c093010.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 quarterly period ended:  September 30, 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 T  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 November 2, 2010
Common Stock - $0.01 par value
78,204,971


 
 

 

NATIONAL INSTRUMENTS CORPORATION

INDEX

 
 PART I.  FINANCIAL INFORMATION    Page No.
     
 Item 1  Financial Statements:  
     
 
 September 30, 2010 (unaudited) and December 31, 2009
 3
     
 
 (unaudited) for the three and nine month periods ended September 30, 2010 and 2009
 4
     
 
 (unaudited) for the nine month periods ended September 30, 2010 and 2009
 5
     
   Notes to Consolidated Financial Statements  6
     
 Item 2  Management's Discussion and Analysis of Financial Condition and Results of Operations  24
     
 Item 3  Quantitative and Qualitative Disclosures about Market Risk  32
     
 Item 4  Controls and Procedures  35
     
 PART II.  OTHER INFORMATION    
     
 Item 1  Legal Proceedings  37
     
 Item 1A  Risk Factors  37
     
 Item 2  Unregistered Sales of Equity Securities and Use of Proceeds  44
     
 Item 4  Reserved  44
     
 Item 5  Other Information  44
     
 Item 6  Exhibits  45
     
   Signatures and Certifications  47
     
 


 
 

 

PART I - FINANCIAL INFORMATION

ITEM 1.
Financial Statements

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


   
September 30,
2010
   
December 31,
2009
 
Assets
 
(unaudited)
       
Current assets:
           
Cash and cash equivalents                                                                                                
  $ 226,844     $ 201,465  
Short-term investments                                                                                                
    111,903       87,196  
Accounts receivable, net                                                                                                
    121,503       103,957  
Inventories, net                                                                                                
    101,532       86,515  
Prepaid expenses and other current assets                                                                                                
    42,132       36,523  
Deferred income taxes, net                                                                                                
    15,449       16,522  
Total current assets                                                                                            
    619,363       532,178  
Property and equipment, net                                                                                                     
    151,667       153,265  
Goodwill, net                                                                                                     
    69,383       64,779  
Intangible assets, net                                                                                                     
    52,553       43,390  
Other long-term assets                                                                                                     
    19,269       19,417  
Total assets                                                                                            
  $ 912,235     $ 813,029  
Liabilities and stockholders' equity
               
Current liabilities:
               
Accounts payable                                                                                                
  $ 33,005     $ 23,502  
Accrued compensation                                                                                                
    39,075       14,934  
Deferred revenue                                                                                                
    63,940       57,242  
Accrued expenses and other liabilities                                                                                                
    18,313       8,560  
Other taxes payable                                                                                                
    15,324       14,181  
Total current liabilities
    169,657       118,419  
Deferred income taxes                                                                                                     
    24,725       25,012  
Liability for uncertain tax positions                                                                                                     
    11,608       11,062  
Other long-term liabilities                                                                                                     
    5,225       4,116  
Total liabilities
    211,215       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; 78,042,121 and 77,367,874 shares issued and outstanding, respectively
    780       774  
Additional paid-in capital                                                                                                
    388,502       336,446  
Retained earnings                                                                                                
    308,535       303,655  
Accumulated other comprehensive income                                                                                                
    3,203       13,545  
Total stockholders’ equity
    701,020       654,420  
Total liabilities and stockholders’ equity
  $ 912,235     $ 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
   
Nine months Ended
 
   
September 30,
   
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net sales:
                       
Product                                                                
  $ 203,188     $ 152,106     $ 573,413     $ 435,348  
Software maintenance                                                                
    17,261       12,929       49,844       39,649  
Total net sales                                                          
    220,449       165,035       623,257       474,997  
                                 
Cost of sales:
                               
Product                                                                
  50,380     40,476     139,818     119,234  
Software maintenance                                                                
    1,523       1,423       3,966       4,034  
Total cost of sales                                                          
    51,903       41,899       143,784       123,268  
                                 
Gross profit                                                                
    168,546       123,136       479,473       351,729  
                                 
Operating expenses:
                               
Sales and marketing                                                                
  79,494     65,126     233,166     199,089  
Research and development                                                                
    39,971       35,016       114,912       99,252  
General and administrative                                                                
    17,392       12,306       49,701       42,838  
Total operating expenses                                                          
    136,857       112,448       397,779       341,179  
                                 
Operating income                                                                
    31,689       10,688       81,694       10,550  
                                 
Other income (expense):
                               
