a033110.htm
 
 
 
 


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

FORM 10-Q

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

For the fiscal quarter ended:  March 31, 2010 or

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

For the transition period from ________________ to ________________

Commission file number:  0-25426


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

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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
    Large accelerated filer   T    Accelerated filer    £    Non-accelerated filer    £  Smaller reporting company    £
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £  No T

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

Class
Outstanding at May 3, 2010
Common Stock - $0.01 par value
77,522,406
 
 


 

NATIONAL INSTRUMENTS CORPORATION

INDEX

     
PART I.  FINANCIAL INFORMATION
Page No.
     
Item 1
Financial Statements:
 
     
   
 
March 31, 2010 (unaudited) and December 31, 2009
3
     
   
 
(unaudited) for the three months ended March 31, 2010 and 2009
4
     
   
 
(unaudited) for the three months ended March 31, 2010 and 2009
5
     
 
6
     
Item 2
22
     
Item 3
29
     
Item 4
32
     
     
PART II.  OTHER INFORMATION
 
     
     
Item 1
34
     
Item 1A
34
     
Item 2
41
     
Item 5
41
     
Item 6
42
     
 
43



 
 

 

PART I - FINANCIAL INFORMATION

ITEM 1.
Financial Statements

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


   
March 31, 2010
   
December 31, 2009
 
   
(unaudited)
       
Assets
           
             
Current assets:
           
Cash and cash equivalents                                                                                                                
  $ 184,618     $ 201,465  
Short-term investments                                                                                                                
    110,952       87,196  
Accounts receivable, net                                                                                                                
    104,818       103,957  
Inventories, net                                                                                                                
    89,826       86,515  
Prepaid expenses and other current assets                                                                                                                
    34,937       36,523  
Deferred income taxes, net                                                                                                                
    15,222       16,522  
Total current assets                                                                                                        
    540,373       532,178  
Property and equipment, net                                                                                                                     
    152,567       153,265  
Goodwill, net                                                                                                                     
    69,296       64,779  
Intangible assets, net                                                                                                                     
    48,369       43,390  
Other long-term assets                                                                                                                     
    19,647       19,417  
Total assets                                                                                                        
  $ 830,252     $ 813,029  
                 
Liabilities and Stockholders’ Equity
               
                 
Current liabilities:
               
Accounts payable                                                                                                                
  $ 27,450     $ 23,502  
Accrued compensation                                                                                                                
    19,465       14,934  
Deferred revenue                                                                                                                
    60,972       57,242  
Accrued expenses and other liabilities                                                                                                                
    12,619       8,560  
Other taxes payable                                                                                                                
    12,306       14,181  
Total current liabilities                                                                                                        
    132,812       118,419  
Deferred income taxes                                                                                                                     
    25,088       25,012  
Liability for uncertain tax positions                                                                                                                     
    10,926       11,062  
Other long-term liabilities                                                                                                                     
    4,259       4,116  
Total liabilities                                                                                                        
    173,085       158,609  
Commitments and contingencies
               
Stockholders’ equity:
               
Preferred stock: par value $0.01; 5,000,000 shares authorized; none issued and outstanding
           
Common stock: par value $0.01; 180,000,000 shares authorized; 77,325,552 and 77,367,874  shares issued and outstanding, respectively
    773       774  
Additional paid-in capital                                                                                                                
    362,857       336,446  
Retained earnings                                                                                                                
    285,422       303,655  
Accumulated other comprehensive income                                                                                                                
    8,115       13,545  
Total stockholders’ equity                                                                                                        
    657,167       654,420  
Total liabilities and stockholders’ equity                                                                                                        
  $ 830,252     $ 813,029  


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
 
   
March 31,
 
   
2010
   
2009
 
             
Net sales:
           
Product                                                                                                   
  $ 175,395     $ 143,450  
Software maintenance                                                                                                   
    15,696       14,349  
Total net sales                                                                                            
    191,091       157,799  
                 
Cost of sales:
               
Product                                                                                                   
    42,262       39,556  
Software maintenance                                                                                                   
    980       1,327  
Total cost of sales                                                                                            
    43,242       40,883  
                 
Gross profit                                                                                                   
    147,849       116,916  
                 
Operating expenses:
               
Sales and marketing                                                                                                   
    74,441       68,826  
Research and development                                                                                                   
    38,546       34,789  
General and administrative                                                                                                   
    15,340       15,780  
Total operating expenses                                                                                            
    128,327       119,395  
                 
Operating income (loss)                                                                                                   
    19,522       (2,479 )
                 
Other income (expense):
               
Interest income                                                                                                   
    300       589  
Net foreign exchange gain (loss)                                                                                                   
    (698 )     (702 )
Other income (expense), net                                                                                                   
    348       163  
Income before income taxes
    19,472       (2,429 )
Provision for (benefit from) income taxes                                                                                                     
    1,119       (2,787 )
                 
Net income                                                                                            
  $ 18,353     $ 358  
                 
Basic earnings per share
  $ 0.24     $ 0.00  
                 
Weighted average shares outstanding – basic                                                                                                     
    77,380       77,277  
                 
Diluted earnings per share
  $ 0.23     $ 0.00  
                 
Weighted average shares outstanding – diluted                                                                                                     
    78,435       77,436  
                 
Dividends declared per share                                                                                                     
  $ 0.13     $ 0.12  

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


 
 

 

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


   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
Cash flow from operating activities:
           
Net income                                                                                                  
  $ 18,353     $ 358  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization                                                                                             
    9,442       8,385  
Stock-based compensation                                                                                             
    4,916       5,082  
Tax expense/(benefit) from deferred income taxes                                                                                             
    1,709       (1,486 )
Tax expense from stock option plans                                                                                             
    1,587       242  
Changes in operating assets and liabilities:
               
Accounts receivable                                                                                         
    (613 )     30,631  
Inventories                                                                                         
    (3,006 )     4,740  
Prepaid expenses and other assets                                                                                         
    (297 )     (5,766 )
Accounts payable                                                                                         
    3,618       (5,747 )
Deferred revenue                                                                                         
    3,730       (549 )
Taxes and other liabilities                                                                                         
    2,162       (11,084 )
Net cash provided by operating activities                                                                                     
    41,601       24,806  
                 
Cash flow from investing activities:
               
Capital expenditures                                                                                                  
    (5,271 )     (3,004 )
Capitalization of internally developed software                                                                                                  
    (3,404 )     (3,114 )
Additions to other intangibles                                                                                                  
    (543 )     (1,340 )
Acquisition, net of cash received                                                                                                  
    (2,191 )      
Purchases of short-term and long-term investments                                                                                                  
    (35,823 )     (11,850 )
Sales and maturities of short-term and long-term investments                                                                                                  
    9,037       4,026  
Net cash (used by) investing activities                                                                                     
    (38,195 )     (15,282 )
                 
Cash flow from financing activities:
               
Proceeds from issuance of common stock                                                                                                  
    22,341       7,237  
Repurchase of common stock                                                                                                  
    (30,935 )     (9,186 )
Dividends paid                                                                                                  
    (10,072 )     (9,285 )
Tax (benefit) from stock option plans                                                                                                  
    (1,587 )     (242 )
Net cash (used by) financing activities                                                                                     
    (20,253 )     (11,476 )
                 
Net change in cash and cash equivalents                                                                                                  
    (16,847 )     (1,952 )
Cash and cash equivalents at beginning of period                                                                                                  
    201,465       229,400  
Cash and cash equivalents at end of period                                                                                                  
  $ 184,618     $ 227,448  



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, 2009, included in our annual report on Form 10-K, filed with the Securities and Exchange Commission. In our opinion, the accompanying consolidated financial statements reflect all adjustments (consisting only of normal recurring items) considered necessary to present fairly our financial position at March 31, 2010 and December 31, 2009, and the results of our operations and cash flows for the three month periods ended March 31, 2010 and March 31, 2009. Operating results for the three month period ended March 31, 2010, are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.

