================================================================================
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 fiscal quarter ended: June 30, 2004 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
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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 August 4, 2004
Common Stock - $0.01 par value 78,811,495
NATIONAL INSTRUMENTS CORPORATION
INDEX
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1 Financial Statements:
Consolidated Balance Sheets (unaudited)
June 30, 2004 and December 31, 2003............................3
Consolidated Statements of Income (unaudited)
Three months and six months ended June 30, 2004 and 2003.......4
Consolidated Statements of Cash Flows (unaudited)
Six months ended June 30, 2004 and 2003........................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.......20
Item 4 Controls and Procedures..........................................20
PART II. OTHER INFORMATION
Item 1 Legal Proceedings................................................22
Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases
of Equity Securities............................................ 23
Item 4 Submission of Matters to a Vote of Security Holders..............23
Item 5 Other Information................................................23
Item 6 Exhibits and Reports on Form 8-K.................................24
Signature........................................................25
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
NATIONAL INSTRUMENTS CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
June 30, December 31,
2004 2003
----------- ------------
Assets
Current assets:
Cash and cash equivalents....................... $ 46,199 $ 53,446
Short-term investments.......................... 145,708 141,227
Accounts receivable, net........................ 85,091 77,970
Inventories, net................................ 60,431 38,813
Prepaid expenses and other current assets....... 14,961 9,742
Deferred income tax, net........................ 11,551 9,927
----------- ------------
Total current assets......................... 363,941 331,125
Property and equipment, net........................ 150,462 151,612
Intangibles, net and other assets.................. 42,721 42,414
----------- ------------
Total assets................................. $ 557,124 $ 525,151
=========== ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable................................ $ 35,102 $ 29,567
Accrued compensation............................ 18,003 12,302
Deferred revenue................................ 10,031 8,148
Accrued expenses and other liabilities.......... 10,261 16,271
Other taxes payable............................. 8,367 9,507
----------- ------------
Total current liabilities.................... 81,764 75,795
Deferred income taxes.............................. 10,391 9,904
----------- ------------
Total liabilities............................ 92,155 85,699
----------- ------------
Commitments and contingencies
Stockholders' equity:
Preferred stock: par value $0.01; 5,000,000
shares authorized; 0 and 0 shares issued and
outstanding, respectively....................... -- --
Common stock: par value $0.01; 180,000,000
shares authorized; 78,757,349 and 78,269,235
shares issued and outstanding, respectively..... 788 783
Additional paid-in capital...................... 98,707 95,070
Retained earnings............................... 367,621 349,994
Accumulated other comprehensive loss............ (2,147) (6,395)
----------- ------------
Total stockholders' equity................... 464,969 439,452
----------- ------------
Total liabilities and stockholders' equity... $ 557,124 $ 525,151
=========== ============
The accompanying notes are an integral part of these financial statements.
NATIONAL INSTRUMENTS CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net sales.............................. $ 127,127 $ 100,165 $ 251,765 $ 199,338
Cost of sales.......................... 33,325 27,150 64,895 53,163
---------- ---------- ---------- ----------
Gross profit........................ 93,802 73,015 186,870 146,175
---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing................. 47,048 38,124 93,745 76,669
Research and development............ 21,345 16,876 41,335 32,127
General and administrative.......... 10,401 9,201 20,437 20,240
---------- ---------- ---------- ----------
Total operating expenses......... 78,794 64,201 155,517 129,036
---------- ---------- ---------- ----------
Operating income................. 15,008 8,814 31,353 17,139
Other income (expense):
Interest income, net................ 717 620 1,430 1,306
Net foreign exchange gain (loss).... (743) 340 (746) 325
Other income, net................... 165 98 212 119
---------- ---------- ---------- ----------
Income before income taxes............. 15,147 9,872 32,249 18,889
Provision for income taxes............. 3,787 2,468 8,062 4,722
---------- ---------- ---------- ----------
Net income....................... $ 11,360 $ 7,404 $ 24,187 $ 14,167
========== ========== ========== ==========
Basic earnings per share............... $ 0.15 $ 0.10 $ 0.31 $ 0.18
========== ========== ========== ==========
Weighted average shares
outstanding-basic................... 78,287 77,235 78,126 76,986
========== ========== ========== ==========
Diluted earnings per share............. $ 0.14 $ 0.09 $ 0.30 $ 0.18
========== ========== ========== ==========
Weighted average shares 81,994 80,450 81,955 80,180
outstanding-diluted................. ========== ========== ========== ==========
Dividends declared per share........... $ 0.05 $ -- $ 0.08 $ --
========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
NATIONAL INSTRUMENTS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended
June 30,
----------------------
2004 2003
---------- ----------
Cash flow from operating activities:
Net income........................................... $ 24,187 $ 14,167
Adjustments to reconcile net income to net cash
provided by operating activities:
Charges to income not requiring cash outlays:
Depreciation and amortization................... 12,058 12,390