Interest income                                                                
  380     339     1,051     1,335  
Net foreign exchange gain (loss)                                                                
    426       940       (2,475 )     1,301  
Other income, net                                                                
    160       482       970       979  
Income before income taxes
    32,655       12,449       81,240       14,165  
Provision for (benefit from) income taxes                                                                  
    4,522       2,518       10,152       (554 )
                                 
Net income                                                          
  $ 28,133     $ 9,931     $ 71,088     $ 14,719  
                                 
Basic earnings per share
  $ 0.36     $ 0.13     $ 0.91     $ 0.19  
                                 
Weighted average shares outstanding - basic
    78,176       77,653       77,832       77,497  
                                 
Diluted earnings per share
  $ 0.36     $ 0.13     $ 0.90     $ 0.19  
                                 
Weighted average shares outstanding - diluted
    78,862       78,103       78,848       77,842  
                                 
Dividends declared per share                                                                  
  $ 0.13     $ 0.12     $ 0.39     $ 0.36  


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


 
 

 

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


   
Nine months Ended
 
   
September 30,
 
   
2010
   
2009
 
Cash flow from operating activities:
           
Net income                                                                                                  
  $ 71,088     $ 14,719  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization                                                                                             
    28,220       28,536  
Stock-based compensation                                                                                             
    14,194       15,238  
Tax expense (benefit) from deferred income taxes                                                                                             
    1,174       (6,802 )
Tax expense from stock option plans                                                                                             
    599       1,445  
Changes in operating assets and liabilities:
               
Accounts receivable                                                                                          
    (17,298 )     30,758  
Inventories                                                                                          
    (14,712 )     18,632  
Prepaid expenses and other assets                                                                                          
    (15,328 )     3,920  
Accounts payable                                                                                          
    9,171       (5,444 )
Deferred revenue                                                                                          
    6,698       3,588  
Taxes and other liabilities                                                                                          
    33,938       (14,245 )
Net cash provided by operating activities                                                                                       
    117,744       90,345  
                 
Cash flow from investing activities:
               
Capital expenditures                                                                                                  
    (14,404 )     (12,331 )
Capitalization of internally developed software                                                                                                  
    (14,300 )     (10,611 )
Additions to other intangibles                                                                                                  
    (2,253 )     (4,009 )
Acquisition, net of cash received                                                                                                  
    (2,191 )      
Purchases of short-term and long-term investments                                                                                                  
    (88,226 )     (38,876 )
Sales and maturities of short-term and long-term investments                                                                                                  
    63,519       10,034  
Net cash (used by) investing activities                                                                                       
    (57,855 )     (55,793 )
                 
Cash flow from financing activities:
               
Proceeds from issuance of common stock                                                                                                  
    38,368       16,351  
Repurchase of common stock                                                                                                  
    (41,862 )     (18,200 )
Dividends paid                                                                                                  
    (30,417 )     (27,958 )
Tax (benefit) from stock option plans                                                                                                  
    (599 )     (1,445 )
Net cash (used by) financing activities                                                                                       
    (34,510 )     (31,252 )
                 
Net change in cash and cash equivalents                                                                                                  
    25,379       3,300  
Cash and cash equivalents at beginning of period                                                                                                  
    201,465       229,400  
Cash and cash equivalents at end of period                                                                                                  
  $ 226,844     $ 232,700  
                 



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 September 30, 2010 and December 31, 2009, and the results of our operations for the three month and nine month periods ended September 30, 2010 and September 30, 2009 and the cash flows for the nine month periods ended September 30, 2010 and September 30, 2009. Operating results for the three month and nine month periods ended September 30, 2010, are not nece ssarily indicative of the results that may be expected for the year ending December 31, 2010.

Note 2 – Earnings per share

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

The reconciliation of the denominators used to calculate basic EPS and diluted EPS for the three month and nine month periods ended September 30, 2010 and 2009, respectively, are as follows (in thousands):

   
Three Months Ended
   
Nine months Ended
 
   
September 30,
   
September 30,
 
   
(unaudited)
   
(unaudited)
 
   
2010
   
2009
   
2010
   
2009
 
Weighted average shares outstanding-basic
    78,176       77,653       77,832       77,497  
Plus: Common share equivalents
                               
Stock options, restricted stock units                                                              
    686       450       1,016       345  
Weighted average shares outstanding-diluted
    78,862       78,103       78,848       77,842  

