the Company is subject to the risks associated with
fluctuations in currency rates. In particular, increases in the value of the
dollar against foreign currencies decrease the U.S. dollar value of foreign
sales requiring the Company either to increase its price in the local currency,
which could render the Company's product prices noncompetitive, or to suffer
reduced revenues and gross margins as measured in U.S. dollars. These dynamics
have adversely affected revenue growth in international markets in previous
years. The Company's foreign currency hedging program includes both foreign
currency forward and purchased option contracts to reduce the effect of exchange
rate fluctuations. However, the hedging program will not eliminate all of the
Company's foreign exchange risks. (See "Net Foreign Exchange Gain (Loss)").
The marketplace for the Company's products dictates that many of the
Company's products be shipped very quickly after an order is received. As a
result, the Company is required to maintain significant inventories. Therefore,
inventory obsolescence is a risk for the Company due to frequent engineering
changes, shifting customer demand, the emergence of new industry standards and
rapid technological advances including the introduction by the Company or its
competitors of products embodying new technology. While the Company maintains
valuation allowances for excess and obsolete inventories and management
continues to monitor the adequacy of such valuation allowances, there can be no
assurance that such valuation allowances will be sufficient.
The Company has no debt or off-balance sheet debt. As of September 30,
2003, the Company did not have any relationships with any unconsolidated
entities or financial partnerships, such as entities often referred to as
structured finance entities, which would have been established for the purpose
of facilitating off-balance sheet arrangements. As such, the Company is not
exposed to any financing, liquidity, market or credit risk that could arise if
the Company were engaged in such relationships.
Market Risk
The Company is exposed to a variety of risks, including foreign currency
fluctuations and changes in the market value of its investments. In the normal
course of business, the Company employs established policies and procedures to
manage its exposure to fluctuations in foreign currency values and changes in
the market value of its investments.
Foreign Currency Hedging Activities. The Company's objective in managing
its exposure to foreign currency exchange rate fluctuations is to reduce the
impact of adverse fluctuations in such exchange rates on the Company's earnings
and cash flow. Accordingly, the Company utilizes purchased foreign currency
option contracts and forward contracts to hedge its exposure on anticipated
transactions and firm commitments. The principal currencies hedged are the euro,
British pound and Japanese yen. The Company monitors its foreign exchange
exposures regularly to ensure the overall effectiveness of its foreign currency
hedge positions. However, there can be no assurance the Company's foreign
currency hedging activities will substantially offset the impact of fluctuations
in currency exchange rates on its results of operations and financial position.
Based on the foreign exchange instruments outstanding at September 30, 2003, an
adverse change (defined as 20% in the Asian currencies and 10% in all other
currencies) in exchange rates would result in a decline in the aggregate fair
market value of all instruments outstanding of approximately $13.0 million.
However, as the Company utilizes foreign currency instruments for hedging
anticipated and firmly committed transactions, management believes that a loss
in fair value for those instruments will be substantially offset by increases in
the value of the underlying exposure.
Short-term Investments. The fair value of the Company's investments in
marketable securities at September 30, 2003 was $138.2 million. Investments with
maturities beyond one year are classified as short-term based on their highly
liquid nature and because such marketable securities represent the investment of
cash that is available for current operations. The Company's investment policy
is to manage its investment portfolio to preserve principal and liquidity while
maximizing the return on the investment portfolio through the full investment of
available funds. The Company diversifies the marketable securities portfolio by
investing in multiple types of investment-grade securities. The Company's
investment portfolio is primarily invested in short-term securities with at
least an investment grade rating to minimize interest rate and credit risk as
well as to provide for an immediate source of funds. Based on the Company's
investment portfolio and interest rates at September 30, 2003, a 100 basis point
increase or decrease in interest rates would result in a decrease or increase of
approximately $700,000, respectively, in the fair value of the investment
portfolio. Although changes in interest rates may affect the fair value of the
investment portfolio and cause unrealized gains or losses, such gains or losses
would not be realized unless the investments are sold.