Benefit from deferred income taxes.............. (1,137) (965)
Tax benefit from stock option plans............. 1,807 1,315
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable...... (7,121) 1,221
Decrease (increase) in inventories.............. (21,618) 3,351
Decrease (increase) in prepaid expense and
other assets.................................... (1,635) 2,511
Increase (decrease) in current liabilities...... 5,969 (6,978)
---------- ----------
Net cash provided by operating activities......... 12,510 27,012
---------- ----------
Cash flow from investing activities:
Capital expenditures................................. (6,802) (7,759)
Capitalization of internally developed software...... (3,413) (8,432)
Additions to other intangibles....................... (336) (4,323)
Purchases of short-term investments.................. (91,367) (77,042)
Sales and maturities of short-term investments....... 86,886 50,651
---------- ----------
Net cash used in investing activities............. (15,032) (46,905)
---------- ----------
Cash flow from financing activities:
Net proceeds from issuance of common stock under
employee plans....................................... 9,240 7,715
Repurchase of common stock........................... (7,405) --
Dividends paid....................................... (6,560) --
---------- ----------
Net cash provided by (used in) financing
activities........................................ (4,725) 7,715
---------- ----------
Net decrease in cash and cash equivalents............... (7,247) (12,178)
Cash and cash equivalents at beginning of period........ 53,446 40,240
---------- ----------
Cash and cash equivalents at end of period.............. $ 46,199 $ 28,062
========== ==========
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, 2003, 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 June 30, 2004 and December 31, 2003, and the
results of operations for the three-month and six-month periods ended June 30,
2004 and 2003, and the cash flows for the six-month periods ended June 30, 2004
and 2003. Operating results for the three-month and six-month periods ended June
30, 2004 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2004.
Certain prior year amounts have been reclassified to conform with the 2004
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 six-month periods ended June 30, 2004 and 2003,
respectively, are as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
(unaudited) (unaudited)
2004 2003 2004 2003
-------- -------- -------- --------
Weighted average shares
outstanding-basic.................... 78,287 77,235 78,126 76,986
Plus: Common share equivalents
Stock options...................... 3,707 3,215 3,829 3,194
-------- -------- -------- --------
Weighted average shares
outstanding-diluted.................. 81,994 80,450 81,955 80,180
======== ======== ======== ========
Stock options to acquire 1,616,000 and 2,346,000 shares for the quarters ended
June 30, 2004 and 2003, respectively, and 1,590,000 and 2,326,500 shares for the
six months ended June 30, 2004 and 2003, respectively, were excluded in the
computations of diluted EPS because the effect of including the stock options
would have been anti-dilutive.
NOTE 3 - Inventories, net
Inventories consist of the following (in thousands):
June 30, December 31,
2004 2003
---------------------------
(unaudited)
---------------------------
Raw materials $ 27,237 $ 17,513
Work-in-process 3,322 1,625
Finished goods 29,872 19,675
----------- ------------
$ 60,431 $ 38,813
=========== ============
NOTE 4 - Comprehensive Income
The Company's comprehensive income is comprised of net income, foreign currency
translation and unrealized gains and losses on forward and option contracts and
securities available for sale. Comprehensive income for the three-month and
six-month periods ended June 30, 2004 and 2003 was as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
(unaudited) (unaudited)
2004 2003 2004 2003
-------- -------- -------- --------
Comprehensive income:
Net income............................ $11,360 $ 7,404 $24,187 $14,167
Foreign currency translation.......... (462) 1,555 (616) 2,165
Unrealized gains (losses) on
derivative instruments.............. 3,768 (705) 5,289 (1,362)
Unrealized losses on securities
available for sale.................. (425) 33 (425) (59)
-------- -------- -------- --------
Total comprehensive income.............. $14,241 $ 8,287 $28,435 $14,911
======== ======== ======== ========
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 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 Six Months Ended
June 30, June 30,
------------------ ------------------
(unaudited) (unaudited)
2004 2003 2004 2003
-------- -------- -------- --------
Net income, as reported............. $11,360 $ 7,404 $24,187 $14,167
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......... (2,992) (3,935) (5,515) (6,671)
-------- -------- -------- --------
Pro-forma net income................ $ 8,368 $ 3,469 $18,672 $ 7,496
-------- -------- -------- --------
Earnings per share:
Basic - as reported................. $ 0.15 $ 0.10 $ 0.31 $ 0.18
Basic - pro-forma................... $ 0.11 $ 0.04 $ 0.24 $ 0.10
Diluted - as reported............... $ 0.14 $ 0.09 $ 0.30 $ 0.18
Diluted - pro-forma................. $ 0.10 $ 0.04 $ 0.23 $ 0.09
NOTE 6 - Authorized Preferred Stock and Preferred Stock Purchase Rights Plan
National Instruments has 5,000,000 authorized shares of preferred stock. On
January 21, 2004, the Board of Directors of National Instruments designated
750,000 of these shares as Series A Participating Preferred Stock in conjunction
with its adoption of a Preferred Stock Rights Agreement (the "Rights Agreement")
and declaration of a dividend of one preferred share purchase right (a "Right")
for each share of common stock outstanding held as of May 10, 2004 or issued
thereafter. Each Right will entitle its holder to purchase one one-thousandth of
a share of National Instruments' Series A Participating Preferred Stock at an
exercise price of $200, subject to adjustment, under certain circumstances. The
Rights Agreement was not adopted in response to any effort to acquire control of
National Instruments.