Stock options to acquire 478,000 shares and 3,509,000 shares for the three month periods ended September 30, 2010 and 2009, respectively, and 568,000 and 3,619,000 shares for the nine month periods ended September 30, 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 and short-term investments
 
Cash, cash equivalents and short-term investments consist of the following (in thousands):

   
As of
September 30, 2010
   
As of
December 31, 2009
 
   
(unaudited)
       
Cash and cash equivalents:
           
Cash                                                                            
  $ 81,264     $ 85,612  
Cash equivalents:
               
Money market accounts                                                                           
    145,580       115,853  
Total cash and cash equivalents                                                                          
    226,844       201,465  
Short-term investments:
               
Municipal bonds                                                                            
    19,952       12,549  
Corporate bonds                                                                            
    42,040       7,587  
U.S. treasuries and agencies                                                                            
    14,235       21,033  
Foreign government bonds                                                                            
    33,224       34,674  
Time deposits                                                                            
    2,452       2,753  
Auction rate securities                                                                            
    -       8,177  
Auction rate securities put option                                                                            
    -       423  
Total short-term investments                                                                          
    111,903       87,196  
Total cash, cash equivalents and investments
  $ 338,747     $ 288,661  

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

 
   
As of September 30, 2010
(unaudited)
 
   
Adjusted Cost
   
Gross
Unrealized Gain
   
Gross
Unrealized Loss
   
Cumulative Translation Adjustment
   
Fair Value
 
Municipal bonds
  $ 19,923     $ 33     $ (4 )   $ -     $ 19,952  
Corporate bonds
    41,988       58       (6 )     -       42,040  
U.S. treasuries and agencies
    14,217       18       -       -       14,235  
Foreign government bonds
    36,065       16       (134 )     (2,723 )     33,224  
Time deposits
    2,452       -       -       -       2,452  
Total investments
  $ 114,645     $ 125     $ (144 )   $ (2,723 )   $ 111,903  


   
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 September 30, 2010
   
As of December 31, 2009
 
   
Adjusted Cost
   
Fair Value
   
Adjusted Cost
   
Fair Value
 
Due in less than 1 year
  $ 81,762     $ 80,460     $ 44,029     $ 43,267  
Due in 1 to 5 years
    32,883       31,443       44,478       43,929  
Total investments
  $ 114,645     $ 111,903     $ 88,507     $ 87,196  
       
Due in less than 1 year
 
Adjusted Cost
   
Fair Value
   
Adjusted Cost
   
Fair Value
 
Municipal bonds                             
  $ 16,910     $ 16,940     $ 4,103     $ 4,110  
Corporate bonds                             
    36,604       36,640       5,384       5,473  
U.S. treasuries and agencies
    8,199       8,205       5,065       5,057  
Foreign government bonds
    17,597       16,223       18,124       17,274  
Time deposits                             
    2,452       2,452       2,753       2,753  
Auction rate securities
    -       -       8,600       8,177  
Auction rate securities put option
    -       -       -       423  
Total investments
  $ 81,762     $ 80,460     $ 44,029     $ 43,267  
       
Due in 1 to 5 years
 
Adjusted Cost
   
Fair Value
   
Adjusted Cost
   
Fair Value
 
Municipal bonds                             
  $ 3,013     $ 3,012     $ 8,388     $ 8,439  
Corporate bonds                             
    5,384       5,400       2,094       2,114  
U.S. treasuries and agencies
    6,018       6,030       16,015       15,976  
Foreign government bonds
    18,468       17,001       17,981       17,400  
Total investments
  $ 32,883     $ 31,443     $ 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 September 30, 2010 and December 31, 2009.

   
Fair Value Measurements at Reporting Date Using
(unaudited)
 
 
 
 
Description
 
 
September 30, 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                                       
  $ 145,580     $ 145,580     $ -     $ -  
Short-term investments available for sale:
                               
Municipal bonds                                       
    19,952       19,952       -       -  
Corporate bonds                                       
    42,040       42,040       -       -  
U.S. treasuries and agencies
    14,235       14,235       -       -  
Foreign government bonds
    33,224       33,224       -       -  
Time deposits                                       
    2,452       2,452       -       -  
Derivatives                                       
    5,569       -       5,569       -  
Total Assets                                       
  $ 263,052     $ 257,483     $ 5,569     $ -  
                                 
Liabilities
                               
Derivatives                                       
  $ (5,456 )   $ -     $ (5,456 )   $ -  
Total Liabilities                                       
  $ (5,456 )   $ -     $ (5,456 )   $ -  
 