Recently Issued Accounting Pronouncement
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 150, Accounting for
Certain Financial Instruments with Characteristics of Both Liabilities and
Equity. This Statement establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances) because that
financial instrument embodies an obligation of the issuer. This Statement is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. It is to be implemented by reporting the
cumulative effect of a change in an accounting principle for financial
instruments created before the issuance date of the Statement and still existing
at the beginning of the interim period of adoption. The adoption of SFAS No. 150
did not have a material effect on the Company's financial position or results of
operations as the Company has no debt.
Factors Affecting the Company's Business and Prospects
U.S./Global Economic Slowdown. As occurred in 2001 and 2002, the markets in
which the Company does business could again experience the negative effects of a
slowdown in the U.S., and/or Global economies. Additionally, the Company could
be impacted by the effects of any recurrence of the SARS virus, either through
increased difficulty or costs of the export of products into affected regions,
the import of components used in our products from affected regions, and/or the
effects the virus or costs to contain the virus have on the economy in regions
in which the Company does business, particularly Asia, which has been the
highest growth region of the Company over the past two years. The worsening of
the U.S. or Global economies could result in reduced purchasing and capital
spending in any of the markets served by the Company which could have a material
adverse effect on the Company's operating results.
Budgets. The Company has established an operating budget for 2003. The
Company's spending for the remainder of the year could exceed this budget due to
a number of factors; including: additional marketing costs for conferences and
tradeshows; increased costs from the over-hiring of product development
engineers or other personnel; increased manufacturing costs resulting from
component supply shortages and/or component price fluctuations and/or additional
expenses related to intellectual property litigation. Any future decreased
demand for our products could result in decreased revenue and could require the
Company to revise its budget and reduce expenditures. Exceeding the established
operating budget or failing to reduce expenditures in response to any decrease
in revenue could have a material adverse effect on the Company's operating
results.
Risk of Component Shortages. As has occurred in the past and as may be
expected to occur in the future, supply shortages of components used in our
products, including sole source components, can result in significant additional
costs and inefficiencies in manufacturing. If the Company is unsuccessful in
resolving any such component shortages, it will experience a significant impact
on the timing of revenue and/or an increase in manufacturing costs, either of
which would have a material adverse impact on the Company's operating results.
Fluctuations in Quarterly Results. The Company's quarterly operating
results have fluctuated in the past and may fluctuate significantly in the
future due to a number of factors, including: changes in the mix of products
sold; the availability and pricing of components from third parties (especially
sole sources); the timing of orders; level of pricing of international sales;
fluctuations in foreign currency exchange rates; the difficulty in maintaining
margins, including the higher margins traditionally achieved in international
sales; and changes in pricing policies by the Company, its competitors or
suppliers. Specifically, if the local currencies in which the Company sells
weaken against the U.S. dollar, and if the local sales prices cannot be raised,
the Company will experience a deterioration of its gross and net profit margins.
If the U.S. dollar strengthens in the future, it could have a material adverse
effect on gross and net profit margins.
As has occurred in the past and as may be expected to occur in the future,
new software products of the Company or new operating systems of third parties
on which the Company's products are based, often contain bugs or errors that can
result in reduced sales and/or cause the Company's support costs to increase,
either of which could have a material adverse impact on the Company's operating
results. Furthermore, the Company has significant revenues from customers in
industries such as semiconductors, automated test equipment, telecommunications,
aerospace, defense and automotive which are cyclical in nature. Downturns in
these industries could have a material adverse effect on the Company's operating
results.
In recent years, with the exception of 2001, the Company's revenues have
been characterized by seasonality, with revenues typically being relatively
constant in the first, second and third quarters, growing in the fourth quarter
and being relatively flat or declining from the fourth quarter of the year to
the first quarter of the following year. The Company believes the seasonality of
its revenue results from the international mix of its revenue and the
variability of the budgeting and purchasing cycles of its customers throughout
each international region. In addition, total operating expenses have in the
past tended to be higher in the second and third quarters of each year, due to
recruiting and increased intern personnel expenses.
New Product Introductions and Market Acceptance. The market for the
Company's products is characterized by rapid technological change, evolving
industry standards, changes in customer needs and frequent new product
introductions, and is therefore highly dependent upon timely product innovation.
The Company's success is dependent on its ability to successfully develop and
introduce new and enhanced products on a timely basis to replace declining
revenues from older products, and on increasing penetration in domestic and
international markets. In the past, the Company has experienced significant
delays between the announcement and the commercial availability of new products.