Note 2 – Earnings per share

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

The reconciliation of the denominators used to calculate basic EPS and diluted EPS for the three month periods ended March 31, 2010 and 2009, respectively, are as follows (in thousands):

   
March 31,
 
   
(unaudited)
 
   
2010
   
2009
 
Weighted average shares outstanding-basic                                                                                            
    77,380       77,277  
Plus: Common share equivalents
               
Stock options, restricted stock units                                                                                        
    1,055       159  
Weighted average shares outstanding-diluted                                                                                            
    78,435       77,436  

Stock options to acquire 1,297,000 shares and 5,495,000 shares for the three month periods ended March 31, 2010 and 2009, respectively, were excluded in the computations of diluted EPS because the effect of including the stock options would have been anti-dilutive.
 
Note 3 – Cash, cash equivalents, short-term and long-term investments

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

   
As of
March 31, 2010
   
As of
December 31, 2009
 
   
(unaudited)
       
Cash and cash equivalents:
           
Cash                                                                                 
  $ 73,787     $ 85,612  
Cash equivalents:
               
Money market accounts                                                                                
    110,831       115,853  
Total cash and cash equivalents                                                                               
    184,618       201,465  
Short-term investments:
               
Municipal bonds                                                                                 
    16,564       12,549  
Corporate bonds                                                                                 
    21,971       7,587  
U.S. treasuries and agencies                                                                                 
    28,234       21,033  
Foreign government bonds                                                                                 
    32,830       34,674  
Time deposits                                                                                 
    2,753       2,753  
Auction rate securities                                                                                 
    8,198       8,177  
Auction rate securities put option                                                                                 
    402       423  
Total short-term investments                                                                               
    110,952       87,196  
Total cash, cash equivalents and investments                                                                           
  $ 295,570     $ 288,661  

The following table summarizes unrealized gains and losses related to our investments designated as available-for-sale (in thousands):
 
   
As of March 31, 2010
(unaudited)
 
   
Adjusted Cost
   
Gross
Unrealized Gain
   
Gross
Unrealized Loss
   
Cumulative Translation Adjustment
   
Fair Value
 
Municipal bonds                                                   
  $ 16,502     $ 62     $     $     $ 16,564  
Corporate bonds                                                   
    21,937       84       (50 )           21,971  
U.S. treasuries and agencies                                                   
    28,271       1       (37 )           28,235  
Foreign government bonds                                                   
    35,700       159             (3,030 )     32,829  
Time deposits                                                   
    2,753                         2,753  
Auction rate securities                                                   
    8,600             (402 )           8,198  
Auction rate securities put option
          402                   402  
Total investments                                              
  $ 113,763     $ 708     $ (489 )   $ (3,030 )   $ 110,952  

   
As of December 31, 2009
 
   
Adjusted Cost
   
Gross
Unrealized Gain
   
Gross
Unrealized Loss
   
Cumulative Translation Adjustment
   
Fair Value
 
Municipal bonds                                                   
  $ 12,491     $ 58     $     $     $ 12,549  
Corporate bonds                                                   
    7,478       110       (1 )           7,587  
U.S. treasuries and agencies                                                   
    21,080             (47 )           21,033  
Foreign government bonds                                                   
    36,105       76             (1,507 )     34,674  
Time deposits                                                   
    2,753                         2,753  
Auction rate securities                                                   
    8,600             (423 )           8,177  
Auction rate securities put option
          423                   423  
Total investments                                              
  $ 88,507     $ 667     $ (471 )   $ (1,507 )   $ 87,196  
 
The following table summarizes the contractual maturities of our investments designated as available-for-sale (in thousands):
 
   
As of March 31, 2010
(unaudited)
   
As of December 31, 2009
 
   
Adjusted Cost
   
Fair Value
   
Adjusted Cost
   
Fair Value
 
Due in less than 1 year                                                      
  $ 57,581     $ 56,227     $ 44,029     $ 43,267  
Due in 1 to 5 years                                                      
    56,182       54,725       44,478       43,929  
Total investments                                                      
  $ 113,763     $ 110,952     $ 88,507     $ 87,196  
             
Due in less than 1 year
 
Adjusted Cost
   
Fair Value
   
Adjusted Cost
   
Fair Value
 
Municipal bonds                                                   
  $ 12,902     $ 12,949     $ 4,103     $ 4,110  
Corporate bonds                                                   
    6,413       6,480       5,384       5,473  
U.S. treasuries and agencies                                                   
    9,149       9,138       5,065       5,057  
Foreign government bonds                                                   
    17,764       16,307       18,124       17,274  
Time deposits                                                   
    2,753       2,753       2,753       2,753  
Auction rate securities                                                   
    8,600       8,198       8,600       8,177  
Auction rate securities put option
          402             423  
Total investments                                                      
  $ 57,581     $ 56,227     $ 44,029     $ 43,267  
             
Due in 1 to 5 years
 
Adjusted Cost
   
Fair Value
   
Adjusted Cost
   
Fair Value
 
Municipal bonds                                                   
  $ 3,600     $ 3,615     $ 8,388     $ 8,439  
Corporate bonds                                                   
    15,524       15,491       2,094       2,114  
U.S. treasuries and agencies                                                   
    19,122       19,096       16,015       15,976  
Foreign government bonds                                                   
    17,936       16,523       17,981       17,400  
Total investments                                                      
  $ 56,182     $ 54,725     $ 44,478     $ 43,929  

Note 4 – Fair value measurements
 
FASB ASC 820, Fair Value Measurements and Disclosures (FASB ASC 820) clarifies the definition of fair value, prescribes methods for measuring fair value, establishes a fair value hierarchy based on the inputs used to measure fair value and expands disclosures about the use of fair value measurements. Effective January 1, 2010, we adopted the update to FASB ASC 820 that required additional disclosures and clarified existing disclosures regarding fair value measurements. The additional disclosures include transfers in and out of Level 1 and 2 as well as activity within Level 3 fair value measurements. The update also provides amendments that clarify existing disclosures on level of disaggregation and disclosures about inputs and valuation techniques. The adoption of the update to FASB ASC 820 did not have a material impact on our consolidated financial position or results of operations.

The following tables present our assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy. The fair value hierarchy has three levels based on the reliability of the inputs used to determine fair value (in thousands). We did not have any items that were measured at fair value on a nonrecurring basis at March 31, 2010 and December 31, 2009.