The Rights only become exercisable in certain limited circumstances following
the tenth day after a person or group announces acquisitions of or tender offers
for 20% or more of National Instruments' common stock. In addition, if an
acquirer (subject to certain exclusions for certain current stockholders of
National Instruments, an "Acquiring Person") obtains 20% or more of National
Instruments' common stock, then each Right (other than the Rights owned by an
Acquiring Person or its affiliates) will entitle the holder to purchase, for the
exercise price, shares of National Instruments common stock having a value equal
to two times the exercise price. Under certain circumstances, the National
Instruments' Board of Directors may redeem the Rights, in whole, but not in
part, at a purchase price of $0.01 per Right. The Rights have no voting
privileges and are attached to and automatically traded with National
Instruments common stock until the occurrence of specified trigger events. The
Rights will expire on the earlier of May 10, 2014 or the exchange or the
redemption of the Rights.
NOTE 7 - Commitments and Contingencies
The Company offers a one or two-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):
Six Months Ended
June 30,
----------------------
(unaudited)
2004 2003
---------- ----------
Balance at the beginning of the period................. $ 715 $ 715
Accruals for warranties issued during the period....... 766 518
Settlements made (in cash or in kind) during the
period............................................... (666) (518)
Balance at the end of the period....................... $ 815 $ 715
As of June 30, 2004, the Company has outstanding guarantees for payment of
foreign leases, customs and foreign grants totaling approximately $4.6 million.
As of June 30, 2004, the Company has non-cancelable purchase commitments with
various suppliers of customized inventory and inventory components totaling
approximately $5.1 million over the next twelve months.
NOTE 8 - 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. Substantially all of the Company's goodwill is recorded in Europe. 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 Six Months Ended
June 30, June 30,
---------------------- ----------------------
(unaudited) (unaudited)
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net sales:
Americas:
Unaffiliated customer sales... $ 62,700 $ 49,562 $ 120,107 $ 96,220
Geographic transfers.......... 20,896 13,239 42,109 27,130
---------- ---------- ---------- ----------
83,596 62,801 162,216 123,350
---------- ---------- ---------- ----------
Europe:
Unaffiliated customer sales... 40,493 31,175 80,252 62,453
Geographic transfers.......... 18,754 11,814 32,869 23,017
---------- ---------- ---------- ----------
59,247 42,989 113,121 85,470
---------- ---------- ---------- ----------
Asia Pacific:
Unaffiliated customer sales... 23,934 19,428 51,406 40,665
---------- ---------- ---------- ----------
Eliminations.................... (39,650) (25,053) (74,978) (50,147)
---------- ---------- ---------- ----------
$ 127,127 $ 100,165 $ 251,765 $ 199,338
========== ========== ========== ==========
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
(unaudited) (unaudited)
2004 2003 2004 2003
---------- ---------- ---------- ----------
Operating income:
Americas........................ $ 16,460 $ 9,337 $ 29,175 $ 15,236
Europe.......................... 12,154 9,399 24,616 17,609
Asia Pacific.................... 7,739 6,954 18,897 16,421
Unallocated:
Research and development
expenses....................... (21,345) (16,876) (41,335) (32,127)
---------- ---------- ---------- ----------
$ 15,008 $ 8,814 $ 31,353 $ 17,139
========== ========== ========== ==========
June 30, December 31,
2004 2003
------------------------
(unaudited)
------------------------
Identifiable assets:
Americas........................ $ 456,963 $ 420,082
Europe.......................... 69,572 77,963
Asia Pacific.................... 30,589 27,106
---------- -----------
$ 557,124 $ 525,151
========== ===========
Total sales outside the United States for the quarter and six months ended June
30, 2004 were $70.1 million and $143.4 million, respectively, and for the
quarter and six months ended June 30, 2003 were $55.3 million and $112.1
million, respectively.