Any significant delay in releasing new products could have a material adverse
effect on the ultimate success of a product and other related products and could
impede continued sales of predecessor products, any of which could have a
material adverse effect on the Company's operating results. There can be no
assurance that the Company will be able to introduce new products in accordance
with announced release dates, that new products will achieve market acceptance
or that any such acceptance will be sustained for any significant period.
Failure of new products to achieve or sustain market acceptance could have a
material adverse effect on the Company's operating results. Moreover, there can
be no assurance that the Company's international sales will continue at existing
levels or grow in accordance with the Company's efforts to increase foreign
market penetration.
Risks Associated with Increased Development of Web Site. The Company has
devoted significant resources in developing its Web site as a key marketing and
sales tool and expects to continue to do so in the future. There can be no
assurance that the Company will be successful in its attempt to leverage the Web
to increase sales. The Company hosts its Web site internally. Failure to
successfully maintain the Web site and to protect it from hackers could have a
significant adverse impact on the Company's operating results.
Operation in Intensely Competitive Markets. The markets in which the
Company operates are characterized by intense competition from numerous
competitors, some of which are divisions of large corporations having far
greater resources than the Company, and the Company expects to face further
competition from new market entrants in the future. A key competitor is Agilent
Technologies Inc. ("Agilent"). Agilent offers its own line of instrument
controllers and also offers hardware and software add-on products for
third-party desktop computers and workstations that provide solutions that
directly compete with the Company's virtual instrumentation products. Agilent is
aggressively advertising and marketing products that are competitive with the
Company's products. Because of Agilent's strong position in the instrumentation
business, changes in its marketing strategy or product offerings could have a
material adverse effect on the Company's operating results.
The Company believes its ability to compete successfully depends on a
number of factors both within and outside its control, including: new product
introductions by competitors; product pricing; quality and performance; success
in developing new products; adequate manufacturing capacity and supply of
components and materials; efficiency of manufacturing operations; effectiveness
of sales and marketing resources and strategies; strategic relationships with
other suppliers; timing of new product introductions by the Company; protection
of the Company's products by effective use of intellectual property laws;
general market and economic conditions; and government actions throughout the
world. There can be no assurance that the Company will be able to compete
successfully in the future.
Management Information Systems. The Company relies on three primary
regional centers for its management information systems. As with any information
system, unforeseen issues may arise that could affect management's ability to
receive adequate, accurate and timely financial information which in turn could
inhibit effective and timely decisions. Furthermore, it is possible that one or
more of the Company's three regional information systems could experience a
complete or partial shutdown. If such a shutdown occurred near the end of a
quarter it could impact the Company's product shipments and revenues, as product
distribution is heavily dependent on the integrated management information
systems in each region. Accordingly, operating results in that quarter would be
adversely impacted. The Company is working to achieve reliable regional
management information systems to control costs and improve the ability to
deliver its products in substantially all of its direct markets worldwide. No
assurances can be given that the Company's efforts will be successful. The
failure to receive adequate, accurate and timely financial information could
inhibit management's ability to make effective and timely decisions.
During the quarter ended September 30, 2003, the Company successfully
upgraded its Americas business applications suite to Oracle's latest web-based
release, 11i. However, there can be no assurance that the Company will not
experience difficulties with the new system. Difficulties with the system may
interrupt normal Company operations, including the ability to: provide quotes,
process orders, ship products, provide services and support to our customers,
bill and track our customers, fulfill contractual obligations and otherwise run
our business. Any disruptions of the system may have a material adverse effect
on the Company's operating results.
Risks Associated with International Operations and Foreign Economies.
International sales are subject to inherent risks, including fluctuations in
local economies, difficulties in staffing and managing foreign operations,
greater difficulty in accounts receivable collection, costs and risks of
localizing products for foreign countries, unexpected changes in regulatory
requirements, tariffs and other trade barriers, difficulties in the repatriation
of earnings and the burdens of complying with a wide variety of foreign laws.