         
Fair Value Measurements at Reporting Date Using
(unaudited)
 
 
 
 
Description
 
 
March 31, 2010
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Assets
                       
Money Market Funds                                                    
  $ 110,831     $ 110,831     $     $  
Short-term investments available for sale:
                               
Municipal bonds                                                 
    16,564       16,564              
Corporate bonds                                                 
    21,971       21,971              
U.S. treasuries and agencies                                                 
    28,234       28,234              
Foreign government bonds                                                 
    32,830       32,830              
Time deposits                                                 
    2,753       2,753              
Auction rate securities                                                 
    8,198                   8,198  
Auction rate securities put option
    402                   402  
Derivatives                                                    
    10,436             10,436        
Total Assets                                                    
  $ 232,219     $ 213,183     $ 10,436     $ 8,600  
                                 
Liabilities
                               
Derivatives                                                    
  $ (578 )   $     $ (578 )   $  
Total Liabilities                                                    
  $ (578 )   $     $ (578 )   $  

         
Fair Value Measurements at Reporting Date Using
 
 
 
 
Description
 
 
December 31, 2009
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Assets
                       
Money Market Funds                                                    
  $ 115,853     $ 115,853     $     $  
Short-term investments available for sale
                               
Municipal bonds                                                 
    12,549       12,549              
Corporate bonds                                                 
    7,587       7,587              
U.S. treasuries and agencies                                                 
    21,033       21,033              
Foreign government bonds                                                 
    34,674       34,674              
Time deposits                                                 
    2,753       2,753              
Auction rate securities                                                 
    8,177                   8,177  
Auction rate securities put option
    423                   423  
Derivatives                                                    
    11,016             11,016        
Total Assets                                                    
  $ 214,065     $ 194,449     $ 11,016     $ 8,600  
                                 
Liabilities
                               
Derivatives                                                    
  $ (318 )   $     $ (318 )   $  
Total Liabilities                                                    
  $ (318 )   $     $ (318 )   $  
 
   
Fair Value Measurements Using Significant Unobservable Inputs
(Level 3)
 
   
Short-term investments available for sale
 
   
(unaudited)
 
       
Beginning Balance at December 31, 2009                                                                                   
  $ 8,600  
Total gains or (losses) (realized/unrealized)
       
Included in earnings                                                                             
    402  
Included in other comprehensive income                                                                             
     
Total losses (realized/unrealized)                                                                                
       
Included in earnings                                                                             
    (402 )
Included in other comprehensive income                                                                             
     
Purchases, issuances and settlements                                                                                
     
Transfer in and/or out of Level 3                                                                                
     
Ending Balance at March 31, 2010                                                                                   
  $ 8,600  
         
The amount of total gains or (losses) for the period included in earnings (or changes in net assets) attributable to the change in unrealized gains or losses relating to assets still held at the reporting date
       
    $  

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

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

Short-term investments available-for-sale included in Level 3 are reported at their fair market value and consist of auction rate securities backed by education loan revenue bonds. One of our auction rate securities is from the Vermont Student Assistance Corporation and has a par value of $2.2 million. The other of our auction rate securities is from the New Hampshire Health and Education Facilities Authority and has a par value of $6.4 million. The ratings for these securities at March 31, 2010, were Baa3/A/AAA and Aaa/NR/AAA, respectively. Historically, we reported the fair market value of these securities at par as differences between par value and the purchase price or settlement value were historically comprised of accrued interest. Auction rate securities are variable rate debt instruments whose interest rates are typically reset approximately every 7 to 35 days. On March 26, 2010, and in prior auction periods beginning in February 2008, the auction process for these securities failed. At March 31, 2010, we reported these as short-term investments at their estimated fair market value of $8.2 million.

In November 2008, we accepted the UBS Auction Rate Securities Rights (the “Rights”) agreement offered by UBS as a liquidity alternative to the failed auction process. This Rights agreement is related to the auction rates securities discussed above. The Rights agreement is a nontransferable right to sell our auction rate securities, at par value, back to UBS at any time during the period June 30, 2010, through July 2, 2012. At March 31, 2010, we reported the Rights agreement at its estimated fair market value of $402,000 as a component of short-term debt securities available for sale.

The estimated fair market value of both the auction rate securities and the Rights agreement was determined using significant unobservable inputs (Level 3) as prescribed by FASB ASC 820. We considered many factors in determining the fair market value of the auction rate securities as well as our corresponding Rights agreement at March 31, 2010, including the fact that the debt instruments underlying the auction rate securities have redemption features which call for redemption at 100% of par value, current credit curves for like securities and discount factors to account for the illiquidity of the market for these securities. During the three month period ended March 31, 2010, we did not make any changes to our valuation techniques or related inputs.

Note 5 – Derivative instruments and hedging activities

FASB ASC 815, Derivatives and Hedging, (FASB ASC 815) requires companies to recognize all of their derivative instruments as either assets or liabilities in the statement of financial position at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation.

We have operations in over 40 countries. Sales outside of the Americas as a percentage of consolidated sales were 59% and 57% for the three month periods ended March 31, 2010 and 2009, respectively. Our activities expose us to a variety of market risks, including the effects of changes in foreign currency exchange rates. These financial risks are monitored and managed by us as an integral part of our overall risk management program.

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

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

We designate foreign currency forward and purchased option contracts as cash flow hedges of forecasted revenues or forecasted expenses. In addition, we hedge our foreign currency denominated balance sheet exposures using foreign currency forward contracts. These derivatives are not designated as hedging instruments under FASB ASC 815. None of our derivative instruments contain a credit-risk-related contingent feature.

Cash flow hedges

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

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

We held forward contracts with a notional amount of $21.6 million dollar equivalent of Euro, $3.1 million dollar equivalent of British pound sterling, $19 million dollar equivalent of Japanese yen, and $23.3 million dollar equivalent of Hungarian forint at March 31, 2010. These contracts are for terms of up to 24 months. At December 31, 2009, we held forward contracts with a notional amount of $28.6 million dollar equivalent of Euro, $4.0 million dollar equivalent of British pound sterling, $24.4 million dollar equivalent of Japanese yen, and $17.8 million dollar equivalent of Hungarian forint.

We held purchased option contracts with a notional amount of $21.5 million dollar equivalent of Euro at March 31, 2010. These contracts are for terms of up to 12 months. At December 31, 2009, we held purchased option contracts with a notional amount of $28.4 million dollar equivalent of Euro.

At March 31, 2010, we expect to reclassify $4.3 million of gains on derivative instruments from accumulated other comprehensive income to net sales during the next twelve months when the hedged international sales occur, $2.4 million of gains on derivative instruments from accumulated OCI to cost of sales and $1.1 million of gains on derivative instruments from accumulated OCI to operating expenses during the next twelve months when the hedged international expenses occur. Expected amounts are based on derivative valuations at March 31, 2010. Actual results may vary as a result of changes in the corresponding exchange rate subsequent to this date.

We did not record any ineffectiveness during the three months ended March 31, 2010. During the three months ended March 31, 2009, hedges with a notional amount of $14.4 million were determined to be ineffective. As a result, we recorded a net gain of $417,000 related to these hedges as a component of “net foreign exchange gain (loss)”.

Other derivatives

Other derivatives not designated as hedging instruments under FASB ASC 815 consist primarily of foreign currency forward contracts that we use to hedge our foreign denominated net receivable or net payable positions to help protect against the change in value caused by a fluctuation in foreign currency exchange rates. We typically hedge up to 90% of our outstanding foreign denominated net receivables or net payables and typically limit the duration of these foreign currency forward contracts to approximately 90 days. The gain or loss on the derivatives as well as the offsetting gain or loss on the hedge item attributable to the hedged risk is recognized in current earnings under the line item “net foreign exchange gain (loss)”. As of March 31, 2010 and December 31, 2009, we held foreign currency forward contracts with a notional amount of $37.6 million and $45.2 million, respectively.

The following table presents the fair value of derivative instruments on our Consolidated Balance Sheets and the effect of derivative instruments on our Consolidated Statements of Income.
 