NOTE 9 - Litigation
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
judgment 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. The initial judgement and the royalties
on the sales of infringing products through June 30, 2004 total $6.3 million and
are escrowed. 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 judgment 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 has been consolidated with the
previously-filed SoftWIRE action, which also includes counterclaims by the
Company that are the same in substance as the Company's claims in the Eastern
District 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. On November 5, 2003, the Court
granted SoftWIRE's motion to amend, thereby adding SoftWIRE's two patents to the
litigation. With respect to those two SoftWIRE patents, SoftWIRE seeks monetary
damages and injunction of the sale of the Company's LabVIEW software products,
as well as attorney's fees and costs. The Company challenges the validity,
enforceability and alleged infringement of those patents and intends to
vigorously defend against SoftWIRE's claims. Discovery in the litigation is
underway. During the fourth quarter of 2003, the Company accrued $3.8 million
related to its probable loss from this contingency, which consists solely of
anticipated patent defense costs that are probable of being incurred. However,
the outcome of any litigation is inherently uncertain and there can be no
assurance as to the ultimate outcome of this matter or any other litigation. The
Company charged approximately $893,000 against this accrual during the second
quarter of 2004. The Company has charged a total of $1.3 million against this
accrual through June 30, 2004.
NOTE 10 - Subsequent Event
The Company's Board of Directors approved on July 27, 2004, a quarterly cash
dividend of $0.05 per common share, payable on August 30, 2004 to shareholders
of record on August 9, 2004.
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
Market Risk section, 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 documents regularly filed by the Company with the
Securities and Exchange Commission, including the Company's Annual Report on
Form 10-K for further discussion of the Company's business and the risks
attendant thereto.
Overview
National Instruments designs, develops, manufactures and markets
instrumentation and automation software and hardware for general commercial,
industrial and scientific applications. The Company offers hundreds of products
used to create virtual instrumentation systems for measurement and automation.
The Company has identified a large and diverse market for test and measurement
("T&M") and industrial automation ("IA") applications. The Company's products
are used in a variety of applications from research and development to
production testing, monitoring and industrial control. In T&M applications, the
Company's products can be used to monitor and control traditional instruments or
to create computer-based instruments that can replace traditional instruments.
In IA applications, the Company's products can be used in the same ways as in
test and measurement and can also be used to integrate measurement functionality
with process automation capabilities. The Company sells to a large number of
customers in a wide variety of industries. No single customer accounted for more
than 3% of the Company's sales in 2003, 2002 or 2001.
The Company has been profitable in every year since 1990. However, there
can be no assurance that the Company's net sales will grow or that the Company
will remain profitable in future periods. As a result, the Company believes
historical results of operations should not be relied upon as indications of
future performance.
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 Six Months Ended
June 30, June 30,
---------------------- ----------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Net sales:
Americas 49.3% 49.5% 47.7% 48.3%
Europe 31.9 31.1 31.9 31.3
Asia Pacific 18.8 19.4 20.4 20.4
---------- ---------- ---------- ----------
Consolidated net sales 100.0 100.0 100.0 100.0
Cost of sales 26.2 27.1 25.8 26.7
---------- ---------- ---------- ----------
Gross profit 73.8 72.9 74.2 73.3
---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing 37.0 38.1 37.2 38.5
Research and development 16.8 16.8 16.4 16.1
General and administrative 8.2 9.2 8.1 10.1
---------- ---------- ---------- ----------
Total operating expenses 62.0 64.1 61.7 64.7
---------- ---------- ---------- ----------
Operating income 11.8 8.8 12.5 8.6
Other income (expense):
Interest income, net 0.6 0.6 0.5 0.7
Net foreign exchange gain
(loss) (0.6) 0.3 (0.3) 0.2
Other income, net 0.1 0.1 0.1 --
---------- ---------- ---------- ----------
Income before income taxes 11.9 9.8 12.8 9.5
Provision for income taxes 3.0 2.4 3.2 2.4
---------- ---------- ---------- ----------
Net income 8.9% 7.4% 9.6% 7.1%
========== ========== ========== ==========
Net Sales. Consolidated net sales increased by $27.0 million or 27% for the
three months ended June 30, 2004 to $127.1 million from $100.2 million for the
three months ended June 30, 2003, and increased $52.4 million or 26% to $251.8
million for the six months ended June 30, 2004 from $199.3 million for the
comparable period in the prior year. The Company believes that the increases in
sales for the three and six months ended June 30, 2004 were primarily
attributable to the introduction of new and upgraded products, the continued
recovery in the global economy, the increase in unit volume from the increased
market acceptance of the Company's products in all regions, and the strength of
the Euro. The increase in sales attributable to the increase in unit volume was
partially offset by the decrease in local currency product pricing in Asia and
Europe. Sales in the Americas in the second quarter of 2004 increased 27% from
the second quarter of 2003 and sales in the Americas for the six months ended
June 30, 2004 increased 25% from the six months ended June 30, 2003.