The Company must also comply with various import and export regulations. Failure
to comply with these regulations could result in fines and/or termination of
import and export privileges, which could have a material adverse effect on the
Company's operating results. Additionally, the regulatory environment in some
countries is very restrictive as their governments try to protect their local
economy and value of their local currency against the U.S. dollar. Sales made by
the Company's international direct sales offices are denominated in local
currencies, and accordingly, the U.S. dollar equivalent of these sales is
affected by changes in the foreign currency exchange rates. Between the third
quarter of 2002 and the third quarter of 2003, net of hedging results, the
change in exchange rates had the effect of increasing the Company's consolidated
sales by 2% as compared to the third quarter of 2002. Since most of the
Company's international operating expenses are also incurred in local
currencies, the change in exchange rates had the effect of increasing operating
expenses by $1.5 million for the quarter ended September 30, 2003, as compared
to the comparable prior year period. If the U.S. dollar weakens in the future,
it could result in the Company having to reduce prices locally in order for its
products to remain competitive in the local marketplace. If the U.S. dollar
strengthens in the future, it could have a materially adverse effect on the
Company's operating results.
Expansion of Manufacturing Capacity. During 2001, the Company completed
construction of a second manufacturing facility. This facility is located in
Hungary and became operational in the fourth quarter of 2001. This facility
sources a significant portion of the Company's sales. Currently the Company is
continuing to develop and implement information systems to support its
operation. This facility and its operation are also subject to risks associated
with a new manufacturing facility and with doing business internationally,
including difficulty in managing manufacturing operations in a foreign country,
difficulty in achieving or maintaining product quality, interruption to
transportation flows for delivery of components to us and finished goods to our
customers, and changes in the country's political or economic conditions. No
assurance can be given that the Company's efforts will be successful.
Accordingly, failure to deal with these factors could result in interruption in
the facility's operation or delays in expanding its capacity, either of which
could have a material adverse effect on the Company's operating results.
Income Tax Rate. The Company established a manufacturing facility in
Hungary in 2001. As a result of certain foreign investment incentives available
under Hungarian law, the profit from the Company's Hungarian operation is
currently exempt from income tax. These benefits may not be available in the
future due to changes in Hungary's political condition and/or tax laws. The
reduction or elimination of these foreign investment incentives would result in
the reduction or elimination of certain tax benefits thereby increasing the
Company's future effective income tax rate, which could have a material adverse
effect on the Company's operating results.
The Company receives a substantial income tax benefit from the
extraterritorial income exemption ("ETI") under U.S. law. The ETI rules provide
that a percentage of the profits from products and intangibles exported from the
U.S. are exempt from U.S. tax. This benefit may not be available in the future
as the ETI has been ruled an illegal export subsidy by the World Trade
Organization. The repeal of the ETI would result in the elimination of this tax
benefit thereby increasing the Company's future effective income tax rate, which
could have a material adverse effect on the Company's operating results.
Products Dependent on Certain Industries. Sales of the Company's products
are dependent on customers in certain industries, particularly the
telecommunications, semiconductor, automotive, automated test equipment, defense
and aerospace industries. As experienced in the past, and as may be expected to
occur in the future, downturns characterized by diminished product demand in any
one or more of these industries could result in decreased sales, which could
have a material adverse effect on the Company's operating results.
Dependence on Key Suppliers. The Company's manufacturing processes use
large volumes of high-quality components and subassemblies supplied by outside
sources. Several of these components are available through sole or limited
sources. Sole-source components purchased by the Company include custom
application-specific integrated circuits ("ASICs") and other components. The
Company has in the past experienced delays and quality problems in connection
with sole-source components, and there can be no assurance that these problems
will not recur in the future. Accordingly, the failure to receive sole-source
components from suppliers could result in a material adverse effect on the
Company's revenues and operating results.
Stock-based Compensation Plans. The Company has two active stock-based
compensation plans and one inactive plan. The two active stock-based
compensation plans are the 1994 Incentive Stock Option Plan and the Employee
Stock Purchase Plan. The Company currently adheres to the disclosure only
provisions of SFAS No. 123, as amended by SFAS No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure, and as such, no
compensation cost has been recognized in the Company's financial statements for
the stock option plan and the stock purchase plan. The Company is currently
monitoring the recent discussions related to possible new regulations regarding
the accounting treatment for stock options. The Company will comply with any
changes in the accounting of stock options required by the FASB. If the fair
value based method of accounting for stock options established under SFAS No.