Fair Values of Derivative Instruments (in thousands):

 
Asset Derivatives
 
 
March 31, 2010
(unaudited)
 
December 31, 2009
 
 
 
Balance Sheet Location
 
Fair Value
 
 
Balance Sheet Location
 
Fair Value
 
Derivatives designated as hedging instruments
               
Foreign exchange contracts – ST forwards
Prepaid expenses and other current assets
  $ 6,476  
Prepaid expenses and other current assets
  $ 7,947  
                     
Foreign exchange contracts – LT forwards
Other long-term assets
    327  
Other long-term assets
    274  
                     
Foreign exchange contracts – ST options
Prepaid expenses and other current assets
    2,331  
Prepaid expenses and other current assets
    1,821  
                     
Total derivatives designated as hedging instruments
    $ 9,134       $ 10,042  
                     
Derivatives not designated as hedging instruments
                   
                     
Foreign exchange contracts – ST forwards
Prepaid expenses and other current assets
  $ 1,302  
Prepaid expenses and other current assets
  $ 974  
                     
Total derivatives not designated as hedging instruments
    $ 1,302       $ 974  
                     
Total derivatives
    $ 10,436       $ 11,016  

 
Liability Derivatives
 
 
March 31, 2010
(unaudited)
 
December 31, 2009
 
 
 
Balance Sheet Location
 
Fair Value
 
 
Balance Sheet Location
 
Fair Value
 
Derivatives designated as hedging instruments
               
Foreign exchange contracts – ST forwards
Accrued expenses and other liabilities
  $ (33 )
Accrued expenses and other liabilities
  $  
                     
Foreign exchange contracts – LT forwards
Other long-term liabilities
    (110 )
Other long-term liabilities
     
                     
Total derivatives designated as hedging instruments
    $ (143 )     $  
                     
Derivatives not designated as hedging instruments
                   
                     
Foreign exchange contracts – ST forwards
Accrued expenses and other liabilities
  $ (435 )
Accrued expenses and other liabilities
  $ (318 )
                     
Total derivatives not designated as hedging instruments
    $ (435 )     $ (318 )
                     
Total derivatives
    $ (578 )     $ (318 )
 
The following tables show the effect of derivative instruments on our Consolidated Statements of Income for the three month periods ended March 31, 2010 and 2009, respectively (in thousands):
 
March 31, 2010
(unaudited)
 
Derivatives in Cash Flow Hedging Relationship
 
Amount of Gain/(Loss) Recognized in OCI (Effective Portion)
 
 
 
Location of Gain/(Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Amount of Gain/(Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Location of Gain/(Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)
 
Amount of Gain/(Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)
 
Foreign exchange contracts – forwards and options
  $  1,515  
Net sales
  $  1,037  
Net foreign exchange gain (loss)
  $  —  
                             
Foreign exchange contracts – forwards and options
    (1,391 )
Cost of sales
      769  
Net foreign exchange gain (loss)
       
                             
Foreign exchange contracts – forwards and options
    (885 )
Operating expenses
      368  
Net foreign exchange gain (loss)
       
                             
Total
  $ (761 )     $ 2,174       $  
 
March 31, 2009
(unaudited)
 
Derivatives in Cash Flow Hedging Relationship
 
Amount of Gain/(Loss) Recognized in OCI (Effective Portion)
 
Location of Gain/(Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Amount of Gain/(Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Location of Gain/(Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)
 
Amount of Gain/(Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)
 
Foreign exchange contracts – forwards and options
  $  3,796  
Net sales
  $  2,633  
Net foreign exchange gain (loss)
  $  940  
                             
Foreign exchange contracts – forwards and options
    (2,746 )
Cost of sales
    (255 )
Net foreign exchange gain (loss)
    (523 )
                             
Foreign exchange contracts – forwards and options
    (888 )
Operating expenses
    (266 )
Net foreign exchange gain (loss)
       
                             
Total
  $ 162       $ 2,112       $ 417  
 
 
Derivatives not Designated as Hedging Instruments
Location of Gain (Loss) Recognized in Income
 
Amount of Gain (Loss) Recognized in Income
   
Amount of Gain (Loss) Recognized in Income
 
     
March 31, 2010
(unaudited)
   
March 31, 2009
(unaudited)
 
Foreign exchange contracts – forwards
Net foreign exchange gain/(loss)
  $ 439     $ 3,089  
                   
Total
    $ 439     $ 3,089  

Note 6 – Inventories

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

   
March 31,
   
December 31,
 
   
2010
   
2009
 
   
(unaudited)
       
             
Raw materials                                                                                
  $ 43,524     $ 42,121  
Work-in-process                                                                                
    2,603       2,042  
Finished goods                                                                                
    43,699       42,352  
    $ 89,826     $ 86,515  

Note 7 – Intangibles

Intangibles at March 31, 2010 and December 31, 2009 are as follows (in thousands):

   
March 31, 2010
   
December 31, 2009
 
   
(unaudited)
                   
   
Gross Carrying Amount
   
Accumulated Amortization
   
Net Carrying Amount
   
Gross Carrying Amount
   
Accumulated Amortization
   
Net Carrying Amount
 
Capitalized software development costs
  $ 42,494     $ (23,053 )   $ 19,441     $ 38,928     $ (20,455 )   $ 18,473  
Acquired technology                                                
    32,830       (21,775 )     11,055       28,022       (20,967 )     7,055  
Patents                                                
    19,482       (5,611 )     13,871       19,033       (5,377 )     13,656  
Leasehold equipment and other
    12,978       (8,976 )     4,002       12,577       (8,371 )     4,206  
    $ 107,784     $ (59,415 )   $ 48,369     $ 98,560     $ (55,170 )   $ 43,390  

Software development costs capitalized for the three month periods ended March 31, 2010 and 2009 were $3.6 million and $3.1 million, respectively, and related amortization expense was $2.6 million and $2.1 million, respectively. Capitalized software development costs for the three month periods ended March 31, 2010 and 2009, included costs related to stock based compensation of $163,000 and $156,000, respectively. Amortization of capitalized software development costs is computed on an individual product basis for those products available for market and is recognized based on the product’s estimated economic life, generally three years. Patents are amortized using the straight-line method over their estimated period of benefit, generally ten to seventeen years. Total intangible assets amortization expenses were $4.2 million and $3.6 million for the three months ended March 31, 2010 and March 31, 2009, respectively.

Acquired core technology and intangible assets are amortized over their useful lives, which range from three to eight years. Amortization expense for acquisition related intangibles was approximately $844,000 and $1.0 million for the three months ended March 31, 2010 and March 31, 2009, respectively, of which approximately $722,000 and $887,000 was recorded in cost of sales, respectively, and approximately $122,000 and $126,000 was recorded in operating expenses for the three months ended March 31, 2010 and March 31, 2009, respectively.

Note 8 – Goodwill

The carrying amount of goodwill as of March 31, 2010, is as follows (in thousands):

   
Amount
 
Balance as of December 31, 2009                                                                                                     
  $ 64,779  
Acquisitions                                                                                                     
    5,000  
Divestitures                                                                                                     
     
Foreign currency translation impact                                                                                                     
    (483 )
Balance as of March 31, 2009                                                                                                     
  $ 69,296  

The excess purchase price over the fair value of assets acquired is recorded as goodwill. As we have one operating segment, we allocate goodwill to one reporting unit for goodwill impairment testing. Goodwill is tested for impairment on an annual basis, and between annual tests if indicators of potential impairment exist, using a fair-value-based approach based on the market capitalization of the reporting unit. Our annual impairment test was performed as of February 28, 2010. No impairment of goodwill has been identified during the period presented. Goodwill is deductible for tax purposes in certain jurisdictions.