Sales outside of the Americas, as a percentage of consolidated sales for
the quarter ended June 30, 2004, increased to 50.7% from 50.5% over the
comparable 2003 period as a result of stronger sales in Asia and a stronger
Euro. International sales as a percentage of consolidated sales for the six
months ended June 30, 2004 increased to 52.3% from 51.7% over the comparable
2003 period due to stronger sales in Asia and a stronger Euro. Compared to the
corresponding periods in 2003, the Company's European sales increased by 30% to
$40.5 million for the quarter ended June 30, 2004 and increased 29% to $80.3
million for the six months ended June 30, 2004. Sales in Asia Pacific increased
by 23% to $23.9 million in the quarter ended June 30, 2004 compared to the same
period in 2003 and increased 26% to $51.4 million for the six months ended June
30, 2004 compared to the same period in 2003. The Company expects sales outside
of North America to continue to represent a significant portion of its revenue.
The Company intends to continue to expand its international operations by
increasing its presence in existing markets, adding a presence in some new
geographical markets and continuing the use of distributors to sell its products
in some countries.
Sales 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 foreign currency exchange rates. Between
the second quarter of 2003 and the second quarter of 2004, net of hedging
results, the change in exchange rates had the effect of increasing the Company's
consolidated sales by 7%; increasing European sales by 18% and increasing sales
in Asia Pacific by 5%. For 2004, year-to-date sales, net of hedging results, the
change in exchange rates had the effect of increasing the Company's consolidated
sales by 7%. The increases in sales in Europe and Asia as a result of the change
in exchange rates was partially offset by the decrease in local currency product
pricing in each region. 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 $3.8 million, or 2.5%, for the
six months ended June 30, 2004 and by $1.5 million, or 1.9%, for the quarter
ended June 30, 2004 compared to the comparable prior year periods.
Gross Profit. As a percentage of sales, gross profit increased to 74% for
the second quarter of 2004 from 73% for the second quarter of 2003 and increased
to 74% for the first six months of 2004 from 73% for the comparable period a
year ago. Approximately 50% of the higher margin in the second quarter of 2004
is attributable to favorable foreign currency exchange rates. The remaining
fraction of the higher margin is attributable to the favorable impact of higher
sales volume. Approximately 60% of the higher margin in the first six months of
2004 compared to the comparable prior year period is attributable to favorable
foreign currency exchange rates. The remaining fraction of the higher margin is
attributable to the favorable impact of 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 second quarter of
2004 increased to $47.0 million, a 23% increase, compared to the second quarter
of 2003 and increased 22% to $93.7 million for the first six months of 2004 from
the comparable 2003 period. Approximately 60% of the increases in these expenses
in the quarter and six months ended June 30, 2004 from the comparable prior year
periods were attributable to increases in international sales and marketing
personnel costs, due to the increase in international sales and marketing
personnel, the increase in variable compensation from higher sales volume and
from the effects of the change in currency exchange rates, with the remaining
fraction of increase attributable to increases in advertising, tradeshows and
special events. As a percentage of net sales, sales and marketing expenses were
37.0% and 38.1% for the three months ended June 30, 2004 and 2003, respectively,
and 37.2% and 38.5% for the six months ended June 30, 2004 and 2003,
respectively. 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
$21.3 million for the quarter ended June 30, 2004, a 26% increase, compared to
$16.9 million for the three months ended June 30, 2003, and increased 29% to
$41.3 million for the six months ended June 30, 2004 from the comparable 2003
period. As a percentage of net sales, research and development expenses remained
flat at 16.8% for the quarter ended June 30, 2004 compared with the quarter
ended June 30, 2003, and increased to 16.4% for the six months ended June 30,
2004 from 16.1% for the comparable 2003 period. The increase in research and
development costs as a percentage of sales in the six-month period ended June
30, 2004 versus the prior year period was primarily due to increases in
personnel costs from the hiring of additional product development engineers and
the decrease in the capitalization of software development 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 the
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 $1.2 million for the quarters ended June 30, 2004 and
2003, respectively, and $3.7 million and $2.2 million during the six months
ended June 30, 2004 and 2003, respectively. Software development costs
capitalized were $1.4 million and $3.9 million for the quarters ended June 30,
2004 and 2003, respectively, and $3.4 million and $8.4 million for the first six
months of 2004 and 2003, respectively.