 
   
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                                                                             
    -  
Included in other comprehensive income                                                                             
    -  
Total losses (realized/unrealized)                                                                                
       
Included in earnings                                                                             
    -  
Included in other comprehensive income                                                                             
    -  
Purchases, issuances and settlements                                                                                
    (8,600 )
Transfer in and/or out of Level 3                                                                                
    -  
Ending Balance at September 30, 2010                                                                                   
  $ -  
         
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 U.S., corporate debt securities and debt securities issued by U.S. government corporations and agencies as well as debt securities issued by foreign governments. All short-term investments available-for-sale have contractual maturities of less than 24 months. There were not any transfers in or out of Level 1 during the nine months ended September 30, 2010.

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. There were not any transfers in or out of Level 2 during the nine months ended September 30, 2010.

The short-term investments available-for-sale included in Level 3 at December 31, 2009, were reported at their fair market value and consisted of auction rate securities backed by education loan revenue bonds. Auction rate securities are variable rate debt instruments whose interest rates are typically reset approximately every 7 to 35 days.

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 for our auction rate securities. The Rights agreement included 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. Under the terms of this Rights agreement, UBS purchased back from us our auction rate securities on June 14, 2010, and July 1, 2010. We received the full par value of $8.6 million from UBS in accordance with the terms of our Rights agreement.

The estimated fair market value of the auction rate securities and the Rights agreement was determined using significant unobservable inputs (Level 3). We considered many factors in determining the fair market value of our auction rate securities as well as our corresponding Rights agreement at December 31, 2009, including the fact that the debt instruments underlying the auction rate securities have redemption features which call for redemption at 100% of par value, current credit curves for like securities and discount factors to account for the illiquidity of the market for these securities.
 
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 56% and 54% in each of the three month periods ended September 30, 2010 and 2009, respectively, and 57% and 55% in each of the nine month periods ended September 30, 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 c urrency 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”. From time to time, 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 d esignated 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 $31.2 million dollar equivalent of Euro, $7.1 million dollar equivalent of British pound sterling, $22.2 million dollar equivalent of Japanese yen, and $32.8 million dollar equivalent of Hungarian forint at September 30, 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 $8.7 million dollar equivalent of Euro at September 30, 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 September 30, 2010, we expect to reclassify $580,000 of losses on derivative instruments from accumulated other comprehensive income to net sales during the next twelve months when the hedged international sales occur, $1.1 million of gains on derivative instruments from accumulated OCI to cost of sales when the cost of sales are incurred and $584,000 of gains on derivative instruments from accumulated OCI to operating expenses during the next twelve months when the hedged operating expenses occur. Expected amounts are based on derivative valuations at September 30, 2010. Actual results may vary as a result of changes in the corresponding exchange rate subsequent to this date.

We did not record any gains or losses due to the ineffectiveness of our hedges during the nine months ended September 30, 2010. During the nine months ended September 30, 2009, hedges with a notional amount of $18.9 million were determined to be ineffective. As a result, we recorded a net gain of $1.2 million related to these hedges as a component of “net foreign exchange gain (loss)” during the nine months ended September 30, 2009.

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 September 30, 2010 and December 31, 2009, we held foreign currency forward contracts with a notional amount of $29.9 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
 
 
September 30, 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
  $ 2,849  
Prepaid expenses and other current assets
  $ 7,947  
                     
Foreign exchange contracts - LT forwards
Other long-term assets
    871  
Other long-term assets
    274  
                     
Foreign exchange contracts - ST options
Prepaid expenses and other current assets
    877  
Prepaid expenses and other current assets
    1,821  
Total derivatives designated as hedging instruments
    $ 4,597       $ 10,042  
                     
Derivatives not designated as hedging instruments
                   
                     
Foreign exchange contracts - ST forwards
Prepaid expenses and other current assets
  $ 972  
Prepaid expenses and other current assets
  $ 974  
Total derivatives not designated as hedging instruments
    $ 972       $ 974  
                     
Total derivatives
    $ 5,569       $ 11,016  
 
 
 
Liability Derivatives
 
 
September 30, 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
  $ (2,156
Accrued expenses and other liabilities
  $ -  
                     
Foreign exchange contracts - LT forwards
Other long-term liabilities
    (850 )
Other long-term liabilities
    -  
Total derivatives designated as hedging instruments
    $ (3,006     $ -  
                     