On February 1, 2010, we acquired all of the outstanding shares of a privately-held company for $2.2 million in net cash, $3.0 million in shares of our common stock with the remainder to be paid in cash over the next four years. The purchase price allocation for this acquisition included net working capital of $1.1 million, amortizable intangible assets of $5.0 million, and goodwill of $5.0 million. Our consolidated financial statements include the operating results from the date of acquisition.

Note 9 – Income taxes

We account for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts. Valuation allowances are established when necessary to reduce deferred tax assets to amounts which are more likely than not to be realized.

FASB ASC 740, Income Taxes (FASB ASC 740) addresses the accounting for uncertainty in income taxes recognized in an entity’s financial statements and prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. We had $10.9 million and $11.1 million of unrecognized tax benefits at March 31, 2010 and December 31, 2009, respectively, all of which would affect our effective income tax rate if recognized. We recorded a gross decrease in unrecognized tax benefits of $1.1 million for the three month period ended March 31, 2010, as a result of a settlement with a taxing authority. As of March 31, 2010, it is deemed reasonable that we will recognize tax benefits in the amount of $2.4 million in the next twelve months due to the closing of open tax years. The nature of the uncertainty is related to deductions taken on returns that have not been examined by the applicable tax authority. Our continuing policy is to recognize interest and penalties related to income tax matters in income tax expense. As of March 31, 2010, we have approximately $744,000 accrued for interest related to uncertain tax positions. The tax years 2003 through 2009 remain open to examination by the major taxing jurisdictions to which we are subject.

Our provision for income taxes reflected an effective tax rate of 6% and 115% for the three month periods ended March 31, 2010 and 2009, respectively. For the three month period ended March 31, 2010, our effective tax rate was lower than the U.S. federal statutory rate of 35% as a result of a tax benefit from equity awards that do not ordinarily result in a tax benefit, the partial release of a deferred tax asset valuation allowance, an enhanced deduction for certain research and development expenses, increased profits in foreign jurisdictions with reduced income tax rates and a decrease in unrecognized tax benefits for uncertain tax positions. For the three months ended March 31, 2009, our effective tax rate was higher than the U.S. federal statutory rate of 35% as a result of non-deductible stock-based compensation expense, a change in a valuation allowance related to deferred tax assets for which tax benefits were previously recognized and the partial release of a deferred tax asset valuation allowance. The partial release of the valuation allowance had the effect of increasing our effective tax rate in the three months ended March 31, 2009, because we reported a net loss before taxes in that period.

The tax position of our Hungarian operation continues to benefit from assets created by the restructuring of our operations in Hungary. In addition, effective January 1, 2010, a new tax law in Hungary provides for an enhanced deduction for the qualified research and development expenses of NI Hungary Software and Hardware Manufacturing Kft. (“NI Hungary”). During the three months ended December 31, 2009, we obtained confirmation of the application of this new tax law for the qualified research and development expenses of NI Hungary. Partial release of the valuation allowance on assets from the restructuring and the enhanced tax deduction for research expenses resulted in income tax benefits of $3.2 and $1.1 million for the three month periods ended March 31, 2010 and 2009, respectively.
 
Note 10 – Comprehensive income

Our comprehensive income is comprised of net income, foreign currency translation, unrealized gains and losses on forward and option contracts and securities available for sale. Comprehensive income for the three month periods ended March 31, 2010 and March 31, 2009, was as follows (in thousands):

   
Three Months Ended
 
   
March 31,
 
   
(unaudited)
 
   
2010
   
2009
 
Comprehensive income:
           
Net income                                                                                           
  $ 18,353     $ 358  
Foreign currency translation (losses), net of taxes                                                                                           
    (3,962 )     (2,775 )
Unrealized (losses) on derivative instruments, net of taxes
    (3,345 )     (78 )
Unrealized gains/(losses) on available for sale securities, net of taxes
    1,877       (180 )
Total comprehensive income
  $ 12,923     $ (2,675 )

Note 11 – Stock-based compensation plans

Stock option plans

Our stockholders approved the 1994 Incentive Stock Option Plan (the “1994 Plan”) on May 9, 1994. At the time of approval, 9,112,500 shares of our common stock were reserved for issuance under this plan. In 1997, an additional 7,087,500 shares of our common stock were reserved for issuance under this plan, and an additional 750,000 shares were reserved for issuance under this plan, as amended, in 2004. The 1994 Plan terminated in May 2005, except with respect to outstanding awards previously granted thereunder. Awards under the plan were either incentive stock options within the meaning of Section 422 of the Internal Revenue Code or nonqualified options. The right to purchase shares vests over a five to ten-year period, beginning on the date of grant. Vesting of ten year awards may accelerate based on the Company’s previous year’s earnings and revenue growth but shares cannot accelerate to vest over a period of less than five years. Stock options must be exercised within ten years from date of grant. Stock options were issued at the market price at the grant date. We estimate potential forfeitures of stock grants and adjust compensation cost recorded accordingly. The estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of stock compensation expense to be recognized in future periods. During the three months ended March 31, 2010, we did not make any changes in accounting principles or methods of estimates.

Restricted stock plan

Our stockholders approved our 2005 Incentive Plan on May 10, 2005. At the time of approval, 2,700,000 shares of our common stock were reserved for issuance under this plan, as well as the number of shares which had been reserved but not issued under the 1994 Plan (our incentive stock option plan which terminated in May 2005), and any shares that returned to the 1994 Plan as a result of termination of options or repurchase of shares issued under such plan. The 2005 Plan, administered by the Compensation Committee of the Board of Directors, provides for granting of incentive awards in the form of restricted stock and restricted stock units (“RSUs”) to directors, executive officers and employees of the Company and its subsidiaries. Awards vest over a three, five or ten-year period, beginning on the date of grant. Vesting of ten year awards may accelerate based on the Company’s previous year’s earnings and growth but ten year awards cannot accelerate to vest over a period of less than five years. Shares available for grant at March 31, 2010 were 2,256,408. We estimate potential forfeitures of RSUs and adjust compensation cost recorded accordingly. The estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of stock compensation expense to be recognized in future periods. During the three months ended March 31, 2010, we did not make any changes in accounting principles or methods of estimates.

Employee stock purchase plan

Our employee stock purchase plan permits substantially all domestic employees and employees of designated subsidiaries to acquire our common stock at a purchase price of 85% of the lower of the market price at the beginning or the end of the purchase period. The plan has quarterly purchase periods beginning on February 1, May 1, August 1 and November 1 of each year. Employees may designate up to 15% of their compensation for the purchase of common stock under this plan. We had 1,573,211 shares of common stock reserved for future employee purchases under this plan at March 31, 2010. We issued 181,860 shares under this plan in the three month period ended March 31, 2010. The weighted average fair value of the employees’ purchase rights was $22.70 per share and was estimated using the Black-Scholes model. During the three months ended March 31, 2010, we did not make any changes in accounting principles or methods of estimates.