General and Administrative. General and administrative expenses for the
second quarter ended June 30, 2004 increased 13% to $10.4 million from $9.2
million for the comparable prior year period. For the first six months of 2004,
general and administrative expenses increased 1% to $20.4 million from $20.2
million for the first six months of 2003. As a percentage of net sales, general
and administrative expenses decreased to 8.2% for the quarter ended June 30,
2004 from 9.2% for the second quarter of 2003. During the first six months of
2004, general and administrative expenses decreased as a percentage of sales to
8.1% from 10.1% for the comparable prior year period. The increases in general
and administrative expenses in absolute terms for the quarter and the six months
ended June 30, 2004 from the comparable prior year periods were primarily
attributable to increases in personnel and insurance costs, and costs associated
with the upgrade of the Company's business applications suite to Oracle's latest
web-based release 11i. The decrease in general and administrative expenses as a
percentage of sales for the quarter ended June 30, 2004 from the prior year
period was primarily attributable to higher sales volume. The decrease in
general and administrative expenses as a percentage of sales for the six months
ended June 30, 2004 from the comparable prior year period was attributable to
decreased litigation costs of approximately $2.8 million associated with a legal
action by the Company brought against The MathWorks, Inc. to enforce the
Company's intellectual property. (See Note 9 of Notes to Consolidated Financial
Statements.) The Company expects that general and administrative expenses in
future periods will fluctuate in absolute amounts and as a percentage of
revenue.
Interest Income, Net. Net interest income in the second quarter of 2004
increased to $717,000 from $620,000 in the second quarter of 2003, and increased
to $1.4 million for the first six months of 2004 from $1.3 million for the
comparable 2003 period. The increases in interest income for the quarter and six
months ended June 30, 2004 were due to higher yields on increased invested
funds. 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 $743,000 in the second quarter of 2004 compared to gains of
$340,000 in the second quarter of 2003. Net foreign exchange losses of $746,000
were recognized for the first six months of 2004 compared to gains of $325,000
for the first six months of 2003. 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 decreased the foreign exchange losses by $427,000
during the quarter ended June 30, 2004, and reduced the foreign exchange losses
by $227,000 for the six months ended June 30, 2004.
Provision for Income Taxes. The provision for income taxes reflects an
effective tax rate of 25% for the three and six months ended June 30, 2004 and
25% for the three and six months ended June 30, 2003. 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 June 30, 2004, the Company had working
capital of approximately $282.2 million compared to $255.3 million at December
31, 2003. Net cash provided by operating activities for the six month periods
ended June 30, 2004 and 2003 totaled $12.5 million and $27.0 million,
respectively.
Accounts receivable increased to $85.1 million at June 30, 2004 from $78.0
million at December 31, 2003. Days sales outstanding increased to 57 at June 30,
2004 compared to 56 at June 30, 2003. Consolidated inventory balances increased
to $60.4 million at June 30, 2004 from $38.8 million at December 31, 2003. The
increase in inventory was due to a planned increase in safety stock inventory.
Inventory turns decreased to 2.2 for the quarter ended June 30, 2004 from turns
of 3.0 for the quarter ended June 30, 2003. Cash used in the first six months of
2004 for the purchase of property and equipment totaled $6.8 million, for the
capitalization of internally developed software costs totaled $3.4 million, and
for additions to other intangibles totaled $336,000. Cash used in the first six
months of 2003 for the purchase of property and equipment totaled $7.8 million,
for the capitalization of internally developed software costs totaled $8.4
million, and for additions to other intangibles totaled $4.3 million.
Cash provided by the issuance of common stock totaled $9.2 million and $7.7
million for the first six months of 2004 and 2003, respectively. The issuance of
common stock was primarily to employees under the Company's Employee Stock
Purchase Plan and 1994 Incentive Plan. Cash used for the repurchase of common
stock totaled $7.4 million and $0 for the first six months of 2004 and 2003,
respectively. Cash used for the payment of dividends totaled $6.6 million and $0
for the first six months of 2004 and 2003, respectively.
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 June 30, 2004 and 2003, the Company had no debt
outstanding. The Company believes that its 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. At June 30, 2004, 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 exchanges rates on its results of operations and financial position.
Based on the foreign exchange instruments outstanding at June 30, 2004, 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 $8.1 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 June 30, 2004 was $145.7 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 its marketable securities portfolio by
investing in multiple types of investment-grade securities. The Company's
investment portfolio is primarily invested in 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 June 30, 2004, a 100 basis point increase or
decrease in interest rates would result in a decrease or increase of
approximately $730,000, 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.
Factors Affecting the Company's Business and Prospects
U.S./Global Economic Changes. As occurred in recent years, 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 the Company's 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 three years. The Company
could also be subject to or impacted by acts of terrorism and/or the effects
that war or continued U.S. military action would have on the U.S. and/or global
economies. 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 2004. 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 the Company's 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, 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's results of operations in the third quarter of
2004 may be adversely affected by lower sales levels in Europe, which typically
occur during the summer months. 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 the Company's Web Site. The Company devotes resources
to maintain 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. Any failure to successfully maintain the Web site
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 more reliable regional
management information systems to control costs and improve its ability to
deliver its products in substantially all of its direct markets worldwide. No
assurance 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 ending March 31, 2005, the Company will be upgrading its
European business applications suite to Oracle's latest web-based release, 11i.