123 were adopted effective January 1, 2003 under the prospective method, the
Company estimates it would have recognized stock option expense of approximately
$261,000 and $462,000 for the quarter and nine month periods ended September 30,
2003, respectively. The impact of the adoption of the fair value based method of
accounting for stock options established under SFAS No. 123 effective January 1,
2003 under the retroactive restatement method is reflected in Note 5 - Stock
Based Compensation Plans.
Proprietary Rights and Intellectual Property Litigation. The Company's
success depends in part on its ability to obtain and maintain patents and other
proprietary rights relative to the technologies used in its principal products.
Despite the Company's efforts to protect its proprietary rights, unauthorized
parties may have in the past infringed or violated certain of the Company's
intellectual property rights. The Company may from time to time engage in
litigation to protect its intellectual property rights. In monitoring and
policing its intellectual property rights, the Company may be required to spend
significant resources. Additionally, as is typical in the industry, the Company
from time to time may be notified that it is infringing certain patent or
intellectual property rights of others. There can be no assurance that
intellectual property litigation initiated in the future will not cause
significant litigation expense, liability and a diversion of management's
attention which may have a material adverse effect on the Company's operating
results.
Dependence on Key Management and Technical Personnel. The Company's success
depends to a significant degree upon the continued contributions of its key
management, sales, marketing, research and development and operational
personnel, including Dr. Truchard, the Company's Chairman and Chief Executive
Officer, and other members of senior management and key technical personnel. The
Company has no agreements providing for the employment of any of its key
employees for any fixed term and the Company's key employees may voluntarily
terminate their employment with the Company at any time. The loss of the
services of one or more of the Company's key employees in the future could have
a material adverse affect on operating results. The Company also believes its
future success will depend upon its ability to attract and retain additional
highly skilled management, technical, marketing, research and development, and
operational personnel with experience in managing large and rapidly changing
companies, as well as training, motivating and supervising employees. In
addition, the recruiting environment for software engineering, sales and other
technical professionals is very competitive. Competition for qualified software
engineers is particularly intense and is likely to result in increased personnel
costs. Failure to attract or retain qualified software engineers could have an
adverse effect on the Company's operating results. The Company also recruits and
employs foreign nationals to achieve its hiring goals primarily for engineering
and software positions. There can be no guarantee that the Company will continue
to be able to recruit foreign nationals at the current rate. These factors
further intensify competition for key personnel, and there can be no assurance
that the Company will be successful in retaining its existing key personnel or
attracting and retaining additional key personnel. Failure to attract and retain
a sufficient number of technical personnel could have a material adverse effect
on the Company's operating results.
Risk of Product Liability Claims. The Company's products are designed to
provide information upon which the users may rely. The Company attempts to
assure the quality and accuracy of the processes contained in its products, and
to limit its product liability exposure through contractual limitations on
liability, including disclaimers in its "shrink wrap" license agreements with
end-users. If future products contain errors that produce incorrect results on
which users rely, customer acceptance of the Company's products could be
adversely affected. Further, the Company could be subject to liability claims
that could have a material adverse effect on the Company's operating results or
financial position. Although the Company maintains liability insurance, there
can be no assurance that such insurance or the contractual provisions used by
the Company to limit its liability will be sufficient.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Response to this item is included in "Item 2 - Management's Discussion and
Analysis of Financial Conditions and Results of Operations - Market Risk" above.
Item 4. Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer, based on
the evaluation of the Company's disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as
amended) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, as of
September 30, 2003, have concluded that the Company's disclosure controls and
procedures were effective to ensure the timely collection, evaluation and
disclosure of information relating to the Company that would potentially be
subject to disclosure under the Securities Exchange Act of 1934, as amended, and
the rules and regulations promulgated thereunder. During the three months ended
September 30, 2003, there were no changes in the Company's internal controls
over financial reporting identified in connection with the evaluation required
by paragraph (d) of the Rule 13a-15 or Rule 15d-15 that has materially affected,
or is reasonably likely to materially affect, the internal controls over
financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As reported in the two previous Form 10Q's of 2003, the Company has filed two
complaints against The MathWorks, Inc. ("Defendant") for patent infringement. In
both complaints, the Company claimed the Defendant infringes certain of its U.S.
patents and the Defendant challenged the validity and enforceability of those
patents and asserts that it does not infringe the claims of those patents.
The first complaint was filed on January 25, 2001 in the U.S. District Court,
Eastern District of Texas (Marshall Division). On January 30, 2003, the jury
found infringement by the Defendant of three of the patents involved and awarded
the Company specified damages. On June 23, 2003, the Court entered final
judgement in favor of the Company in an amount of approximately $4 million
dollars and entered an injunction against Defendant's sale of its Simulink and
related products. The Court stayed the injunction pending appeal of the case and
required the Defendant to pay a specified royalty on its U.S. sales of the same
products during the pendency of appeal. On July 22, 2003, Defendant filed its
Notice of Appeal and the case is currently pending on appeal before the U.S.
Court of Appeals for the Federal Circuit. The final judgement has not been
recorded in the financial statements of the Company pending the disposition of
the appeal.
The second complaint was filed October 21, 2002, also in the U.S. District
Court, Eastern District of Texas (Marshall Division) and on August 27, 2003, the
complaint was dismissed by agreement of the parties.
On January 15, 2003, SoftWIRE Technology, LLC ("SoftWIRE") and Measurement
Computing Corporation ("MCC") filed a complaint against the Company in the U.S.
District Court for the District of Massachusetts asking the court to declare
that SoftWIRE does not infringe certain of the Company's U.S. patents and that
such patents are invalid and unenforceable. On February 21, 2003, the Company
filed a complaint against SoftWIRE and MCC in the U.S. District Court, Eastern
District of Texas (Marshall Division) claiming that both SoftWIRE and MCC
infringe the same and certain other of the Company's U.S. patents. SoftWIRE and
MCC challenge the validity and enforceability of these patents and assert that
they do not infringe any of these patents. In the Eastern District action, the
Company seeks monetary damages and injunction of the sale of certain products of
SoftWIRE and MCC as well as attorney's fees and costs. By order of the Court,
the Eastern District action was transferred to the U.S. District Court for the
District of Massachusetts on May 9, 2003, and the parties are seeking to
consolidate this action with the previously-filed SoftWIRE action. On June 12,
2003, SoftWIRE moved for leave to amend its complaint in order to allege that
the Company infringes two U.S. patents that SoftWIRE acquired by purchase on May
23, 2003. MCC joined SoftWIRE's motion to amend. With respect to the two U.S.
patents that SoftWIRE acquired, SoftWIRE seeks monetary damages and injunction
of the sale of certain products of the Company as well as attorney's fees and
costs. The Company opposes SoftWIRE's and MCC's motion for leave to amend. The
motion is currently pending before the Court. Should the Court permit amendment
to allow assertion of SoftWIRE's patents, the Company is prepared to vigorously
defend against SoftWIRE's claims and challenges the validity, enforceability and
alleged infringement of those patents.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
3.1* Certificate of Incorporation of the Company.
3.2* Bylaws of the Company.
4.1* Specimen of Common Stock certificate of the Company.
4.2* Rights Agreement dated as of May 19, 1994, between the Company and
The First National Bank of Boston.
10.1* Form of Indemnification Agreement.
10.2* 1994 Incentive Plan.**
10.3* 1994 Employee Stock Purchase Plan.**
10.4 Agreement regarding Terms of Employment incorporated by reference
from Exhibit 10.4 of the Company's 10-K filed January 28, 2003.**
31.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
* Incorporated by reference to the Company's Registration Statement
on Form S-1 (Reg. No. 33-88386) declared effective March 13, 1995.
** Management Contract or Compensatory Plan or Arrangement.
(b) Reports on Form 8-K.
On July 23, 2003, the Company filed aForm 8-K reporting on the same date
under Item 7 "Financial Statements and Exhibits" and Item 9 "Regulation FD
Disclosure" the Company's press release related to its financial results.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NATIONAL INSTRUMENTS CORPORATION
Registrant
BY: /s/ Alex Davern
Alex Davern
Chief Financial Officer and Treasurer
(principal financial and accounting officer)
Dated: October 24, 2003
NATIONAL INSTRUMENTS CORPORATION
INDEX TO EXHIBITS
Exhibit No. Description Page
----------- ----------- ----
31.1 Certification of Chief Executive 24
Officer Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial 25
Officer Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive 26
Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.