For the three months ended March 31, 2010 and March 31, 2009, stock-based compensation recorded as a component of cost of sales, sales and marketing, research and development, and general and administrative was as follows (in thousands):

   
Three Months Ended
 
   
March 31,
 
   
(unaudited)
 
   
2010
   
2009
 
Stock-based compensation
           
Cost of sales
  $ 362     $ 310  
Sales and marketing
    2,104       2,185  
Research and development
    1,765       1,737  
General and administrative
    685       799  
      4,916       5,031  
Provision for income taxes
    (1,545 )     (3,014 )
Total
  $ 3,371     $ 2,017  

Authorized Preferred Stock and Preferred Stock Purchase Rights Plan

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

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

Note 12 – Segment information

We determine operating segments using the management approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of our operating segments. It also requires disclosures about products and services, geographic areas and major customers.

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

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

   
Three Months Ended
March 31,
 
   
(unaudited)
 
   
2010
   
2009
 
Net sales:
           
  Americas:                                                      
  $ 79,197     $ 68,439  
                 
  Europe:                                                      
    57,923       49,480  
                 
  Asia Pacific:                                                      
    53,971       39,880  
    $ 191,091     $ 157,799  

   
Three Months Ended
March 31,
 
   
(unaudited)
 
   
2010
   
2009
 
Operating income (loss):
           
Americas                                                    
  $ 13,379     $ 5,307  
Europe                                                    
    27,039       16,780  
Asia Pacific                                                    
    17,650       10,223  
Unallocated:
               
Research and development expenses
    (38,546 )     (34,789 )
    $ 19,522     $ (2,479 )

   
Three Months Ended
March 31,
 
   
(unaudited)
 
   
2010
   
2009
 
Interest income:
           
Americas                                                    
  $ 111     $ 294  
Europe                                                    
    159       274  
Asia Pacific                                                    
    30       21  
    $ 300     $ 589  

 
 
March 31,
2010
   
December 31,
2009
 
   
(unaudited)
       
Long-lived assets:
           
Americas                                                     
  $ 100,555     $ 100,489  
Europe                                                     
    35,407       36,555  
Asia Pacific                                                     
    16,605       16,221  
    $ 152,567     $ 153,265  

Total sales outside the United States for the three month periods ended March 31, 2010 and 2009 were $119.4 million and $96.2 million, respectively.

Note 13 – Commitments and Contingencies

We offer a one-year limited warranty on most hardware products, with a two or three-year warranty on a subset of our hardware products, which is included in the sales price of many of our products. Provision is made for estimated future warranty costs at the time of the sale, for the estimated costs that may be incurred under the basic limited warranty. Our estimate is based on historical experience and product sales during this period.
 
The warranty reserve for the three month periods ended March 31, 2010 and 2009, respectively, was as follows (in thousands):

   
Three Months Ended
 
   
March 31,
 
   
(unaudited)
 
   
2010
   
2009
 
Balance at the beginning of the period                                                                                
  $ 921     $ 952  
Accruals for warranties issued during the period                                                                                
    485       496  
Settlements made (in cash or in kind) during the period
    (484 )     (602 )
Balance at the end of the period                                                                                
  $ 922     $ 846  

As of March 31, 2010, we have outstanding guarantees for payment of foreign operating leases, customs and foreign grants totaling approximately $5.1 million.

As of March 31, 2010, we have non-cancelable purchase commitments with various suppliers of customized inventory and inventory components totaling approximately $7.5 million over the next twelve months.

Note 14 – Recently issued accounting pronouncements

In October 2009, the FASB updated FASB ASC 605, Revenue Recognition (FASB ASC 605) that amended the criteria for separating consideration in multiple-deliverable arrangements. The amendments establish a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence if available, third–party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. The amendments will change the application of the residual method of allocation and require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The relative selling price method allocates any discount in the arrangement proportionally to each deliverable on the basis of each deliverable’s selling price. This update will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. We are currently evaluating the requirements of this update and have not yet determined the impact on our consolidated financial statements.

In October 2009, the FASB updated FASB ASC 985, Software (FASB ASC 985) that changes the accounting model for revenue arrangements that include both tangible products and software elements. Tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality are no longer within the scope of the software revenue guidance in Subtopic 985-605. In addition, the amendments require that hardware components of a tangible product containing software components always be excluded from the software revenue guidance. This update will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted. We are currently evaluating the requirements of this update and have not yet determined the impact on our consolidated financial statements.

In January 2010, the FASB updated FASB ASC 820, Fair Value Measurements and Disclosures (FASB ASC 820) that requires additional disclosures and clarifies existing disclosures regarding fair value measurements. The additional disclosures include 1) transfers in and out of Levels 1 and 2 and 2) activity in Level 3 fair value measurements. The update provides amendments that clarify existing disclosures on 1) level of disaggregation and 2) disclosures about inputs and valuation techniques. This update will be effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. These disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. We adopted the update on January 1, 2010 as required and concluded it did not have a material impact on our consolidated financial position or results of operations.

In February 2010, the FASB updated FASB ASC 855, Subsequent Events (FASB ASC 855) that requires an entity that is an SEC filer to evaluate subsequent events through the date that the financial statements are issued. For an SEC filer, this guidance also eliminates the required disclosure of the date through which subsequent events are evaluated.  This update is effective upon issuance. We adopted the update on January 1, 2010 as required and concluded it did not have a material impact on our consolidated financial position or results of operations.

Note 15 – Litigation

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

An action was filed by MathWorks against us on September 22, 2004, in the U.S. District Court, Eastern District of Texas (Marshall Division), claiming that on that day MathWorks had released modified versions of its Simulink and related products, and seeking a declaratory judgment that the modified products do not infringe the three patents adjudged infringed in the District Court's decision of September 23, 2003 (and affirmed by the Court of Appeals on September 3, 2004). On November 2, 2004, MathWorks served the complaint on us. We filed an answer to MathWorks’ declaratory judgment complaint, denying MathWorks’ claims of non-infringement and alleging our own affirmative defenses. On January 5, 2005, the Court denied a contempt motion by us to enjoin the modified Simulink products under the injunction in effect from the first case. On January 7, 2005, we amended our answer to include counterclaims that MathWorks’ modified products are infringing three of our patents, and requested unspecified damages and an injunction. MathWorks filed its reply to our counterclaims on February 7, 2005, denying the counterclaims and alleging affirmative defenses. On March 2, 2005, we filed a notice of appeal regarding the Court's denial of the contempt motion. On March 15, 2005, the Court stayed MathWorks’ declaratory judgment action, pending a decision on the appeal by the Court of Appeals for the Federal Circuit. On February 9, 2006, the Court of Appeals for the Federal Circuit affirmed the District Court’s January 2005 order. On November 22, 2006, the District Court lifted the stay. The case schedule has yet to be set in this action. During the fourth quarter of 2004, we accrued $4 million related to our probable loss from this contingency, which consists entirely of anticipated patent defense costs that are probable of being incurred.  In the fourth quarter of 2006, we accrued an additional $600,000 related to this contingency. During the third quarter of 2009, we reduced the accrual by $2 million and during the first quarter of 2010, we reduced the accrual by an additional $1,037,000 to reflect a decrease in the estimated costs that are probable of being incurred in this action. To date, we have charged a cumulative total of $623,000 against this accrual. At March 31, the remaining accrual was $936,000.

Note 16 – Subsequent events

We have evaluated subsequent events through the date the financial statements were issued.

On April 21, 2010, our Board of Directors declared a quarterly cash dividend of $0.13 per common share, payable June 1, 2010, to shareholders of record on May 10, 2010.

On April 21, 2010, our Board of Directors approved a new share repurchase plan that increased the aggregate number of shares of common stock that we are authorized to repurchase from 674,098 to 3.0 million.