There can be no assurance that the Company will not experience difficulties
implementing the new system. Difficulties or delays in the implementation may
interrupt normal Company operations, including the ability to provide quotes,
process orders, ship products, provide services and support to its customers,
bill and track its customers, fulfill contractual obligations and otherwise run
its business. Any disruptions occurring in the implementation 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 second
quarter of 2004 and the second quarter of 2003, net of hedging results, the
change in exchange rates had the effect of increasing the Company's consolidated
sales by $6.2 million, or 7%, compared to the second quarter of 2003. Since most
of the Company's international operating expenses are also incurred in local
currencies, the change in exchanges rates had the effect of increasing operating
expenses by $1.5 million for the quarter ended June 30, 2004 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, and the Company is unable to successfully raise its international
selling prices, it could have a material 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 the operation
of this facility. 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, any 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 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 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 proposal requiring
changes in the accounting treatment for stock options. The Company will comply
with any changes in the accounting of stock options required by the FASB and the
Securities and Exchange Commission.
Provisions in Our Charter Documents and Delaware Law and Our Stockholder
Rights Plan May Delay or Prevent an Acquisition of Us. Our certificate of
incorporation and bylaws and Delaware law contain provisions that could make it
more difficult for a third party to acquire us without the consent of our Board
of Directors. These provisions include a classified Board of Directors,
prohibition of stockholder action by written consent, prohibition of
stockholders to call special meetings and the requirement that the holders of at
least 80% of our shares approve any business combination not otherwise approved
by two-thirds of the Board of Directors. Delaware law also imposes some
restrictions on mergers and other business combinations between us and any
holder of 15% or more of our outstanding common stock. In addition, our Board of
Directors has the right to issue preferred stock without stockholder approval,
which could be used to dilute the stock ownership of a potential hostile
acquirer. Our Board of Directors adopted a new stockholders rights plan on
January 21, 2004, pursuant to which we declared a dividend of one right for each
share of our common stock outstanding as of May 10, 2004. This rights plan
replaced a similar rights plan that had been in effect since our initial public
offering in 1995. Unless redeemed by us prior to the time the rights are
exercised, upon the occurrence of certain events, the rights will entitle the
holders to receive upon exercise thereof shares of our preferred stock, or
shares of an acquiring entity, having a value equal to twice the then-current
exercise price of the right. The issuance of the rights could have the effect of
delaying or preventing a change of control of us.
Proprietary Rights and Intellectual Property Litigation. The Company's
success depends 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 from time to time engages in
litigation to protect its intellectual property rights. In monitoring and
policing its intellectual property rights, the Company has been and may be
required to spend significant resources. 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 the SoftWIRE case and/or other existing
litigation, or any other intellectual property litigation initiated in the
future, will not cause significant litigation expense, liability, injunction
against some of the Company's products, and a diversion of management's
attention, any of which may have a material adverse effect on the Company's
operating results.
Recently Enacted and Proposed Changes in Securities Laws and Related
Regulations Could Result in Increased Costs to Us. Recently enacted and proposed
changes in the laws and regulations affecting public companies, including the
provisions of the Sarbanes-Oxley Act of 2002 and recent rules enacted and
proposed by the SEC, Nasdaq and the NYSE, are resulting in increased costs to us
as we respond to their requirements. In particular, complying with the internal
control audit requirements of Sarbanes-Oxley Section 404 will result in
increased internal efforts and higher fees from our independent accounting firm.
The current estimate of our total cost of both the additional internal resource
requirement and the additional external cost to implement these new and proposed
rules, including Sarbanes-Oxley Section 404, is approximately $1.0 million.
However, any internal controls that need to be implemented or improved in order
to comply with these new rules, and/or any changes to the requirements, could
result in the Company exceeding its current internal resource and/or external
cost estimates. If the amount of the costs we incur increases or the timing of
such costs that we may incur as we implement these new and proposed rules
changes, it could have a material adverse impact on the Company's operating
results. The new rules could make it more difficult for us to obtain certain
types of insurance, including director and officer liability insurance, and we
may be forced to accept reduced policy limits and coverage or incur
substantially higher costs to obtain the same or similar coverage. The impact of
these events could also make it more difficult for us to attract and retain
qualified persons to serve on our Board of Directors, on committees of our Board
of Directors, or as executive officers.