Derivatives not designated as hedging instruments
                   
                     
Foreign exchange contracts - ST forwards
Accrued expenses and other liabilities
  $ (2,450
Accrued expenses and other liabilities
  $ (318 )
Total derivatives not designated as hedging instruments
    $ (2,450     $ (318 )
                     
Total derivatives
    $ (5,456     $ (318 )
 

The following unaudited table shows the effect of derivative instruments on the Consolidated Statements of Income for the three month periods ended September 30, 2010 and 2009, respectively (in thousands):
 
September 30, 2010
(unaudited)
 
Derivatives in Cash Flow Hedging Relationship
 
Gain or (Loss) Recognized in OCI on Derivative (Effective Portion)
 
Location of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion)
 
Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion)
 
   
2010
     
2010
     
2010
 
Foreign exchange contracts - forwards and options
  $ (6,201 )
Net sales
  $ 1,358  
Net foreign exchange gain (loss)
  $ -  
                             
Foreign exchange contracts - forwards and options
    2,558  
Cost of sales
    374  
Net foreign exchange gain (loss)
    -  
                             
Foreign exchange contracts - forwards and options
    1,299  
Operating expenses
    266  
Net foreign exchange gain (loss)
    -  
Total
  $ (2,344 )     $ 1,998       $ -  
 
 
September 30, 2009
(unaudited)
 
Derivatives in Cash Flow Hedging Relationship
 
Gain or (Loss) Recognized in OCI on Derivative (Effective Portion)
 
Location of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion)
 
Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion)
 
   
2009
     
2009
     
2009
 
Foreign exchange contracts - forwards and options
  $ (5,037 )
Net sales
  $ (401 )
Net foreign exchange gain (loss)
  $ 181  
                             
Foreign exchange contracts - forwards and options
    1,465  
Cost of sales
    (72 )
Net foreign exchange gain (loss)
    395  
                             
Foreign exchange contracts - forwards and options
    82  
Operating expenses
    380  
Net foreign exchange gain (loss)
    81  
Total
  $ (3,490 )     $ (93 )     $ 657  
 
 
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
 
     
September 30, 2010 (unaudited)
   
September 30, 2009 (unaudited)
 
Foreign exchange contracts - forwards
Net foreign exchange gain/(loss)
  $ (2,233 )   $ (1,607 )
                   
Total
    $ (2,233 )   $ (1,607 )
 
 
The following unaudited table shows the effect of derivative instruments on the Consolidated Statements of Income for the nine month periods ended September 30, 2010 and 2009, respectively (in thousands):
 

September 30, 2010
(unaudited)
 
Derivatives in Cash Flow Hedging Relationship
 
Gain or (Loss) Recognized in OCI on Derivative (Effective Portion)
 
Location of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion)
 
Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion)
 
   
2010
     
2010
     
2010
 
Foreign exchange contracts - forwards and options
  $ (4,457 )
Net sales
  $ 4,407  
Net foreign exchange gain (loss)
  $ -  
                             
Foreign exchange contracts - forwards and options
    (2,152 )
Cost of sales
    1,785  
Net foreign exchange gain (loss)
    -  
                             
Foreign exchange contracts - forwards and options
    (1,095 )
Operating expenses
    853  
Net foreign exchange gain (loss)
    -  
Total
  $ (7,704 )     $ 7,045       $ -  

September 30, 2009
(unaudited)
 
Derivatives in Cash Flow Hedging Relationship
 
Gain or (Loss) Recognized in OCI on Derivative (Effective Portion)
 
Location of Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Gain or (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
 
Location of Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion)
 
Gain or (Loss) Recognized in Income on Derivative (Ineffective Portion)
 
   
2009
     
2009
     
2009
 
Foreign exchange contracts - forwards and options
  $ (8,822 )
Net sales
  $ 2,578  
Net foreign exchange gain (loss)
  $ 1,132  
                             
Foreign exchange contracts - forwards and options
    2,776  
Cost of sales
    (740 )
Net foreign exchange gain (loss)
    (44 )
                             
Foreign exchange contracts - forwards and options
    1,747  
Operating expenses
    184  
Net foreign exchange gain (loss)
    81  
Total
  $ (4,299 )     $ 2,022       $ 1,169  
 
 
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
 
     
September 30, 2010
(unaudited)
   
September 30, 2009
(unaudited)
 
Foreign exchange contracts - forwards
Net foreign exchange gain/(loss)
  $ (857 )   $ (1,791 )
                   
Total
    $ (857 )   $ (1,791 )
 