 
 

 

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

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Any statements contained herein regarding our future financial performance or operations (including, without limitation, statements to the effect that we “believe,” "expect," "plan," "may," "will," "project," "continue," or "estimate" or other variations thereof or comparable terminology or the negative thereof) should be considered forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of important factors, including those set forth under the heading “Risk Factors” beginning on page 34, and the discussion below. Readers are also encouraged to refer to the documents regularly filed by us with the Securities and Exchange Commission, including our Annual Report on Form 10-K for further discussion of our business and the risks attendant thereto.

Overview

National Instruments Corporation (“we”, “us” or “our”) is a leading supplier of measurement and automation products that engineers and scientists use in a wide range of industries. These industries comprise a large and diverse market for design, control and test applications. We provide flexible application software and modular, multifunctional hardware that users combine with industry-standard computers, networks and third party devices to create measurement, automation and embedded systems, which we also refer to as “virtual instruments”. Our approach gives customers the ability to quickly and cost-effectively design, prototype and deploy unique custom-defined solutions for their design, control and test application needs. We sell to a large number of customers in a wide variety of industries. No single customer accounted for more than 3% of our sales in the three months ended March 31, 2010 or in the years 2009, 2008 or 2007.

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

Expanding our broad customer base

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

Maintaining a high level of customer satisfaction

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

Leveraging external and internal technology

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

We sell into test and measurement (“T&M”) and industrial/embedded applications in a broad range of industries and as such are subject to the economic and industry forces which drive those markets. It has been our experience that the performance of these industries and our performance is impacted by general trends in industrial production for the global economy and by the specific performance of certain vertical markets that are intensive consumers of measurement technologies. Examples of these markets are semiconductor capital equipment, telecom, defense, aerospace, automotive and others. In assessing our business, we consider the trends in the Global Purchasing Managers Index (“PMI”) published by JP Morgan, global industrial production as well as industry reports on the specific vertical industries that we target. Starting in August 2009, the PMI has had readings above 50 which are indicative of expansion in the industrial global economy. We are unable to predict whether the current expansion cycle, as measured by the PMI, will be sustained throughout 2010.

We distribute our software and hardware products primarily through a direct sales organization. We also use independent distributors, OEMs, VARs, system integrators and consultants to market our products. We have sales offices in the U.S. and sales offices and distributors in key international markets. Sales outside of the Americas accounted for approximately 59% and 57% or our revenues for the three month periods ended March 31, 2010 and 2009, respectively. The vast majority of our foreign sales are denominated in the customers’ local currency, which exposes us to the effects of changes in foreign currency exchange rates. We expect that a significant portion of our total revenues will continue to be derived from international sales. (See Note 12 – Segment information of Notes to Consolidated Financial Statements for details concerning the geographic breakdown of our net sales, operating income, interest income and long-lived assets).

We manufacture a substantial majority of our products at our facilities in Debrecen, Hungary. Additional production primarily of low volume or newly introduced products is done in Austin, Texas. Our product manufacturing operations can be divided into four areas: electronic circuit card and module assembly; chassis and cable assembly; technical manuals and product support documentation; and software duplication. We manufacture most of the electronic circuit card assemblies, and modules in-house, although subcontractors are used from time to time. We currently use subcontractors in Asia to manufacture a significant portion of our chassis but we review these arrangements periodically. We manufacture some of our electronic cable assemblies in-house, but many assemblies are produced by subcontractors. We primarily subcontract our software duplication, our technical manuals and product support documentation.

We believe that our long-term growth and success depends on delivering high quality software and hardware products on a timely basis. Accordingly, we focus significant efforts on research and development. We focus our research and development efforts on enhancing existing products and developing new products that incorporate appropriate features and functionality to be competitive with respect to technology, price and performance. Our success also is dependent on our ability to obtain and maintain patents and other proprietary rights related to technologies used in our products. We have engaged in litigation and where necessary, will likely engage in future litigation to protect our intellectual property rights. In monitoring and policing our intellectual property rights, we have been and may be required to spend significant resources.

We have been profitable in every year since 1990. However, there can be no assurance that our net sales will grow or that we will remain profitable in future periods. Our operating results fluctuate from period to period due to changes in global economic conditions and a number of other factors. As a result, we believe historical results of operations should not be relied upon as indications of future performance.

Current business outlook

Many of the industries we serve have historically been cyclical and have experienced periodic downturns. Our customers across all industries and geographic regions demonstrated reduced order patterns throughout most of 2009.  During the fourth quarter of 2009, we began to see positive trends in the order patterns of our customers and have seen those trends continue during our first quarter of 2010. These positive order trends are consistent with the expansion we have seen in the global industrial economy as measured by the global PMI which has risen from 50 in July 2009 to 57 in March 2010. We have seen these positive trends across all geographic regions and across all the vertical markets that we serve although the strength of the trend varies by region and by market. We are unable to predict whether the current expansion cycle, as measured by the PMI, will be sustained throughout 2010. If this expansion cannot be sustained, it could have an adverse effect on the spending patterns of businesses including our current and potential customers which could adversely affect our revenues and therefore harm our business and result of operations. Our key strategies are to maintain a stable gross margin and to optimize our operating cost structure while maintaining strong employee productivity.
 
Results of Operations

The following table sets forth, for the periods indicated, the percentage of net sales represented by certain items reflected in our Consolidated Statements of Income:

   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
Net sales:
           
Americas
    41.4 %     43.4 %
Europe
    30.3       31.3  
Asia Pacific
    28.3       25.3  
Consolidated net sales
    100.0       100.0  
Cost of sales
    22.6       25.9  
Gross profit
    77.4       74.1  
Operating expenses:
               
Sales and marketing
    39.0       43.6  
Research and development
    20.2       22.1  
General and administrative
    8.0       10.0  
Total operating expenses
    67.2       75.7  
Operating income (loss)
    10.2       (1.6 )
Other income (expense):
               
Interest income
    0.2       0.4  
Net foreign exchange gain (loss)
    (0.4 )     (0.4 )
Other income (expense), net
    0.2       0.1  
Income (loss) before income taxes
    10.2       (1.5 )
Provision for (benefit from) income taxes
    0.6       (1.7 )
Net income
    9.6 %     0.2 %

Net Sales.  Consolidated net sales were $191 million and $158 million for the three month periods ended March 31, 2010 and 2009, respectively, an increase of 21%.  This increase can be attributed to increases in sales volume across all areas of our business. Products in the areas of virtual instrumentation and graphical system design, which comprised approximately 92% of our revenue in the three months ended March 31, 2010, saw a year-over-year revenue increase of 19%. Instrument control products, which comprised approximately 8% of our revenues in the three months ended March 31, 2010, saw a year-over-year revenue increase of 48%. For the three months ended March 31, 2009, instrument control products comprised 6% of our revenues, while virtual instrumentation and graphical system design comprised 94% of our revenues. Our instrument control products are the most economically sensitive portion of our revenue. We did not take any significant action with regard to product pricing during the three months ended March 31, 2010, and thus, the increase in revenues is attributable to an increase in customer orders.

Sales in the Americas were $79 million and $68 million for the three month periods ended March 31, 2010 and 2009, respectively, an increase of 16%. Sales outside of the Americas, as a percentage of consolidated sales, increased to 59% for the three months ended March 31, 2010 compared to 57% for the comparable period in 2009. Sales in Europe were $58 million and $49 million for the three month periods ended March 31, 2010 and 2009, respectively, an increase of 17%. Sales in Asia were $54 million and $40 million for the three month periods ended March 31, 2010, and 2009, respectively, an increase of 35%. We expect sales outside of the Americas to continue to represent a significant portion of our revenue. We intend to continue to expand our international operations by increasing our presence in existing markets, adding a presence in some new geographical markets and continuing the use of distributors to sell our products in some countries.