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 effect on the Company's 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 the Company's key 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 June 30,
2004, 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 quarter ended June 30, 2004,
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
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
judgment 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. The initial judgement and the royalties
on the sales of infringing products through June 30, 2004 total $6.3 million and
are escrowed. 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 judgment 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 has been consolidated with the
previously-filed SoftWIRE action, which also includes counterclaims by the
Company that are the same in substance as the Company's claims in the Eastern
District 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. On November 5, 2003, the Court
granted SoftWIRE's motion to amend, thereby adding SoftWIRE's two patents to the
litigation. With respect to those two SoftWIRE patents, SoftWIRE seeks monetary
damages and injunction of the sale of the Company's LabVIEW software products,
as well as attorney's fees and costs. The Company challenges the validity,
enforceability and alleged infringement of those patents and intends to
vigorously defend against SoftWIRE's claims. Discovery in the litigation is
underway. During the fourth quarter of 2003, the Company accrued $3.8 million
related to its probable loss from this contingency, which consists solely of
anticipated patent defense costs that are probable of being incurred. However,
the outcome of any litigation is inherently uncertain and there can be no
assurance as to the ultimate outcome of this matter or any other litigation. The
Company charged approximately $893,000 against this accrual during the second
quarter of 2004. The Company has charged a total of $1.3 million against this
accrual through June 30, 2004.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Maximum number
Total number of of shares that
shares purchased may yet be
Total Average as part of a purchased under
number of price paid publicly announced the plan or
Period shares per share plan or program program
- ------------------ ---------- ---------- ------------------ ----------------
April 1, 2004 to
April 30, 2004 -- -- -- 3,000,000
May 1, 2004 to
May 31, 2004 234,250 $ 31.61 234,250 2,765,570
June 1, 2004 to
June 30, 2004 -- -- -- 2,765,570
---------- ---------- ------------------ ----------------
Total 234,250 $ 31.61 234,250 2,765,750
========== ==================
The Company's share repurchase plan was announced on October 17, 2002.
Under the plan, the Company has authorization to repurchase up to 3,000,000
shares of National Instruments stock. The plan has no expiration date.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The annual meeting of stockholders was held on May 11, 2004.
(b) The following directors were elected at the meeting to serve a term of
three years:
James J. Truchard
Charles J. Roesslein
The following directors are continuing to serve their terms:
Jeffrey L. Kodosky
Donald M. Carlton
Ben G. Streetman
R. Gary Daniels
(c) The matters voted upon at the meeting and results of the voting with
respect to those matters were as follows:
(1) Election of directors: For Abstain
James J. Truchard 68,696,207 5,261,283
Charles J. Roesslein 67,591,196 6,366,294
(2) The Company's stockholders approved the amendment and restatement
of the Company's 1994 Incentive Plan to increase the number of
shares reserved for issuance thereunder by 750,000 shares to an
aggregate of 16,950,000 shares and to extend the termination date
of the plan by one year to 2005, with [60,044,423] votes in
favor, [7,334,392] votes against and [423,898] votes abstaining.
The foregoing matters are described in detail in the Company's definitive
proxy statement dated April 5, 2004.
ITEM 5. OTHER INFORMATION
From time to time the Company's directors, executive officers and other
insiders may adopt stock trading plans pursuant to Rule 10b5-1(c) promulgated by
the Securities and Exchange Commission under the Securities Exchange Act of
1934, as amended. Jeffrey L. Kodosky and James J. Truchard have made periodic
sales of the Company's stock pursuant to such plans.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits.
3.1(2) Certificate of Incorporation, as amended, of the Company.
3.2(2) Amended and Restated Bylaws of the Company.
3.3(4) Certificate of Designation of Rights, Preferences and Privileges of
Series A Participating Preferred Stock of the Company.
4.1(1) Specimen of Common Stock certificate of the Company.
4.2(3) Rights Agreement dated as of January 21, 2004, between the Company
and EquiServe Trust Company, N.A.
10.1(1) Form of Indemnification Agreement.
10.2 1994 Incentive Plan, as amended.*
10.3(1) 1994 Employee Stock Purchase Plan.*
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.
(1) Incorporated by reference to the Company's Registration Statement on
Form S-1 (Reg. No. 33-88386) declared effective March 13, 1995.
(2) Incorporated by reference to the same-numbered exhibit filed with
the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2003.
(3) Incorporated by reference to exhibit 4.1 filed with the Company's
Current Report on Form 8-K filed on January 28, 2004.
(4) Incorporated by reference to the same-numbered exhibit filed with
the Company's Form 8-A on April 27, 2004.
* Management Contract or Compensatory Plan or Arrangement.
b) Reports on Form 8-K.
In connection with the Company's earnings press release for the quarter
ended March 31, 2004, the Company furnished a Current Report on Form 8-K on
April 28, 2004.
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: August 5, 2004