Note 6 – Inventories

Inventories, net at September 30, 2010 and December 31, 2009, consist of the following (in thousands):

   
September 30,
   
December 31,
 
   
2010
   
2009
 
   
(unaudited)
       
             
Raw materials                                                                                
  $ 48,054     $ 42,121  
Work-in-process                                                                                
    4,351       2,042  
Finished goods                                                                                
    49,127       42,352  
    $ 101,532     $ 86,515  

Note 7 – Intangibles

Intangibles at September 30, 2010 and December 31, 2009, are as follows:

   
September 30, 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
  $ 53,883     $ (28,321 )   $ 25,562     $ 38,928     $ (20,455 )   $ 18,473  
Acquired technology                                                
    32,853       (23,995 )     8,858       28,022       (20,967 )     7,055  
Patents                                                
    20,464       (6,078 )     14,386       19,033       (5,377 )     13,656  
Leasehold equipment and other
    13,936       (10,189 )     3,747       12,577       (8,371 )     4,206  
    $ 121,136     $ (68,583 )   $ 52,553     $ 98,560     $ (55,170 )   $ 43,390  

Software development costs capitalized during the three month periods ended September 30, 2010 and 2009, were $3.4 million and $1.3 million, respectively, and related amortization expense was $2.8 million and $2.5 million, respectively. Capitalized software development costs for the three month periods ended September 30, 2010 and 2009, included costs related to stock based compensation of $144,000 and $71,000, respectively. During the nine month periods ended September 30, 2010 and 2009, we capitalized software development costs of $15.0 million and $11.2 million, respectively, and related amortization expense was $7.9 million and $6.6 million, respectively. Capitalized software development costs for the nine month periods ended September 30, 2010 and 2009, included costs related to stock based compensation of $655,000 and $617,000, 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 $5.2 million and $4.7 million during the three month periods ended September 30, 2010 and 2009, respectively, and $13.4 million and $12.2 million during the nine month periods ended September 30, 2010 and 2009, respectively.

Acquired core technology and intangible assets are amortized over their useful lives, which range from three to eight years. Amortization expense for intangible assets acquired was approximately $1.0 million and $1.0 million for the three month periods ended September 30, 2010 and 2009, respectively, of which approximately $921,000 and $853,000 was recorded in cost of sales, respectively, and approximately $89,000 and $125,000 was recorded in operating expenses, respectively. For the nine month periods ended September 30, 2010 and 2009, amortization expense for intangible assets acquired was approximately $2.9 million and $3.0 million, respectively, of which approximately $2.6 million and $2.6 million was recorded in cost of sales, respectively, and approximately $311,000 and $377,000 was recorded in operating expenses, respectively.< /font>

Note 8 – Goodwill

The carrying amount of goodwill as of September 30, 2010, is as follows (in thousands):

   
Amount
 
Balance as of December 31, 2009                                                                                                     
  $ 64,779  
Acquisitions                                                                                                     
    5,013  
Divestitures                                                                                                     
    -  
Foreign currency translation impact                                                                                                     
    (409 )
Balance as of September 30, 2010                                                                                                     
  $ 69,383  

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 of the acquired company 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 $11.6 million and $11.1 million of unrecognized tax benefits at September 30, 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 $2.4 million and $3.5 million for the three and nine month periods ended September 30, 2010, as a result of the closing of open tax years and a settlement with a taxing authority. As of September 30, 2010, it is de emed reasonable that we will recognize tax benefits in the amount of $3.5 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 September 30, 2010, we have approximately $652,000 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 14% and 20% for the three month periods ended September 30, 2010 and 2009, respectively, and 12% and (4)% for the nine month periods ended September 30, 2010 and 2009, respectively. For the three months ended September 30, 2010, our effective tax rate was lower than the U.S. federal statutory rate of 35% as a result of the partial release of a deferred tax asset valuation allowance, an enhanced deduction for certain research and development expenses, profits in foreign jurisdictions with reduced income tax rates and a decrease in unrecognized tax benefits for uncertain tax positions. For the nine months ended September 30, 2010, our effective tax rate was lower than the U.S. federal statutory rate of 35% as a result of  the partial release of a deferred tax as set valuation allowance, an enhanced deduction for certain research and development expenses and profits in foreign jurisdictions with reduced income tax rates. For the three and nine month periods ended September 30, 2009, our effective tax rate was lower than the U.S. federal statutory rate of 35% due to a partial release of a deferred tax asset valuation allowance, the research credit and a decrease in unrecognized tax benefits for uncertain tax positions. These benefits were partially offset by non-deductible stock-based compensation expenses, losses in foreign jurisdictions with reduced income tax rates and a valuation allowance related to a deferred tax asset for which a tax benefit was previously recognized.