Almost all sales made by our direct sales offices in the non U.S. Americas, in Europe and in 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. For the three months ended March 31, 2010, net of hedging results, the change in exchange rates had the effect of increasing our consolidated sales by $12 million or 7%, increasing Americas sales by $1.5 million or 2%, increasing European sales by $7 million or 14%, and increasing sales in Asia Pacific by $3.1 million or 8% compared to the three months ended March 31, 2009.
 
Gross Profit.  As a percentage of sales, gross margin was 77% and 74% for the three month periods ended March 31, 2010, and 2009, respectively. Gross margin increased in the three months ended March 31, 2010, primarily as a result of increased sales volumes compared to the same period in 2009. For the three months ended March 31, 2010, charges related to acquisition related intangibles and stock based compensation decreased to $1.1 million from $1.2 million during the comparable period in 2009. For the three months ended March 31, 2010, the net impact of foreign currency exchange rates had the effect of increasing our cost of goods sold by $759,000 million or 2%.

Sales and Marketing.  Sales and marketing expenses were $74 million and $69 million for the three month periods ended March 31, 2010, and 2009, respectively, an increase of 8%. As a percentage of net sales, sales and marketing expenses were 39% and 44% over the same periods. The decrease in sales and marketing expense as a percentage of revenue was due to the 21% increase in revenue during the three months ended March 31, 2010, compared to the three months ended March 31, 2009. The increase in sales and marketing expenses in absolute dollars was due to an increase in personnel related expenses of $2.3 million which includes commissions and variable compensation, as well as an increase caused by the net impact of changes in foreign currency exchange rates of $3.5 million. We plan to continue to make investments in our field sales force during the remainder of 2010. However, our field sales expansion during the remainder of 2010 will likely be targeted to strategic areas of need, whether technical or regional. We expect sales and marketing expenses in future periods to continue to fluctuate as a percentage of sales based on recruiting, 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 were $39 million and $35 million for the three month periods ended March 31, 2010, and 2009, respectively, an increase of 11%. As a percentage of net sales, research and development expenses were 20% and 22% over the same periods. The decrease in research and development expenses as a percentage of revenue was due to the 21% increase in revenue during the three months ended March 31, 2010, compared to the three months ended March 31, 2009. The increase in research and development expenses in absolute dollars was due to an increase in personnel related expenses of $3.1 million which primarily consist of benefits and variable compensation as well as an increase caused by the net impact of changes in foreign currency exchange rates of $740,000. The suspension of temporary cost cutting measures implemented during 2009, which included a company-wide wage reduction as well as a reduction in the number of accrued vacation hours that employees were allowed to carry beyond the end of a fiscal year, resulted in an additional cost increase of $955,000 compared to the first quarter of 2009. We plan to continue to make additional investments in our research and development group during the remainder of 2010. However, our research and development expansion during the remainder of 2010 will likely be targeted to strategic areas of need.

We capitalize software development costs in accordance with FASB ASC 985.  We amortize such costs over the related product’s estimated economic life, generally three years, beginning when a product becomes available for general release. Software amortization expense included in cost of goods sold totaled $2.6 million and $2.1 million during the three month periods ended March 31, 2010 and 2009, respectively. Internally developed software costs capitalized during the three month periods ended March 31, 2010 and 2009, were $3.6 million and $3.1 million, respectively. Capitalization of internally developed software costs varies depending on the timing of when each project reaches technological feasibility and the length and scope of the development cycle of each individual project. (See Note 7 - Intangibles of Notes to Consolidated Financial Statements for a description of intangibles).

General and Administrative.  General and administrative expenses were $15 million and $16 million for the three month periods ended March 31, 2010 and 2009, respectively, a decrease of 3%. As a percentage of net sales, general and administrative expenses were 8% and 10% over the same periods. The decrease in general and administrative expenses as a percentage of revenue was driven by the 21% increase in revenue during the three months ended March 31, 2010, compared to the three months ended March 31, 2009. During the three months ended March 31, 2010, we recorded a reduction of our patent litigation accrual which resulted in a non-cash decrease to our general and administrative expenses of $1.1 million. This decrease was offset to some extent by personnel related expenses consisting of variable compensation had the effect of increasing general and administrative expenses by $400,000 and the net impact of changes in foreign currency exchange rates had the effect of increasing our general and administrative expenses by $541,000. We expect that general and administrative expenses in future periods will fluctuate in absolute dollars and as a percentage of revenue.

Interest Income.  Interest income was $300,000 and $589,000 for the three month periods ended March 31, 2010 and 2009, respectively, a decrease of 49%. The decrease is attributable to a continued decrease in investment yields. The source of interest income is from the investment of our cash and short-term and long-term investments.

Net Foreign Exchange Gain (Loss).  Net foreign exchange (loss) was ($698,000) and ($702,000) for the three month periods ended March 31, 2010 and 2009, respectively. These results are attributable to movements in the foreign currency exchange rates between the U.S. dollar and foreign currencies in subsidiaries for which our functional currency is not the U.S. dollar. We recognize the local currency as the functional currency in virtually all of our international subsidiaries.

We utilize foreign currency forward contracts to hedge our foreign denominated net foreign currency balance sheet positions to help protect against the change in value caused by a fluctuation in foreign currency exchange rates. We typically hedge up to 90% of our outstanding foreign denominated net receivable or payable positions and typically limit the duration of these foreign currency forward contracts to approximately 90 days. The gain or loss on these derivatives as well as the offsetting gain or loss on the hedge item attributable to the hedged risk is recognized in current earnings under the line item “Net foreign exchange gain (loss)”. Our hedging strategy reduced our foreign exchange losses by $439,000 and $3.1 million during the three month periods ended March 31, 2010 and 2009, respectively.

To protect against the change in the value caused by a fluctuation in foreign currency exchange rates of forecasted foreign currency cash flows resulting from international sales and expenses over the next one to two years, we have a foreign currency cash flow hedging program. We hedge portions of our forecasted revenue and forecasted expenses denominated in foreign currencies with forward and option contracts. For forward contracts, when the dollar strengthens significantly against the foreign currencies, the change in the present value of future foreign currency cash flows may be offset by the change in the fair value of the forward contracts designated as hedges. For purchased option contracts, when the dollar strengthens significantly against the foreign currencies, the change in the present value of future foreign currency cash flows may be offset by the change in the fair value of the option contracts designated as hedges, net of the premium paid. Our foreign currency purchased option contracts are purchased “at-the-money” or “out-of-the-money.” We purchase foreign currency forward and option contracts for up to 100% of our forecasted exposures in selected currencies (primarily in Euro, Japanese yen, British pound sterling and Hungarian forint) and limit the duration of these contracts to 40 months or less. As a result, our hedging activities only partially address our risks from foreign currency transactions, and there can be no assurance that this strategy will be successful. We do not invest in contracts for speculative purposes. (See Note 5 - Derivative instruments and hedging activities of Notes to Consolidated Financial Statements for a description of our forward and purchased option contracts and hedged positions).

Provision for Income Taxes.  Our provision for income taxes reflected an effective tax rate of 6% and 115% for the three month periods ended March 31, 2010 and 2009, respectively. The decrease in our effective tax rate for the three months ended March 31, 2010, compared to March 31, 2009, was due to the following;