The 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”). 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 $4.5 million and $1.7 million for the three month periods ended September 30, 2010 and 2009, respectively and $12.3 million and $5.9 million for the nine month periods ended September 30, 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 unrealized gains and losses on our investments designated as available for sale. Comprehensive income for the three and nine month periods ended September 30, 2010 and September 30, 2009, was as follows (in thousands):

   
Three Months Ended
   
Nine months Ended
 
   
September 30,
   
September 30,
 
   
(unaudited)
   
(unaudited)
 
   
2010
   
2009
   
2010
   
2009
 
Comprehensive income:
                       
Net income                                                                  
  $ 28,133     $ 9,931     $ 71,088     $ 14,719  
Foreign currency translation gains (losses), net of taxes
    8,792       2,413       (2,577 )     2,908  
Unrealized gains (losses) on derivative instruments, net of taxes
    (908 )     (1,987 )     (8,000 )     (1,838 )
Unrealized gains (losses) on investments designated as available for sale, net of taxes
    (536 )     241       235       115  
Total comprehensive income
  $ 35,481     $ 10,598     $ 60,746     $ 15,904  

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 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 with an exercise price which was equal to the market price of our common stock 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 forfe itures 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 nine months ended September 30, 2010, we did not make any changes in accounting principles or methods of estimates.

Restricted stock plans

Our stockholders approved our 2005 Incentive Plan (the “2005 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, provided 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 t he 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. The 2005 Plan terminated on May 11, 2010, except with respect to outstanding awards previously granted thereunder.  There were 2,241,536 share of common stock that were reserved but not issued under the 1994 Plan and the 2005 Plan as of May 11, 2010.
 
Our stockholders approved our 2010 Incentive Plan (the “2010 Plan”) on May 11, 2010. At the time of approval, 2,000,000 shares of our common stock were reserved for issuance under this plan, as well as the 2,241,536 share of common stock that were reserved but not issued under the 1994 Plan and the 2005 Plan as of May 11, 2010, and any shares that are returned to the 1994 Plan and the 2005 Plan as a result of forfeiture or termination of options or RSUs or repurchase of shares issued under these plans. The 2010 Plan, administered by the Compensation Committee of the Board of Directors, provides for granting of incentive awards in the form of restricted stock and RSUs to employees, directors and consultants of the Company and employees and consultants of any parent or subsidiary of the Company. Awards vest over a three, fiv e 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. There were 4,188,716 shares available for grant under the 2010 Plan at September 30, 2010.

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 nine months ended September 30, 2010, we did not make any changes in accounting principles or methods of estimates related to the 2010 Plan.

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 1,237,994 shares of common stock reserved for future employee purchases under this plan at September 30, 2010. We issued 517,077 shares under this plan in the nine months ended September 30, 2010. The weighted average fair value of the employees’ purchase rights was $24.84 per share and was estimated using the Black-Scholes model. During the nine months en ded September 30, 2010, we did not make any changes in accounting principles or methods of estimates related to the employee stock purchase plan.

For the three and nine month periods ended September 30, 2010 and September 30, 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
   
Nine months Ended
 
   
September 30,
   
September 30,
 
   
(unaudited)
   
(unaudited)
 
   
2010
   
2009
   
2010
   
2009
 
Stock-based compensation
                       
Cost of sales
  $ 332     $ 335     $ 1,014     $ 975  
Sales and marketing
    1,960       2,210       6,060       6,626  
Research and development
    1,771       1,929       5,129       5,349  
General and administrative
    672       728       1,991       2,288  
                                 
Provision for income taxes
    (1,295 )     (409 )     (4,422 )     (5,288 )
Total
  $ 3,440     $ 4,793     $ 9,772     $ 9,950  

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
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
(unaudited)
   
(unaudited)
 
   
2010
   
2009
   
2010
   
2009
 
Net sales:
                       
Americas:
                       
Unaffiliated customer sales                                             
  $ 97,031     $ 75,459     $ 266,300     $ 211,991  
Europe:
                               
Unaffiliated customer sales                                            
    59,882       46,683       177,681       143,026  
Asia Pacific:
                               
Unaffiliated customer sales                                            
    63,536       42,893       179,276       119,980  
    $ 220,449     $ 165,035     $ 623,257     $ 474,997  


   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
(unaudited)
   
(unaudited)
 
   
2010
   
2009
   
2010
   
2009
 
Operating income:
                       
Americas                                               
  $ 21,395     $ 15,058     $ 52,689     $ 28,658  
Europe                                               
    31,347       20,087       87,409       52,562  
Asia Pacific                                               
    18,918       10,559       56,508       28,582  
Unallocated:
                               
Research and development expenses
    (39,971 )     (35,016 )     (114,912 )     (99,252 )
    $ 31,689     $ 10,688     $ 81,694     $ 10,550  

 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
(unaudited)
   
(unaudited)
 
   
2010
   
2009
   
2010
   
2009
 
Interest income:
                       
Americas                                               
  $ 177     $ 165     $ 433     $ 685  
Europe                                               
    182       145       546       581  
Asia Pacific                                               
    21       29       72       69  
    $ 380     $ 339     $ 1,051     $ 1,335  

 
 
September 30,
2010
   
December 31,
2009
 
   
(unaudited)
       
Long-lived assets:
           
Americas                                                     
  $ 100,245     $ 100,489  
Europe                                                     
    34,773       36,555  
Asia Pacific                                                     
    16,649       16,221  
    $ 151,667     $ 153,265  

Total sales outside the United States for the three month periods ended September 30, 2010 and 2009, were $131.3 million and $95.4 million, respectively. Total sales outside the United States for the nine month periods ended September 30, 2010 and 2009, were $378.9 million and $282.5 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 nine month periods ended September 30, 2010 and 2009, was as follows (in thousands):.

   
Nine Months Ended
 
   
September 30,
(unaudited)
 
 
 
2010
   
2009
 
Balance at the beginning of the period                                                                             
  $ 921     $ 952  
Accruals for warranties issued during the period                                                                             
    1,485       1,518  
Settlements made( in cash or in kind) during the period
    (1,483 )     (1,551 )
Balance at the end of the period                                                                             
  $ 923     $ 919  

As of September 30, 2010, we have outstanding guarantees for payment of foreign operating leases, customs and foreign grants totaling approximately $2.0 million.

As of September 30, 2010, we have non-cancelable purchase commitments with various suppliers of customized inventory and inventory components totaling approximately $8.9 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 rel ative 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 permi tted. 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 is 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 b eginning 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 f irst 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 b eing 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 $638,000 against this accrual. At September 30, 2010, the remaining accrual was $925,000.

Note 16 – Subsequent events

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

On October 19, 2010, our Board of Directors declared a quarterly cash dividend of $0.13 per common share, payable on November 19, 2010, to shareholders of record on November 8, 2010.



 
 

 

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

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Any statements contained herein regarding our future financial performance or operations (including, without limitation, statements to the effect that we “believe,” "expect," "plan," "may," "will," "project," "continue," or "estimate" or other variations thereof or comparable terminology or the negative thereof) should be considered forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of important factors, including those set forth under the heading “Risk Factors” beginning on page 37, and t he 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 ind ustries. No single customer accounted for more than 5% and 4% of our sales in the three and nine month periods ended September 30, 2010, respectively, or 3% of our sales 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. Since August 2009, the PMI has had readings above 50 which are indicative of expansion in the industrial global economy, although in recent months, the PMI has been declining. We are unable to predict whether the current expansion cycle, as measured by the PMI, will be sustained throughout 2010 or into 2011.

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 56% and 54% of our revenues for the three month periods ended September 30, 2010 and 2009, respectively, and approximately 57% and 55% of our revenues for the nine month periods ended September 30, 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 deri ved 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 a subcontractor in Asia to manufacture a significant portion of our chassis but we are steadily moving an increasing percentage of this production in-house. 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 depend 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 our 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 the first nine months 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 53 in September 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 believe it is likely that the peak of the gl obal PMI for this cycle was reached during the second quarter of 2010 when it reached a high of 58. Moving forward, we expect that the global PMI will trend towards its historical mean and reflect a more moderate rate of expansion. Given the relatively low levels of global inventory, we believe the industrial economy is positioned to manage the moderation of the global PMI, and that we are positioned to grow revenue through this moderating trend.  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 in this economic environment are to maintain a stable gross margin, to maintain a disciplined approach toward operating expenses, and to maintain strong employee productivity. As a result, we expect to increase our operating expenses at a rate closer to that of our reven ue growth going forward.

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
September 30,
   
Nine months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Net sales: