ITEM 1. BUSINESS
National Instruments Corporation (the "Company" or "National Instruments") is a leading supplier of computer-based instrumentation hardware and software products that engineers and scientists use in a wide range of industries. These industries are spread across two large markets: test and measurement ("T&M") and industrial automation ("IA"). The Company provides flexible application software and modular, multifunction hardware that users combine with industry-standard desktop computers, portable computers and workstations to create "virtual instruments."
A virtual instrument consists of an industry standard desktop computer, portable computer or workstation equipped with the Company's user-friendly application software, cost-effective hardware and driver software that together perform the functions of traditional instruments. Virtual instrumentation represents a fundamental shift from traditional hardware-centered instrumentation systems to software-centered systems that exploit the computational, display, productivity and connectivity capabilities of popular desktop computers, portable computers and workstations. Because virtual instruments exploit these computation and display capabilities, users can define and change the functionality of their instruments, rather than being restricted by fixed-functions imposed by traditional instrument vendors. The Company's products empower users to monitor and control traditional instruments, create innovative computer-based systems that can replace traditional instruments at a lower cost, and develop systems that integrate measurement functionality with industrial automation. The Company believes that giving users flexibility to create their own virtual instruments for an increasing number of applications in a wide variety of industries, and making such instruments portable between popular computers and operating systems, shortens system development time and reduces both short- and long-term costs of developing, owning and operating measurement and automation systems, and improves efficiency and precision of applications spanning research, design, production and service.
The Company is based in Austin, Texas and was incorporated under the laws of the State of Texas in May 1976 and was reincorporated in Delaware in June 1994. On March 13, 1995, the Company completed an initial public offering of shares of its Common Stock. The Company's Common Stock, $0.01 par value, is quoted on the NASDAQ National Market System under the trading symbol NATI.
Industry Background
Engineers and scientists have long used instruments to observe, better understand and manage the real-world phenomena, events and processes related to their industries or areas of expertise. Instruments measure and control electrical signals, such as voltage, current and power, and physical phenomena, such as temperature, pressure, speed, flow, volume, torque and vibration. Common instruments include voltmeters, signal generators, oscilloscopes, dataloggers, spectrum analyzers and temperature and pressure monitors and controllers. Instruments generally perform three basic functions: data acquisition and control; data analysis; and presentation of results. Instruments are used pervasively in research, education, manufacturing and service applications in numerous fields including electronics, automotive, aerospace, telecommunications, medical research and pharmaceutical, semiconductor and petrochemical.
Instrument applications can be generally categorized as either T&M or IA. In research and development settings, scientists and engineers use T&M instruments to collect and analyze experimental data, and IA instruments and systems to simulate manufacturing processes or techniques. In manufacturing environments, engineers use T&M instruments to test and verify the proper operation of the products being manufactured while IA instruments and systems monitor and control the manufacturing machines and processes.
Test and Measurement
A typical T&M instrument is a stand-alone unit that has signal input, output and analysis capabilities; knobs, switches and push buttons for user operation; and gauges, meters or other displays for visual data presentation. Traditionally, most T&M instruments were vendor-defined, fixed-function devices designed to address specific applications. As a result, users had limited flexibility to adapt their instruments to changing requirements. In the 1960's, vendors began to incorporate integrated circuits, including programmable microcontrollers, to increase instrument flexibility. In the mid-1970's, the General Purpose Interface Bus ("GPIB" or "IEEE 488") was developed as a standard interface to connect instruments to external computers. The first computer controllers for GPIB instruments were based on proprietary hardware architectures. In the later 1970's, some minicomputers with general purpose but complex operating systems were equipped for GPIB instrument control. In the early 1980's, personal computers with limited processing power equipped with MS-DOS, a standard, character-based operating system, began replacing minicomputers as the preferred platforms for instrument control applications.
Industrial Automation
IA systems have long included mechanical devices, analog gauges and meters, and since the 1960's, have also included electronic instruments such as data loggers and strip chart recorders. In the 1970's, programmable logic controllers ("PLCs"), special-purpose, proprietary stand-alone industrial computers, were introduced and were used primarily for "discrete" manufacturing applications such as automobile assembly. PLCs have traditionally had primitive operator interface panels incorporating buttons, lights and indicators. In parallel, sophisticated instrumentation systems called distributed control systems ("DCSs") were also adopted to provide computer control of large-scale continuous processes, such as those found in oil refineries. DCSs integrated a variety of sensors and control elements using both analog and digital connections, all controlled by a central computer running proprietary software. In the mid-1980's, when industrial PC-based IA systems came into use, another approach became available. These early PC-based systems generally ran proprietary, vendor-defined software and incorporated plug-in data acquisition boards or interfaced to PLCs.
Limitations of Traditional Approaches to Instrumentation
Instruments and systems for both the T&M and IA markets have historically shared common limitations, including: fixed, vendor-defined functionality; proprietary, closed architectures that were generally difficult to program and integrate with other systems; and inflexible operator interfaces that were usually cumbersome to operate and change. These problems have been further complicated in the IA market because specialized data transfer and communications standards have not evolved rapidly or been widely adopted. For example, PLCs, while greatly improving control of individual processes, created multiple "islands of information" that were generally unable to communicate or share data with other systems throughout the manufacturing enterprise. Furthermore, proprietary instrumentation systems have traditionally been very expensive, with IA system prices ranging as high as several million dollars and T&M instrumentation system prices often ranging in the hundreds of thousands of dollars. In addition, the limitations on programmability of traditional systems means that adopting these systems to changing requirements is both expensive and time consuming, and users are often required to purchase multiple single-purpose instruments.
Although desktop computers in the 1980's typically were based on open architectures, until recently they have lacked higher-level application software development tools and intuitive graphical user interfaces ("GUIs"). Consequently, the process of creating intuitive operator interface and control panels was difficult and expensive. These early desktop computers also lacked the power to rapidly process and analyze the volume of data characteristic of many high data rate T&M and IA applications. In addition, desktop computers were difficult to network reliably until standard network operating systems evolved late in the decade. For all of these reasons, users and vendors were relatively slow to incorporate desktop computers in their instrumentation systems.
In the 1990's, desktop and portable computers improved significantly in data and graphics processing power, storage and communication capabilities, user-friendliness and reliability. Nevertheless, users accustomed to the flexibility, efficiency, power and open architecture of these later-generation computers, and the highly evolved application software available for business computing needs, have been generally frustrated in their efforts to integrate these computers into instrumentation solutions. Standard desktop computers were not equipped with the hardware connections required to control many types of instruments and lacked instrumentation-specific application development tools, including GUI development environments. Neither standard programming languages such as C/C++ and Visual Basic, nor operating systems such as Windows, Linux and UNIX, are "instrument aware." Without the aid of instrumentation-specific software to facilitate the integration of various instrumentation system capabilities and components, engineers and scientists could not easily utilize the full potential of their modern desktop and portable computers to meet their instrument requirements.
The Company's Virtual Instrument Approach to Measurement and Automation
The Company pioneered a new instrumentation approach to measurement and automation called virtual instrumentation in 1986 when it introduced its LabVIEW application software, which is a graphical programming environment. While a traditional instrument bundles the data acquisition, analysis and presentation functions in a single, stand-alone unit, a "virtual instrument" consists of an industry standard computer or workstation equipped with the Company's user-friendly application software, cost-effective hardware and driver software that together perform the functions of traditional instruments. By unbundling the key instrumentation functions, virtual instruments represent a fundamental shift from traditional hardware-centered instrumentation systems to software-centered systems that exploit the computational, display, productivity and connectivity capabilities of popular desktop and portable computers and workstations. The Company's virtual instrumentation application software products give users the power and flexibility to define, implement, modify and control each of the three core instrumentation functions. Users can mix and match their choice of the Company's DAQ, GPIB, VXI, PXI, image acquisition, motion control or industrial communications products to create virtual instrumentation systems that meet their specific instrumentation needs. The Company's products empower users to monitor and control traditional instruments, create innovative computer-based systems that can replace traditional instruments at a lower cost, and integrate measurement functionality with industrial automation to improve efficiency and precision of applications spanning research, design, production and service. Because much of the instrumentation functionality resides in the software, in a significant sense, the software is the instrument.
User Benefits
Compared with traditional solutions, the Company believes its products and virtual instrumentation approach provide the following significant customer benefits:
Performance, Ease-of-Use and Efficiency
The Company's virtual instrument application software brings the power and ease-of-use of desktop and portable computers to the instrumentation market. With features such as graphical programming, automatic code generation capabilities, graphical tools libraries, ready-to-use example programs and libraries of specific instrumentation functions, users can quickly build a virtual instrument system that meets their individual application needs. For example, a user may build the data acquisition and analysis functions of an instrument by selecting and connecting icons representing particular instrumentation functions and may customize the display on the computer's monitor to reflect the desired presentation. With faster time to solution, users have more time to optimize system functionality and performance, and can devote more time to their core work rather than to programming instruments.
Modularity, Reusability and Reconfigurability
The Company's products include reusable hardware and software modules that offer considerable flexibility in configuring systems. This ability to reuse and reconfigure instruments systems allows users to reduce development time and maximize efficiency by eliminating duplicated programming efforts and to quickly adapt their instruments to new and changing needs. In addition, these features help protect both hardware and software investments against obsolescence.
Mix and Match Capabilities
The flexibility of the Company's virtual instrumentation approach permits users to mix and match many combinations of GPIB, VXI, DAQ, PXI, image acquisition, motion control and industrial communications products to build customized instrument solutions. The Company's open product architecture provides a high level of integration between the Company's products and other industry standard instrumentation products. This approach provides users with the flexibility to mix and match the Company's and third-party hardware components when developing custom virtual instrumentation systems.
Long-Term Compatibility Across Multiple Computer Platforms
The Company offers a variety of multi-platform software products so users can choose the platform and programming methodology that best meets their needs and skills. These software products also have portable, open architectures so users can move their applications among multiple platforms and operating systems. In addition, the Company strives to ensure long-term compatibility between its products and the latest industry-standard computers, operating systems, programming languages and tools, as well as backward compatibility with its own product offerings.
Network and Integrate with Customers' Computing Environments
The Company's products facilitate connectivity of measurement and automation systems with the enterprise by utilizing industry communication standards such as Ethernet and TCP/IP. The Company's products provide data and file transfer between computers, distributed access to databases and remote test and measurement and process monitoring capabilities. In addition, the Company's products are also compatible with a wide variety of familiar, easy-to-use software applications such as word processors, spreadsheets, web browsers, and databases. In many cases, a single computer or workstation can serve both the instrumentation and general purpose computing needs of scientists and engineers.
Large User Base
The Company supports and encourages the sharing of ideas, derived software libraries and modules among its broad user base through user groups, newsletters, conferences and seminars. This large base of users stimulates the expansion of the Company's network of over 500 third party system integrators and consultants, who can save users time and money by providing value-added expertise, software programs and integration of systems for use with the Company's products.
Lower Total Solution Cost
The Company believes that its virtual instrumentation products and solutions offer price/performance advantages over traditional instrumentation. Virtual instrumentation provides users the ability to utilize industry standard computers and workstations equipped with modular and reusable application software, cost-effective hardware and driver software that together perform the instrumentation functions that would otherwise be performed by costly, proprietary instrumentation systems. In addition, virtual instrumentation gives users the flexibility and portability to adapt to changing needs, whereas traditional closed systems are both expensive and time consuming to adapt, if adaptable at all.
Strategy
The Company's objective is to be a leading supplier of virtual instrumentation products and solutions to engineers, scientists and others in both the T&M and IA markets. To achieve this objective, the Company is pursuing a strategy that includes the following elements:
Expand Broad Customer Base
Serve Two Large Markets. The Company's products and services are designed to serve the broad customer bases found in both the T&M and IA markets. The Company defines product features and capabilities by working closely with technically sophisticated customers in each of these markets and seeks to achieve high unit volumes by selling these same products to a large base of customers.
Support Many Computer and Instrument Options. The Company diversifies its customer base by accommodating many popular computer platforms and a variety of instrumentation options. In addition, the Company expects to continue to create or adapt products for computer systems and instrumentation options that gain market acceptance. Customers are provided a range of price/performance options through the Company's extensive line of products.
Provide Worldwide Marketing and Distribution. The Company uses multiple coordinated distribution channels in its major world markets. The Company's distribution channels include direct sales, distributors, OEMs, VARs and systems integrators and consultants. By using this broad range of channels, the Company seeks to develop and maintain relations with its customers and prospects and to provide the levels of support, training and education required by the market. The Company devotes significant resources to direct sales activities in the United States and in key international markets. To address the range of sales opportunities, the Company expects to continue to pursue value-added sales channels through formal relationships with OEMs, VARs, consultants or other third parties when such relationships can add significant value to its products or revenues. The Company intends to expand each of these distribution networks to take advantage of market opportunities.
Acquire New Technologies. The Company has in the past acquired companies, products, and technologies to augment its product offerings, and intends to continue to seek opportunities to satisfy customer needs and build market penetration through acquisitions of new products and technologies in the future. In connection with these acquisitions, the Company has leveraged its established sales channels in an effort to accelerate the delivery of the acquired product to the market and build market share.
Target Academic Environments. The Company markets and sells its products to colleges and universities, increasing the potential for future growth as students gain experience using the Company's products before entering the work force.
Maintain High Levels of Customer Satisfaction
Offer Innovative Modular and Integrated Solutions. The Company intends to continue to deliver innovative, modular software and hardware tools with open, portable architectures that can be easily integrated to create instrumentation systems and solutions. The Company solicits regular feedback from its customers, resulting in the addition of new product features and enhanced performance, to help ensure that existing and new products meet or surpass customer expectations.
Provide Comprehensive Customer Support and Education. The Company's sales and marketing engineers have the technical expertise necessary to understand customers' instrumentation application needs and work with them to identify cost-effective solutions using the virtual instrumentation approach. The Company also offers comprehensive customer support, including technical support via fax and telephone, electronic mail and world-wide web forums, bulletin boards, newsletters, warranty service and repair, upgrade programs, free and paid seminars and technical classes.
Deliver Long-Term Compatibility. The Company emphasizes consistency in the implementation of its products across different platforms and strives to maintain a high degree of backward compatibility between existing and new products, engendering a high degree of customer loyalty.
Leverage External and Internal Technology
Leverage Generally Available Technology. The Company leverages the research and development efforts of vendors of desktop and portable computers and workstations, operating systems, programming languages and software development tools, and their suppliers. These technologies are combined with the Company's products to achieve advanced solutions at a lower development cost.
Support Open Architecture on Multiple Platforms. The Company approaches the market with an open architecture so users have the flexibility to combine the Company's products with those from traditional instrument suppliers, computer vendors and competitors.
Leverage Core Technologies. The Company designs proprietary ASICs to optimize performance and reduce production costs. The Company utilizes these ASICs and its other internally developed hardware and software components in multiple products to achieve consistency and compatibility between products.
Develop and Support Industry Standards. The Company actively participates in efforts to standardize key technologies by participating in industry consortia and serving on standards committees, such as IEEE 488, VXI, PXI and the Interchangeable Virtual Instrumentation Foundation, also called IVI, for the T&M market and Fieldbus and OPC for the IA market. The Company's ongoing strategy is to conform its products to established and emerging standards in both the general computer and the instrumentation industries.
Products and Technology
The Company offers an extensive line of hundreds of computer-based products. Engineers, scientists and other users in both the T&M and IA markets can use these products with desktop and portable computers and workstations to develop customer-defined virtual instruments. The Company's products consist of application software, and hardware components together with related driver software. In T&M applications, the Company's products can be used to monitor and control traditional instruments or to create computer-based instruments that can replace the traditional instruments. In IA applications, the Company's products can be used in the same ways as in T&M and can also be used to integrate measurement functionality with process automation capabilities. The Company's products are designed to work either in an integrated solution or separately. The Company believes that the flexibility, functionality and ease of use of its application software promotes sales of the Company's other software and hardware products. There are now several books available on the Company's technology, both in English and other languages.
Application Software
The Company's application software products include both instrumentation and automation software. The Company believes that application software is playing an increasingly important role in the development of computer-based instruments and systems in measurement and automation applications. The Company's application software products leverage the increasing capability of desktop and portable computers and workstations for data analysis, connectivity and presentation power to bring increasing efficiency and precision to measurement and automation applications. The Company's instrumentation software products include LabVIEW, LabWindows/CVI, ComponentWorks, Measure, Virtual Bench, TestStand and DASYLab. The Company's automation software products include BridgeVIEW and Lookout. All of the Company's application software products are highly integrated with the Company's hardware/driver software.
Instrumentation Software
The Company offers a variety of software products for developing instrumentation applications to meet the different programming and computer preferences of its customers. LabVIEW, LabWindows/CVI and ComponentWorks are programming environments with which users can develop GUIs, control instruments and acquire, analyze and present data. With these software products, users can design custom virtual instruments by creating a GUI on the computer screen through which they operate the actual program and control selected hardware. Users can customize front panels with knobs, buttons, dials and graphs to emulate control panels of traditional instruments or add custom graphics to visually represent the control and operation of processes. LabVIEW and LabWindows/CVI also have ready-to-use libraries for controlling hundreds of programmable instruments, including serial, GPIB and VXI, the Company's plug-in DAQ boards and PXI/PCI computer-based instruments. ComponentWorks has libraries for controlling GPIB instruments and the Company's plug-in DAQ boards. Once created, virtual instruments can be modified or used as components of another program by the original developer or another user.
The principal difference between these products is in the way users develop programs. With LabVIEW, users program graphically, developing application programs by connecting icons to create "block diagrams" which are natural design notations for scientists and engineers. LabVIEW is based on dataflow programming techniques invented and patented by the Company. LabWindows/CVI is designed for instrumentation users who are more comfortable programming with the conventional, text-based language of C, and automatically generates and debugs code for instrumentation programs. ComponentWorks adds application-specific OLE or ActiveX controls and libraries to the Microsoft Visual Basic, Visual C++ and Borland Delphi development environments.
The Company also sells a range of optional add-on products for LabVIEW, LabWindows/CVI and ComponentWorks, such as advanced analysis libraries, database tools and Internet integration.
The Company also offers a class of software products, VirtualBench and Measure, which do not require any programming. VirtualBench is a collection of "turnkey" virtual instruments that mimic the operation of traditional benchtop instruments, through the use of a PC and a plug-in DAQ board. Measure is an instrumentation add-on for Microsoft Excel that lets engineers and scientists collect instrumentation data directly into a spreadsheet.
In 1998, the Company added DASYLab to its line of instrumentation software products. DASYLab is a schematic environment by which users can quickly configure simple DAQ applications using both the Company's and third-party DAQ boards.
Also in 1998, the Company introduced a new software product called TestStand targeted for the T&M market. TestStand is a test management environment for organizing, controlling, and running automated production test systems on the factory floor. It also generates customized test reports and integrates product and test data across the customers' enterprise and across the Internet. TestStand manages tests that are written in LabVIEW, LabWindows/CVI, C and C++, and VisualBasic, so test engineers can easily share and re-use test code throughout their organization and from one product to the next. TestStand is a key element of the Company's strategy to broaden the reach of its application software products across the corporate enterprise.
Automation Software
The Company's Lookout and BridgeVIEW automation software products are targeted for the IA market. Lookout is a non-programming solution. Lookout is a human machine interface/supervisory control and data acquisition ("HMI/SCADA") software product that requires no programming or script writing. Lookout provides a scalable architecture for applications ranging from HMIs to large, sophisticated SCADA applications. BridgeVIEW industrial automation software offers a new approach to automation. The graphical programming technology pioneered by the Company's LabVIEW data acquisition and instrumentation software is core to BridgeVIEW. In the automation world, LabVIEW has been used for applications ranging from manufacturing execution systems (MES) in a frame plant to supervisory control of paper machines. BridgeVIEW builds on LabVIEW with tools tailored to IA systems.
Hardware Products and Related Driver Software
The Company's hardware and related driver software products include GPIB, VXI, DAQ, PXI, image acquisition, motion control, and industrial communications. The Company believes it can deliver significant cost/performance benefits to users and clearly distinguish its products from competitive products by designing proprietary ASICs for use in its hardware products. Software drivers are necessary to link hardware to the operating system and the Company's application software. The high level of integration between the Company's products provides users with the flexibility to mix and match hardware components when developing custom virtual instrumentation systems.
GPIB Interfaces/Driver Software. GPIB, also known as the IEEE 488 standard, has existed since 1975 and defines the protocol for transferring data between certain instruments and computers over an industry-standard cable. The computer must be equipped with a GPIB interface. Driver software controls the interface and the transfer of data between the instrument and the computer. GPIB is largely used in the T&M market.
The Company began selling GPIB products in 1977 and is a leading supplier of GPIB interface boards and driver software to control traditional GPIB instruments. These traditional instruments are manufactured by a variety of third-party vendors and are used primarily in the T&M market. The Company's diverse portfolio of hardware and software products for GPIB instrument control is available for a wide range of desktop computers, workstations and minicomputers. The Company's GPIB product line also includes products for portable computers such as a PCMCIA-GPIB interface card, and products for controlling GPIB instruments using the computer's standard parallel USB, IEEE 1394 (Firewire) and Ethernet ports.
Portability of GPIB application programs is provided by the Company's NI-488.2 driver software, considered a de facto industry standard, and NI-VISA driver software. The Company offers networking capabilities through its GPIB products. With these products, users can communicate with and control GPIB instruments from any point on an Ethernet-based TCP/IP network. The Company also offers a variety of GPIB support products, including converters, expanders, extenders, data buffers and GPIB system analyzers as well as cables and other accessories.
VXI Controllers/Driver Software. VXI is an industry standard high-end instrumentation platform developed in 1987 through an industry consortium to take advantage of the computation and display capabilities of desktop computers and workstations. With VXI, the physical size of multiple instrument systems can be decreased and communication between instruments and computers can be dramatically improved. Like GPIB, VXI is supported by a variety of traditional third-party instrument manufacturers and is largely used in the T&M market.
VXI instruments are modular in design and can be inserted into an industry-standard chassis. Unlike GPIB instruments, VXI modules do not have a front panel for manual operation or visual data presentation. Therefore, software is necessary for users to create, define the functionality of and operate VXI instrumentation systems. Today, VXI is being used primarily to supplement or replace high-end GPIB products in T&M applications.
The Company is a leading supplier of VXI computer controller hardware and the accompanying NI-VXI and NI-VISA driver software.
DAQ Hardware/Driver Software. DAQ hardware and driver software products are "instruments on a board" that users can combine with sensors, signal conditioning hardware and software to acquire analog data and convert it into a digital format that can be accepted by a computer. The Company believes that DAQ products are typically a lower-cost solution than traditional instrumentation.
The Company believes that applications suitable for automation with DAQ products are widespread throughout many industries for both T&M and IA applications, and that many systems currently using traditional instrumentation (either manual or computer-controlled) could be displaced by DAQ-based systems. The Company offers a range of DAQ products, including models for digital, analog and timing input-output, and for transferring data directly to a computer's random-access memory.
In 1997, the Company introduced a family of computer-based instruments that deliver stand-alone instrument quality and measurement capabilities with the flexibility and scalability inherent to PC-based virtual instrumentation solutions. Computer-based instruments deliver features comparable to stand-alone traditional instruments such as oscilloscopes, DMMs, and function and arbitrary waveform generators.
The Company's DAQ products provide a range of price/performance options, and include products for high speed applications such as on-line monitoring and control as well as products designed for long-term recording of slowly changing data such as temperatures. The Company offers DAQ hardware/driver software products for numerous desktop and notebook computers. The Company also offers SCXI (signal conditioning extensions for instrumentation) hardware, which expands the types and quantity of sensors that can be connected to the Company's data acquisition boards.
PXI Modular Instrumentation. The Company's PXI modular instrument platform, which was introduced in 1997, is a desktop PC packaged in a small, rugged form factor with expansion slots and instrumentation extensions. It combines mainstream PC software and PCI hardware with advanced instrumentation capabilities designed in the VXI architecture. In essence, PXI is an instrumentation PC - delivering many of the benefits of VXI in a much smaller package and at much lower prices. In 1998, the Company expanded its PXI product offerings to include modules which address a wide variety T&M and IA applications. Also, during 1998, PXI was formally established as an open industry standard and received endorsements from over 40 suppliers. The Company has targeted its PXI products for both the T&M and IA markets.
Image Acquisition. In late 1996, the Company introduced its first image acquisition hardware and software for the machine vision market. In the past, building PC-based machine vision systems was reserved for integrators, OEMs, and vision experts. Today, with the advanced technologies in personal computers and the Company's vision products, it is cost-effective for end-users to integrate vision into their T&M and IA applications. The Company's vision software is designed to work with many different environments, including LabVIEW, LabWindows/CVI, ComponentWorks and BridgeVIEW. Image acquisition is commonly used in applications for quality control of manufactured products.
Motion Control. During 1997, the Company acquired technologies and assets that resulted in the addition of a line of motion control hardware, software and peripheral products. This intelligent PC-based motion control hardware is programmable from industry standard development environments including LabVIEW, LabWindows/CVI, and BridgeVIEW. Virtual instrument software tools for motion are easily integrated with the Company's product line, allowing motion to be combined with image acquisition, test, measurement, data acquisition and automation. As in many areas, motion control is moving to PC-based systems and the motion products allow users to leverage standard hardware and software in measurement and automation applications to create robust, flexible solutions.
Industrial Communications Interfaces. In mid-1995, the Company began shipping its first interface boards for communicating with serial devices, such as dataloggers and PLCs targeted for IA applications, and benchtop instruments, such as oscilloscopes, targeted for T&M applications. Industrial applications need the same high-quality, easy-to-use hardware and software tools for communicating with industrial devices such as process instrumentation, PLCs, single-loop controllers, and a variety of I/O and DAQ devices. National Instruments offers three hardware and driver software product lines for communication with industrial devices - Controller Area Network (CAN), Foundation Fieldbus, and RS-485 and RS-232. The Company's industrial communication products are designed to work with standard serial software drivers, and Windows versions of LabVIEW, LabWindows/CVI, Lookout and BridgeVIEW.
Distributed Input/Output Hardware/Software. The Company introduced its FieldPoint product for distributed I/O applications in mid-1997. FieldPoint is an intelligent, distributed, and modular I/O system that gives industrial system developers an economical solution for monitoring and control applications. The FieldPoint system includes isolated analog and digital I/O modules, terminal base options, and network modules. FieldPoint software includes a server that provides seamless integration into BridgeVIEW, driver libraries for support under LabVIEW, LabWindows/CVI and Lookout, and an OPC server that provides wide compatibility of FieldPoint hardware with other industrial automation software packages.
Customer Training Courses
The Company offers fee-based training classes and self-paced course kits for its LabVIEW, LabWindows/CVI, Lookout, BridgeVIEW, ComponentWorks, GPIB, VXI, DAQ, image acquisition, and signal processing products. On-site courses are quoted per customer requests. The Company also offers programs to certify programmers and instructors for its products.
Markets and Applications
The Company's products are used across many industries in a variety of applications from research and development to production testing and industrial control.
Customers
The Company has a broad customer base, with no customer accounting for more than 3% of the Company's sales in 1998, 1997 or 1996.
Marketing
Through its worldwide marketing efforts, the Company strives to educate engineers and scientists about the benefits of the Company's virtual instrumentation philosophy, products and technology, and to highlight the performance, ease of use and cost advantages of its products. The Company also seeks to present its position as a technological leader among producers of instrumentation software and hardware and to help promulgate industry standards that will benefit users of computer-controlled instrumentation.
The Company reaches its intended audience through distribution of written and electronic materials and demonstration disks, participation in tradeshows and technical conferences and training and user seminars. An in-house staff develops the advertising, publicity, and promotional materials that the Company uses worldwide. The primary marketing/sales tool is the Company's catalog, published annually and distributed worldwide. The catalog is over 800 pages, with detailed tutorial information that educates readers about the Company's integrated product architecture and virtual instrumentation concept. Short-form versions of the catalog are typically also available in languages of major international markets, including French, German, Spanish and Japanese. Product and technical information is also provided through the Company's World Wide Web site on the Internet and through interactive CD-ROM. In 1997, the Company began selling some of its products over the Internet. During 1998, the Company introduced several new web initiatives including features that allow customers to view the Company's on-line catalog, interactively configure a system, place orders, track the status of orders, register products and obtain software upgrades. On January 1, 1999, the Company introduced a new feature to enable customers to obtain pricing in U.S. dollars, euros and yen. The Company expects to increase efforts in this area in the future.
The Company also uses two quarterly newsletters to educate current and prospective customers about its products and technologies: Instrumentation Newsletter and AutomationVIEW. The Instrumentation Newsletter includes new product information, feature articles that educate readers about new instrumentation technology, user solution case studies of real-world applications, product news from Alliance Program members and key customers, and event and customer education schedules. The Company's AutomationVIEW newsletter is targeted at IA prospects and customers.
The Company actively markets its products in higher education environments, and identifies many colleges, universities and trade and technical schools as key accounts. The Company offers special academic pricing and products to enable universities to utilize Company products in their classes and laboratories. The Company believes its prominence in the higher education area can contribute to its future success because students gain experience using the Company's products before they enter the work force.
Sales and Distribution
The Company distributes its software and hardware products through a direct sales organization, independent distributors, OEMs, VARs, system integrators and consultants. The Company has sales offices in the United States and sales offices and distributors in key international markets. International sales accounted for approximately 44%, 41% and 43% of the Company's revenues in 1998, 1997 and 1996, respectively. The Company expects that a significant portion of its total revenues will continue to be derived from international sales. See Note 12 of Notes to Consolidated Financial Statements for details concerning the geographic breakdown of the Company's net sales, operating income and identifiable assets.
Through all of its sales channels, the Company seeks to approach potential customers with a highly technical sales force. The Company believes that the majority of sales are made directly to those persons within an organization who actually use the Company's products to integrate their own systems. The Company identifies and targets major end-user accounts as those having a large number of actual or potential end users, and believes that it achieves a high level of repeat customer sales. The Company targets major accounts with a variety of targeted sales and marketing campaigns such as seminars, user groups, newsletters and direct mail.
Direct Sales
The Company directly markets and sells its products in the United States, Canada and many European and Asia/Pacific countries. The Company has sales offices located throughout the United States (including the District of Columbia) and in key international markets. Many of the Company's international sales offices employ application engineering technical support specialists as well as sales, marketing and administrative personnel.
The Company's international sales are subject to inherent risks, including fluctuations in local economies; difficulties in staffing and managing foreign operations; greater difficulty in accounts receivable collection; costs and risks of localizing products for foreign countries; unexpected changes in regulatory requirements, tariffs and other trade barriers, difficulties in the repatriation of earnings and burdens of complying with a wide variety of foreign laws. The Company's sales outside of North America are denominated in local currencies, and accordingly, the Company is subject to the risks associated with fluctuations in currency rates. In particular, increases in the value of the dollar against foreign currencies decrease the dollar value of foreign sales requiring the Company either to increase its price in the local currency, which could render the Company's product prices noncompetitive, or to suffer reduced revenues and gross margins as measured in US dollars. These dynamics have adversely affected revenue growth in international markets in recent years. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 11 of Notes to Consolidated Financial Statements.
Distributors
The Company utilizes distributors primarily to market its products in geographic areas not served by the Company's direct sales organization.
OEMs
The Company utilizes OEMs such as traditional instrument manufacturers who offer integrated systems and/or services to their customer bases. The Company approaches OEM accounts with its standard product lines and offers quantity discounts based on volume commitments and technical support capabilities and requirements. The Company also promotes its sales and marketing capabilities to its OEMs by providing specialized product training, documentation, packaging and part numbers to simplify ordering, flexible shipping and warranty repair options and joint promotion.
VARs, System Integrators and Consultants
The Company has relationships with third-party VARs, system integrators and consultants who offer add-on products and system integration services. These third-party developers expand the Company's market and sales opportunities by adding value to the Company's standard products, making them suitable for vertical market applications such as manufacturing automation or image processing and analysis. The Company maintains a formal third-party sales/marketing/training program, called the Alliance Program, which it uses to work with many of the VARs, system integrators and consultants. Applicants must be sponsored for membership by a Company sales engineer, pass qualification criteria and pay a nominal annual membership fee. In late 1998, the Company introduced an elite level of its Alliance Program called Select Integrators. Select Integrators must qualify for the program based upon their level of business with the Company. As of December 31, 1998, the Company's Alliance Program had over 500 members including several Select Integrators. The Company publishes on-line directories on its website of third-party Alliance Program member products and services for use by its sales force and its end users to locate additional products and/or services compatible with the Company's products. The Company makes available to qualified third-parties the opportunity to participate in joint marketing and sales programs, such as trade shows, customer sales events and the Instrumentation Newsletter. In addition to its relationships with third party VAR, system integrators and consultants, the Company has a direct presence in the German DAQ systems integration market through its DATALOG subsidiary.
Customer Support
The Company believes the ability to provide comprehensive service and support to its customers is an important factor in its business. The Company permits customers to return products within 30 days from receipt for a refund of the purchase price less a restocking charge, and generally provides a two-year warranty on GPIB hardware products, a one-year warranty on other hardware products, and a 90-day warranty on cables and software (medium only). Historically, warranty costs have not been material. Some of the key elements of the Company's service and support strategy include:
Customer Technical Support
The Company maintains a large staff of application engineers at its corporate facility, all of whom are highly qualified technical professionals. Application engineers are also assigned to the Company's major international offices. These application engineers provide customer support by telephone, fax, electronic mail and world-wide web forums, and electronic bulletin boards, and are trained in both instrumentation and computer technology.
Upgrades
The Company typically offers programs in which existing customers can upgrade to the latest Company products at a reduced cost. Application software customers have the option of purchasing a one-year renewable maintenance and support program, which entitles them to new software releases for no additional charge and priority access to the Company's technical support hotline.
Customer Education
The Company offers a variety of fee-based training classes ranging in scope from basic and introductory courses for new users to advanced courses for experienced users.
Competition
The markets in which the Company operates are characterized by intense competition from numerous competitors, and the Company expects to face further competition from new market entrants in the future. A key competitor is Hewlett-Packard Company ("HP"), which has been the leading supplier of traditional instrumentation solutions for decades. The Company believes HP is the dominant supplier of GPIB and VXI-compatible instruments and systems in the T&M market. HP is also a leading supplier of equipment used in data acquisition and control applications. Although HP offers its own line of instrument controllers, HP also offers hardware and software add-on products for third-party desktop computers and workstations that directly compete with the Company's virtual instrumentation products. HP is aggressively advertising and marketing its products and system integration services. Because of HP's dominance in the instrumentation business, changes in its marketing strategy or product offerings could have a material adverse affect on the Company. The Company also faces competition from a variety of other competitors.
Certain of the Company's competitors have substantial competitive advantages in terms of breadth of technology, sales, marketing and support capability and resources, including the number of sales and technical personnel and their ability to cover a geographic area and/or particular account more extensively and with more complete solutions than the Company can offer, and more extensive warranty support, system integration and service capabilities than those of the Company. In addition, large competitors can often enter into strategic alliances with key customers or target accounts of the Company, which can potentially have a negative impact on the Company's success with those accounts.
The Company believes its ability to compete successfully depends on a number of factors both within and outside its control, including: product pricing, quality and performance; success in developing new products; adequate manufacturing capacity and supply of components and materials; efficiency of manufacturing operations; effectiveness of sales and marketing resources and strategies; strategic relationships with other suppliers; timing of new product introductions by the Company and its competitors; protection of the Company's products by effective use of intellectual property laws; general market and economic conditions; and events related to weather and government actions throughout the world. There can be no assurance that the Company will be able to compete successfully in the future.
The Company is continually designing new and improved products to maintain its competitive position. Because of the rapidly changing computer technology for which many of the Company's products are designed, the Company believes that its future success will depend in part on its ability to continue to improve its products and technologies. In the past, certain competitors have cloned some of the Company's hardware products at much lower prices, and promoted these hardware products as being capable of running the Company's software. The Company has responded to this tactic in the past by releasing new and improved versions of its products designed around proprietary ASICs that have improved performance and functionality in an effort to surpass the competition.
Research and Development
The Company believes that its long-term growth and success depends, in part, on delivering high quality software and hardware products on a timely basis. The Company intends to focus its 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 and price/performance.
The Company's research and development staff strives to build quality into products at the design stage in an effort to reduce overall development and manufacturing costs. The Company's research and development staff also designs proprietary ASICs, many of which are designed for use in several products. The goal of the ASIC design program is to further differentiate the Company's products from competing products, to improve manufacturability and to reduce costs. The Company seeks to reduce the time to market for new and enhanced products by sharing its internally developed hardware and software components across multiple products.
In the past, the Company has experienced significant delays in the introduction of new products. The Company's strategy of developing products based primarily on third parties' operating environments is substantially dependent on the Company's ability to gain pre-release access to, and to develop expertise in, current and future product developments of such companies. There can be no assurance that the Company will continue to receive such pre-release access from any of these companies, or, even with such access, that the Company will be able to develop products on a timely basis that are compatible with future releases.
The Company has implemented certain programs, including pre-release bug analysis measures and enhanced project-tracking efforts, in order to improve the product development process and to permit more accurate product development scheduling. Nonetheless, there can be no assurance that the Company's research and development efforts will not encounter delays or other difficulties, that development efforts will result in commercially successful products, or that the Company's products will not be rendered obsolete by changing technology or new product announcements by other companies.
As of December 31, 1998, the Company employed 424 people in product research and development. The Company's research and development expenses were $34.8 million, $30.3 million, and $24.4 million for 1998, 1997, and 1996, respectively.
Intellectual Property
The Company relies on a combination of patent, trade secret, copyright and trademark law, contracts and technical measures to establish and protect its proprietary rights in its products. The Company believes that legal protection through means such as the patent and copyright laws will be less influential on the Company's ability to compete than such factors as the creativity of its development staff, its ability to expand its market share, develop new markets and serve its customers.
As of December 31, 1998, the Company held 65 United States patents and 4 patents in foreign countries (one patent registered in Europe and 8 countries; one patent in Canada, one patent in Europe and 3 countries, and one patent in Japan), and had 89 patent applications pending in the United States and foreign countries. Twenty-three of such United States patents are software patents related to LabVIEW, and cover fundamental aspects of the graphical programming approach used in LabVIEW. The Company's patents expire from 2007 to 2017. No assurance can be given that the Company's pending patent applications will result in the issuance of patents. The Company also owns certain registered trademarks in the United States and abroad.
Although the Company relies to some extent on trade secret protection for much of its technology, and regularly obtains confidentiality agreements with key customers who wish to know more about the Company's product development philosophy and/or future directions, there can be no assurance that third parties will not either independently develop the same or similar technology, obtain unauthorized access to the Company's proprietary technology or misuse the technology to which the Company has granted access.
The laws of certain foreign countries treat the protection of proprietary rights of the Company in its products differently from those in the United States, and in many cases the protection afforded by such foreign laws is not as strong as in the United States. The Company believes that its products and their use do not infringe the proprietary rights of third parties. There can be no assurance, however, that infringement claims will not successfully be made.
Manufacturing and Suppliers
The Company manufactures its products at its facilities in Austin, Texas. Product manufacturing operations at the Company can be divided into four areas: electronic circuit card and module assembly; cable assembly; technical manuals and product support documentation; and software duplication. The Company manufactures most of the electronic circuit card assemblies and modules in-house, although subcontractors are used from time to time. The Company manufactures some of its electronic cable assemblies in-house, but many assemblies are produced by subcontractors. The Company primarily subcontracts its software duplication and packaging functions. Reliance on contract manufacturers entails risks of quality problems, less control of product pricing, and potential unavailability of or delays in delivery of products, any of which could have a material adverse effect on the Company's results of operations. There can be no assurance that the Company, together with its third-party manufacturers, will be able to produce sufficient quantities of the Company's products in a timely manner.
The marketplace dictates that many of the Company's products be shipped very quickly after an order is received. Since purchased component and manufacturing lead times are typically much longer than the short order fulfillment time, the Company is required to keep adequate amounts of finished goods inventory and must use an accurate system for forecasting demand for those products in its production planning operations. Fluctuations in demand for the Company's products typically result from month-to-month variations in the quantity and mix of products and from normal, seasonal variations. A variety of circumstances, including inaccurate forecasts of customer demand, poor availability of purchased components, supplier quality problems, production equipment problems, carrier strikes or damage to products in manufacturing operations, could create a buildup of excess finished goods on the one hand or an inability to timely deliver product on the other. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Engineering refinements to the Company's new hardware and software products are fairly common. These changes can result in the disruption of the manufacturing operation and concurrent delays in delivery dates. Finished goods inventory at the Company's international branches typically has a short shelf life due to engineering changes and product upgrades initiated by the Company's product development operation, and, if managed incorrectly, can result in significant quantities of obsolete inventory. This relatively short shelf life, and the resulting requirement to properly manage the quantity of inventory to meet customer demand while minimizing inventory obsolescence, has been and continues to be a challenge to the Company and its branch offices. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."
The Company obtains most of its electronic components from suppliers located principally in the United States and Asia. Some of the components purchased by the Company, including ASICs, are sole-sourced. Any disruption of the Company's supply of sole or limited source components, whether resulting from quality, production or delivery problems, could adversely affect the Company's ability to manufacture its products, which could in turn adversely affect the Company's business and results of operations.
Backlog
The Company typically ships products shortly following the receipt of an order. Accordingly, the Company does not view backlog data as an indicator of future sales.
Employees
As of December 31, 1998, the Company had 1,658 employees, including 424 in research and development, 803 in sales and marketing and customer support, 220 in manufacturing and 211 in administration and finance. None of the Company's employees is represented by a labor union and the Company has never experienced a work stoppage. The Company considers its employee relations to be good.
ITEM 2.
ITEM 2. PROPERTIES
The Company's principal administrative, sales, marketing, manufacturing, research and development activities are conducted at three Company-owned buildings in Austin, Texas. The Company owns approximately 69 acres of land in north Austin, Texas. In 1998, the Company completed construction of a 232,000 square foot office facility, which is located next to an existing 140,000 square foot manufacturing facility. The Company also owns a 136,000 square foot office building in Austin, Texas in which it houses certain of its sales operations. A portion of the 136,000 square foot office building is currently leased to International Business Machines Corporation.
As of December 31, 1998, the Company also maintained a number of sales and support offices in the United States and overseas. The Company believes existing field sales and support facilities are adequate to meet its current requirements.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Not Applicable.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock, $0.01 par value, began trading on the Nasdaq National Market System under the symbol NATI effective March 13, 1995. Prior to that date, there was no public market for the Common Stock. The high and low closing prices for the Common Stock in the following table, as reported by Nasdaq, have been retroactively restated to reflect the three-for-two stock split declared by the Company's Board of Directors on October 15, 1997 for holders of record as of the close of business on October 28, 1997.
1998 High Low
First Quarter 1998 34 7/8 25 1/4 Second Quarter 1998 36 3/8 26 5/8 Third Quarter 1998 34 1/4 21 7/8 Fourth Quarter 1998 34 4/7 19
1997 High Low
First Quarter 1997 25 5/6 20 2/3 Second Quarter 1997 23 1/2 18 1/2 Third Quarter 1997 31 21 5/6 Fourth Quarter 1997 33 1/3 25
At the close of business on February 25, 1999, there were approximately 896 holders of record of the Common Stock and approximately 5,000 shareholders of beneficial interest.
The Company believes factors such as quarterly fluctuations in results of operations, announcements by the Company or its competitors, technological innovations, new product introductions, governmental regulations, litigation or changes in earnings estimates by analysts may cause the market price of the Common Stock to fluctuate, perhaps substantially. In addition, stock prices for many technology companies fluctuate widely for reasons that may be unrelated to their operating results. These broad market and industry fluctuations were most recently noted during the third quarter of 1998 when many technology stocks declined in price. There can be no assurances that these market concerns will not continue in the immediate future and may adversely affect the market price of the Company's Common Stock.
To date, the Company has not paid any cash dividends on its Common Stock. The Company currently anticipates that it will retain any available funds to finance the growth and operation of its business and does not anticipate paying any cash dividends in the immediate future.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements, including the Notes to Consolidated Financial Statements. The information set forth below is not necessarily indicative of results of future operations. The information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations."
Years Ended December 31, ------------------------------------------------ 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- (in thousands, except per share data) Statements of Income Data: Net sales:.............. North America......... $153,435 $141,784 $114,382 $ 93,001 $ 77,333 Europe................ 86,961 66,318 58,108 51,145 38,505 Asia Pacific.......... 33,834 32,777 28,225 20,673 11,165 -------- -------- -------- -------- -------- Consolidated net sales 274,230 240,879 200,715 164,819 127,003
Cost of sales........... 65,187 55,096 49,755 39,525 30,627 -------- -------- -------- -------- -------- Gross profit.......... 209,043 185,783 150,960 125,294 96,376 -------- -------- -------- -------- --------
Operating expenses: Sales and marketing... 100,783 87,096 72,067 63,733 49,957 Research and development 34,757 30,296 24,387 19,991 15,163 General and administrative 20,455 18,508 17,129 15,071 11,414 ------- -------- -------- -------- -------- Total operating expenses 155,995 135,900 113,583 98,795 76,534 -------- -------- -------- -------- --------
Operating income...... 53,048 49,883 37,377 26,499 19,842
Other income (expense): Interest income....... 3,439 3,455 2,405 1,635 240 Interest expense...... (463) (502) (844) (875) (542) Net foreign exchange (loss) gain.......... (224) (2,649) (899) 150 1,556 -------- -------- -------- -------- -------- Income before income taxes 55,800 50,187 38,039 27,409 21,096
Provision for income taxes 18,414 16,562 12,553 9,986 8,129 -------- -------- -------- -------- --------
Net income............ $ 37,386 $ 33,625 $ 25,486 $ 17,423 $ 12,967 ======== ======== ======== ======== ========
Basic earnings per share $ 1.14 $ 1.03 $ 0.79 $ 0.56 $ 0.48 ======== ======== ======== ======== ======== Weighted average shares outstanding-basic....... 32,832 32,563 32,359 31,158 27,164 ======== ======== ======== ======== ========
Diluted earnings per share $ 1.10 $ 1.00 $ 0.77 $ 0.55 $ 0.47 ======== ======== ======== ======== ======== Weighted average shares outstanding-diluted..... 34,100 33,656 32,943 31,424 27,483 ======== ======== ======== ======== ========
December 31, ------------------------------------------------ 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- (in thousands) Balance Sheet Data: Cash and cash equivalents $ 51,538 $ 31,943 $ 30,211 $ 12,016 $ 7,526 Short-term investments.. 49,158 51,067 48,956 37,765 --- Working capital......... 133,510 112,142 99,294 74,546 26,869 Total assets............ 249,786 204,490 169,225 137,102 70,751 Long-term debt, net of current portion 4,379 5,151 9,175 11,603 9,083 Total stockholders' equity 204,184 161,754 126,953 98,736 40,474
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussion in this document contains trend analysis and other forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Actual results could differ materially from those projected in the forward-looking statements throughout this document as a result of a number of important factors. For a discussion of important factors that could affect the Company's results, please refer to the risk factors set forth below in Factors Affecting the Company's Business, in the financial line item discussions below and elsewhere in this document.
Overview
National Instruments Corporation designs, develops, manufactures and markets instrumentation and automation software and specialty interface cards for general commercial, industrial and scientific applications. The Company offers hundreds of products used to create virtual instrumentation systems for measurement and automation. The Company has identified two major markets for its products: test and measurement and industrial automation. Many of the Company's products may be used in either environment, and consequently, specific application of the Company's products is determined by the end-customer and often is not known to the Company at the time of sale. The Company's products are used in a variety of applications from research and development to production testing and industrial control. In test and measurement applications, the Company's products can be used to monitor and control traditional instruments or to create computer-based instruments that can replace traditional instruments. In industrial automation applications, the Company's products can be used in the same ways as in test and measurement and can also be used to integrate measurement functionality with process automation capabilities. The Company sells to a large number of customers in a wide variety of industries. No single customer accounted for more than 3% of the Company's sales in 1998, 1997 or 1996.
The Company's revenues have grown every year since 1977 and the Company has been profitable in every year since 1990. There can be no assurance that the Company's net sales will continue to grow or that the Company will remain profitable in future periods. As a result, the Company believes historical results of operations should not be relied upon as indications of future performance.
Results of Operations
The following table sets forth, for the periods indicated, the percentage of net sales represented by certain items reflected in the Company's consolidated statements of income:
Years Ended December 31, --------------------------------------- 1998 1997 1996 ----------- ----------- ----------- Net sales North America............. 56.0% 58.9% 57.0% Europe.................... 31.7 27.5 29.0 Asia Pacific.............. 12.3 13.6 14.0 ----------- ----------- ----------- Consolidated net sales.... 100.0 100.0 100.0 Cost of sales............... 23.8 22.9 24.8 ----------- ----------- ----------- Gross profit.............. 76.2 77.1 75.2 Operating expenses: Sales and marketing....... 36.7 36.1 35.9 Research and development.. 12.7 12.6 12.2 General and administrative 7.5 7.7 8.5 ----------- ----------- ----------- Total operating expenses 56.9 56.4 56.6 ----------- ----------- ----------- Operating income........ 19.3 20.7 18.6 Other income (expense): Interest income .......... 1.3 1.4 1.2 Interest expense.......... (0.2) (0.2) (0.4) Net foreign exchange loss. (0.1) (1.1) (0.4) ----------- ----------- ----------- Income before income taxes.. 20.3 20.8 19.0 Provision for income taxes.. 6.7 6.9 6.3 ----------- ----------- ----------- Net income.................. 13.6% 13.9% 12.7% =========== =========== ===========
Net Sales. In 1998, net sales for the Company's products reached $274.2 million, a 14% increase from the level achieved in 1997, which followed an increase in net sales of 20% in 1997 over the level achieved in 1996. This year marks the twenty-second year of double-digit annual sales growth. The increase in sales in these periods is primarily attributable to the introduction of new and upgraded products in each period, increased market acceptance of the Company's products in each of the major geographical areas in which the Company operates, and an expanded customer base. The decrease in the 1998 U.S. dollar annual growth rate, 14% as compared to 20% in 1997, is attributed to a slowdown in sales growth in North America and Asia Pacific.
North American revenue was $153.4 million in 1998, an increase of 8.2% from 1997, following a 24% increase in 1997 over 1996. The increase in sales in North America in 1998 is primarily attributable to increased demand for the Company's products in the telecom and automotive industries and the industrial automation market. The decrease in the North American revenue growth rate is attributed to a decrease in sales of the Company's products as a result of an overall downturn in the test and measurement market. This downturn was most pronounced in sales to customers in the automated test equipment, semiconductor, defense and aerospace industries. The slowdown in the automated test equipment and semiconductor markets is partially attributable to the effect on the U.S. economy of the Asian economic situation. In addition, the Company was not successful in increasing its U.S. field sales force until the fourth quarter of 1998.
European revenue was $87.0 million in 1998, an increase of 31% over 1997, following a 14% increase in 1997 from 1996. The increase in revenue growth in Europe is primarily attributable to market acceptance of the Company's products, the strong local economies and the Company's expansion in its European sales force.
Asia Pacific revenue grew 3% to $33.8 million in 1998, which followed a 16% increase in 1997 over 1996 levels. The decrease in the Asia Pacific revenue growth rate during 1998 is primarily attributed to the weakening of the Japanese yen, Korean won and other Asian currencies and the weak state of these economies. See the discussion below for more information concerning the impact of foreign currency fluctuations on sales growth.
International sales (sales to customers outside of North America) accounted for 44%, 41% and 43% of the Company's consolidated net sales for 1998, 1997 and 1996, respectively. The Company intends to continue to expand its international operations by increasing market presence in existing markets, and continuing to use distributors to sell its products in countries in which the sales volume does not justify direct sales activities.
The Company's international sales are subject to inherent risks, including fluctuations in local economies; difficulties in staffing and managing foreign operations; greater difficulty in accounts receivable collection; costs and risks of localizing products for foreign countries; unexpected changes in regulatory requirements, tariffs and other trade barriers; difficulties in the repatriation of earnings and burdens of complying with a wide variety of foreign laws. The Company's sales outside of North America are denominated in local currencies, and accordingly, the Company is subject to the risks associated with fluctuations in currency rates. In particular, increases in the value of the dollar against foreign currencies decrease the U.S. dollar value of foreign sales requiring the Company either to increase its price in the local currency, which could render the Company's product prices noncompetitive, or to suffer reduced revenues and gross margins as measured in U.S. dollars. These dynamics have adversely affected revenue growth in international markets in 1998 and 1997. The Company's foreign currency hedging program includes both foreign currency forward and purchased option contracts to reduce the effect of exchange rate fluctuations. However, the hedging program will not eliminate all of the Company's foreign exchange risks. (See "Foreign Exchange Gain/Loss" below and Note 11 of Notes to Consolidated Financial Statements.)
Sales made by the Company's direct sales offices in Europe and Asia Pacific are denominated in local currencies, and accordingly, the U.S. dollar equivalent of these sales is affected by changes in the weighted average value of the U.S. dollar. This weighted average is calculated as the percentage change in the value of the currency relative to the dollar, multiplied by the proportion of international sales recorded in the particular currency. Between 1997 and 1998 this weighted average value of the U.S. dollar increased by 4%, causing an equivalent decrease in the U.S. dollar value of the Company's foreign currency sales and expenses. If the weighted average value during 1998 had been the same as that in 1997, the Company's consolidated net sales for 1998 would have been $278.9 million representing an increase of $4.7 million, which represents 16% consolidated sales growth. If the weighted average value during 1998 had been the same as that in 1997, the Company's consolidated operating expenses would have been $157.0 million, representing an increase of $1.0 million. The preceding proforma amounts and percentages are presented for comparison purposes.
Gross Profit. As a percentage of sales, gross profit represented 76%, 77% and 75% in 1998, 1997, and 1996, respectively. The relatively high software content of the Company's products is demonstrated in the gross margins achieved by the Company. In 1998, the effect of foreign currency exchange rate fluctuations and the weak Asia Pacific economies negatively impacted revenue growth and gross margin. A lesser factor affecting gross margin includes increased manufacturing expenses attributable to the addition of a third production line in April 1998. The higher margin in 1997 is the result of reduced direct material costs used in production and the favorable leveraging of our production overhead expenses against the increase in sales. There can be no assurance that the Company will maintain its historical margin.
The marketplace for the Company's products dictates that many of the Company's products be shipped very quickly after an order is received. As a result, the Company is required to maintain significant inventories. Therefore, inventory obsolescence is a risk for the Company due to frequent engineering changes, shifting customer demand, the emergence of new industry standards and rapid technological advances including the introduction by the Company or its competitors of products embodying new technology. While the Company maintains valuation allowances for excess and obsolete inventory and management continues to monitor the adequacy of such valuation allowances, there can be no assurance that such valuation allowances will be sufficient.
The Company believes its current manufacturing capacity is more than adequate to meet current needs.
Sales and Marketing. Sales and marketing expense in 1998 increased 16% from 1997, which followed an increase of 21% in 1997 from 1996. The increase in the expense in absolute amounts during 1998 and 1997 is primarily attributable to programs to increase the Company's international presence in both the European and Asia Pacific markets, increases in sales and marketing personnel both internationally and in North America, increased marketing for new products and a worldwide seminar series. Sales and marketing personnel increased by 132 during 1998 from 671 at December 31, 1997 to 803 at December 31, 1998. Sales and marketing expense as a percentage of revenue increased to 37% in 1998 from 36% in 1997 and 1996.
The Company expects sales and marketing expenses in future periods to increase in absolute dollars, and to fluctuate as a percentage of sales based on initial marketing and advertising campaign costs associated with major new product releases and entry into new market areas, increasing product demonstration costs and the timing of domestic and international conferences and trade shows.
Research and Development. Research and development expense in 1998 increased 15% compared to 1997 following an increase of 24% in 1997 over 1996. Excluding the effect of acquisition of products, technology and assets, research and development expense grew 12%, 26% and 17% during 1998, 1997 and 1996, respectively. (See Note 8 of Notes to Consolidated Financial Statements for a description of the Company's acquisitions.) The increase in research and development expenditures (excluding the acquisition related charges in 1998 and 1997) in absolute amounts and as a percentage of sales in each period was primarily due to the hiring of additional product development engineers. Research and development personnel increased from 373 at December 31, 1997 to 424 at December 31, 1998. The Company believes that a significant investment in research and development is required to remain competitive and continue revenue growth.
The Company capitalizes software development costs in accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." The Company amortizes such costs over the related product's estimated economic life, generally three years, beginning when a product becomes available for general release. Amortization expense totaled $2.8 million, $1.5 million and $2.1 million during 1998, 1997 and 1996, respectively. The increase in amortization expense is due primarily to amortization of $750,000 of purchased software capitalized in the 1998 Datalog acquisition. Software development costs capitalized during such years were $3.3 million, $2.1 million and $3.0 million, respectively. The levels of capitalization for 1998 were primarily a result of LabVIEW 5.0 and 5.1, NI-DAQ 6.5 and purchased software development costs related to the Datalog acquisition. The significant items capitalized in 1997 include NI-DAQ, LabVIEW 5.0, LabWindows/CVI and purchased software development costs related to the nuLogic acquisition. (See Note 5 of Notes to Consolidated Financial Statements for a description of intangibles.)
General and Administrative. General and administrative expenses in 1998 increased 10.5% from 1997, considerably lower than the increase in revenue of 14%. The continued leveraging of expenses is primarily due to the implementation of new management information systems in the U.S., Europe and Japan. In absolute dollars, the majority of the increase was comprised of cost attributable to staffing increases in the information system department. Support of the new management information systems and web based applications was the main focus areas for incremental investment in 1998. The 1998 increase followed an 8% increase in 1997 which also was driven by training and implementation costs of the new management information systems. General and administrative expenses as a percentage of revenue declined to 7.5% during 1998. This marks the third consecutive year of reduced general and administrative expenses as a percent of revenue. This decline is attributable to the efficiencies brought on by the improvements made in recent years to the worldwide management information system. The Company expects that general and administrative costs will continue to increase in absolute amounts as the Company continues to invest in developing web based commerce and management information systems.
Interest Income and Expense. Interest income in 1998 was flat from 1997, which followed an increase of 44% in 1997 from 1996. The primary source of interest income is from the investment of proceeds from the Company's issuance of common stock under an initial public offering in March 1995 and cash flow generated from operations. Net cash provided by operating activities in 1998 totaled $46.0 million. During the first half of 1998, $16.5 million was used to pay construction costs of the Company's new office building. During 1997, interest income increased due to the investment of cash generated from operations. Interest expense decreased 8% from 1997, which followed a decrease of 41% in 1997 from 1996. Interest expense represents less than 1% of net sales and fluctuates as a result of bank borrowings and interest terms thereon. The 8% decrease in interest expense in 1998 from 1997 is attributed to scheduled repayments on the manufacturing facility loan. The large decrease in interest expense from 1996 to 1997 is attributed to repayments of equipment and facility loans during January 1997. (See Note 6 of Notes to Consolidated Financial Statements for a description of the Company's debt.)
Foreign Exchange Gain/Loss. The Company experienced net foreign exchange losses of $224,000 in 1998, compared to losses of $2.6 million and $899,000 in 1997 and 1996, respectively. These results are attributable to movements between the U.S. dollar and the local currencies in countries in which the Company's sales subsidiaries are located. The Company recognizes the local currency as the functional currency of its international subsidiaries.
During 1998, the Company utilized foreign currency forward exchange contracts to economically hedge a majority of its foreign currency-denominated receivables in order to reduce its exposure to significant foreign currency fluctuations. The Company typically limits the duration of its foreign exchange forward contracts to 90 days.
In December 1997, the Company expanded its foreign currency hedging program to also include foreign currency purchased option contracts in order to reduce its exposures to fluctuations in future net foreign currency cash flows. The Company's policy allows for the purchase of 5% "out-of-the-money" foreign currency purchased option contracts for up to 80% of its risk and limits the duration of these contracts to 12 months. As a result, the Company's hedging activities only partially address its risks in foreign currency transactions, and there can be no assurance that this strategy will be successful.
Effective January 1, 1999, the Company elected to adopt SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." (See Note 15 of Notes to Consolidated Financial Statements.)
The Company does not currently invest in contracts for speculative purposes nor does it intend to do so in the foreseeable future. (See Note 11 of Notes to Consolidated Financial Statements for a description of the Company's forward and purchased option contracts and hedged positions.)
Provision for Income Taxes. The provision for income taxes reflects an effective tax rate of 33% in 1998, 1997 and 1996.
At December 31, 1998, seven of the Company's subsidiaries had available, for income tax purposes, foreign net operating loss carryforwards of approximately $4.2 million, of which $3.5 million expire between 2000 and 2008. The remaining $654,000 of loss carryforwards may be carried forward indefinitely to offset future taxable income in the related tax jurisdictions. (See Note 7 of Notes to Consolidated Financial Statements for further discussion of the Company's income tax provision.)
Liquidity and Capital Resources
The Company is currently financing its operations and capital expenditures through cash flow from operations. At December 31, 1998, the Company had working capital of approximately $133.5 million compared to $112.1 million at December 31, 1997.
Accounts receivable increased to $45.6 million at December 31, 1998 from $37.4 million at December 31, 1997, as a result of higher sales levels. Receivable days outstanding at December 31, 1998 was 57 days compared to 54 days outstanding at December 31, 1997. Consolidated inventory balances have increased to $16.5 million at December 31, 1998 from $15.5 million at December 31, 1997. Inventory turns of 4.2 per year represent an improvement over turns of 4.1 per year at December 31, 1997 and reflect improvements in inventory management occurring at the Company's manufacturing facility in Austin, Texas as well as at the centralized European warehouse in Amsterdam.
Cash used for investing activities in 1998 includes $28.0 million for the purchase of property and equipment, capitalization of software development costs of $2.8 million and purchase price of $2.2 million for the purchase of Datalog. The Company completed an office building located next to its manufacturing facility in Austin, Texas in the summer of 1998. The total cost for the new building, including furniture, fixtures and equipment was $31.0 million of which $16.5 million was paid in 1998 out of cash generated from operations.
The Company currently expects to fund expenditures for capital requirements as well as liquidity needs created by changes in working capital from a combination of available cash and short-term investment balances, internally generated funds, and financing arrangements with its current financial institutions. The Company has a $28.5 million credit agreement with NationsBank of Texas, N.A. which consists of (i) a $20.0 million revolving line of credit, and (ii) an $8.5 million manufacturing facility loan. As of December 31, 1998, the Company had no outstanding balance on the line of credit and had a balance of $5.2 million on the manufacturing facility loan. The revolving line of credit expires on December 31, 1999. The Company's credit agreements contain certain financial covenants and restrictions as to various matters, including the bank's prior approval of significant mergers and acquisitions. Borrowings under the line of credit are collateralized by substantially all of the Company's assets. (See Note 6 of Notes to Consolidated Financial Statements for additional information regarding the Company's debt.)
The Company believes that the cash flow from operations, if any, existing cash balances and short-term investments and credit available under the Company's existing credit facilities, will be sufficient to meet its cash requirements for at least the next twelve months. Cash requirements for periods beyond the next twelve months depend on the Company's profitability, its ability to manage working capital requirements and its rate of growth.
Market Risk
The Company is exposed to a variety of risks, including foreign currency fluctuations and changes in the market value of its investments. In the normal course of business, the Company employs established policies and procedures to manage its exposure to fluctuations in foreign currency values and changes in the market value of its investments.
Foreign Currency Hedging Activities. The Company's objective in managing its exposure to foreign currency exchange rate fluctuations is to reduce the impact of adverse fluctuations in such exchange rates on the Company's earnings and cash flow. Accordingly, the Company utilizes purchased foreign currency option contracts and forward contracts to hedge its exposure on anticipated transactions and firm commitments. The principal currencies hedged are the British pound, Japanese yen, German deutsche mark, French franc, Italian lire and Swedish krona. The Company monitors its foreign exchange exposures regularly to ensure the overall effectiveness of its foreign currency hedge positions. However, there can be no assurance the Company's foreign currency hedging activities will substantially offset the impact of fluctuations in currency exchange rates on its results of operations and financial position. Based on the foreign exchange instruments outstanding at December 31, 1998, an adverse change (defined as 20% in certain Asian currencies and 10% in all other currencies) in exchange rates would result in a decline in income before taxes of less than $4.0 million. Additionally, as the Company utilizes foreign currency instruments for hedging anticipated and firmly committed transactions, a loss in fair value for those instruments is generally offset by increases in the value of the underlying exposure. (See Note 11 of Notes to Consolidated Financial Statements for a description of the Company's financial instruments at December 31, 1998 and 1997.)
Short-term Investments. The fair value of the Company's investments in marketable securities at December 31, 1998 was $49.2 million. The Company's investment policy is to manage its investment portfolio to preserve principal and liquidity while maximizing the return on the investment portfolio through the full investment of available funds. The Company diversifies the marketable securities portfolio by investing in multiple types of investment-grade securities. The Company's investment portfolio is primarily invested in short-term securities with at least an investment grade rating to minimize interest rate and credit risk as well as to provide for an immediate source of funds. Based on the Company's investment portfolio and interest rates at December 31, 1998, a 100 basis point increase or decrease in interest rates would result in a decrease or increase of less than $400,000, respectively, in the fair value of the investment portfolio. Although changes in interest rates may affect the fair value of the investment portfolio and cause unrealized gains or losses, such gains or losses would not be realized unless the investments are sold.
Factors Affecting the Company's Business
Fluctuations in Quarterly Results. The Company's quarterly operating results have fluctuated in the past and may fluctuate significantly in the future due to a number of factors, including: changes in the mix of products sold; the availability and pricing of components from third parties (especially sole sources); the timing of orders; level of pricing of international sales; fluctuations in foreign currency exchange rates like the past devaluation in certain Asian currencies; the difficulty in maintaining margins, including the higher margins traditionally achieved in international sales; and changes in pricing policies by the Company, its competitors or suppliers. Specifically, if the Asian currencies again weaken against the U.S. dollar, and if the local sales prices cannot be raised, the Company could experience additional deterioration of its Asian profit margin. As has occurred in the past and as may be expected to occur in the future, new software products of the Company or new operating systems of third parties on which the Company's products are based, often contain bugs or errors that can result in reduced sales and/or cause the Company's support costs to increase, either of which could have a material adverse impact on the Company's operating results. Furthermore, the Company has significant revenues from customers in industries such as semiconductors, automated test equipment, telecommunications, aerospace, defense and automotive which are cyclical in nature. Downturns in these industries have adversely affected revenue growth in 1998 and they could continue to do so.
In recent years, the Company's revenues have been characterized by seasonality, with revenues typically being relatively constant in the first, second and third quarters, growing in the fourth quarter and being relatively flat or declining from the fourth quarter of the year to the first quarter of the following year. If this historical pattern continues, revenues for the first quarter of 1999 may not exceed revenues from the fourth quarter of 1998. The Company's results of operations in the third quarter of 1999 may be adversely affected by lower sales levels in Europe which typically occur during the summer months. The Company believes the seasonality of its revenue results from the international mix of its revenue and the variability of the budgeting and purchasing cycles of its customers throughout each international region.
New Product Introductions and Market Acceptance. The market for the Company's products is characterized by rapid technological change, evolving industry standards, changes in customer needs and frequent new product introductions, and is therefore highly dependent upon timely product innovation. The Company's success is dependent in part on its ability to successfully develop and introduce new and enhanced products on a timely basis to replace declining revenues from older products, and on increasing penetration in international markets. In the past, the Company has experienced significant delays between the announcement and the commercial availability of new products. Any significant delay in releasing new products could have a material adverse effect on the ultimate success of a product and other related products and could impede continued sales of predecessor products, any of which could have a material adverse effect on the Company's operating results. There can be no assurance that the Company will be able to introduce new products in accordance with announced release dates, that new products will achieve market acceptance or that any such acceptance will be sustained for any significant period. Failure of new products to achieve or sustain market acceptance could have a material adverse effect on the Company's operating results. Moreover, there can be no assurance that the Company's international sales will continue at existing levels or grow in accordance with the Company's efforts to increase foreign market penetration.
Operation in Intensely Competitive Markets. The markets in which the Company operates are characterized by intense competition from numerous competitors, and the Company expects to face further competition from new market entrants in the future. A key competitor is Hewlett-Packard Company ("HP"), which has been the leading supplier of traditional instrumentation solutions for decades. Although HP offers its own line of instrument controllers, HP also offers hardware and software add-on products for third-party desktop computers and workstations that provide solutions that directly compete with the Company's virtual instrumentation products. HP is aggressively advertising and marketing products that are competitive with the Company's products. Because of HP's strong position in the instrumentation business, changes in its marketing strategy or product offerings could have a material adverse effect on the Company's operating results.
The Company believes its ability to compete successfully depends on a number of factors both within and outside its control, including: new product introductions by competitors; product pricing; quality and performance; success in developing new products; adequate manufacturing capacity and supply of components and materials; efficiency of manufacturing operations; effectiveness of sales and marketing resources and strategies; strategic relationships with other suppliers; timing of new product introductions by the Company; protection of the Company's products by effective use of intellectual property laws; general market and economic conditions; and government actions throughout the world. There can be no assurance that the Company will be able to compete successfully in the future.
Management Information Systems.
During 1998, the Company implemented a contact management and technical support incident tracking system in 10 European branches, as well as a data warehouse to aid in real-time worldwide sales information analysis. In 1999, the Company will complete implementation of the contact management and technical support incident tracking system in the three remaining European branches, the U.S. and Japan. The Company will also devote significant effort on the development of our web commerce offerings.
Implementation of the new order entry, distribution and finance management information systems in Europe and Japan was completed in 1997. As with any information system, unforeseen issues may arise that could affect management's ability to receive adequate, accurate and timely financial information which in turn could inhibit effective and timely decisions. Furthermore, it is possible that one or more of the Company's three regional information systems could experience a complete or partial shutdown. If this shutdown occurred near the end of a quarter it could impact the Company's product shipments and revenues as product distribution is heavily dependent on the integrated management information systems in each region. Accordingly, operating results in that quarter would be adversely impacted due to the shipments which would not occur until the following period. The Company is working to achieve reliable regional management information systems to control costs and improve the ability to deliver its products in substantially all of its direct markets worldwide. No assurance can be given that the Company's efforts will be successful. The failure to receive adequate, accurate and timely financial information could inhibit management's ability to make effective and timely decisions. For further information related to the management information system see the discussion of the Impact of Year 2000 included in this document.
Risks Associated with International Operations and Foreign Economies. International sales are subject to inherent risks, including fluctuations in local economies, difficulties in staffing and managing foreign operations, greater difficulty in accounts receivable collection, costs and risks of localizing products for foreign countries, unexpected changes in regulatory requirements, tariffs and other trade barriers, difficulties in the repatriation of earnings and the burdens of complying with a wide variety of foreign laws. The regulatory environment in some emerging countries is very restrictive as their governments try to protect their local economy and value of their local currency against the U.S. dollar. Sales made by the Company's direct sales offices in Europe and Asia Pacific are denominated in local currencies, and accordingly, the U.S. dollar equivalent of these sales is affected by changes in the weighted average value of the U.S. dollar. This weighted average is calculated as the percentage change in the value of the currency relative to the dollar, multiplied by the proportion of international sales recorded in the particular currency. Between 1997 and 1998 this weighted average value of the U.S. dollar increased by 4%, causing an equivalent decrease in the U.S. dollar value of the Company's foreign currency sales and expenses. If the weighted average value during 1998 had been the same as that in 1997, the Company's consolidated net sales for 1998 would have been $278.9 million representing an increase of $4.7 million, which represents 16% consolidated sales growth. If the weighted average value during 1998 had been the same as that in 1997, the Company's consolidated operating expenses would have been $157.0 million, representing an increase of $1.0 million, or 15% from 1997. If the U.S. dollar strengthens again in the future, it could have a materially adverse effect on the operating results of the Company.
Dependence on Key Suppliers. The Company's manufacturing processes use large volumes of high-quality components and subassemblies supplied by outside sources. Several of these components are available through sole or limited sources. Sole-source components purchased by the Company include application-specific integration circuits ("ASICS") and other components. The Company has in the past experienced delays and quality problems in connection with sole-source components, and there can be no assurance that these problems will not recur in the future. Accordingly, the failure to receive sole-source components from suppliers could result in a material adverse effect on revenues and results of operations.
Proprietary Rights and Intellectual Property Litigation. The Company's success depends in part on its ability to obtain and maintain patents and other proprietary rights relative to the technologies used in its principal products. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may have in the past infringed or violated certain of the Company's intellectual property rights. As is typical in the industry, the Company from time to time may be notified that it is infringing certain patent or intellectual property rights of others. While no actions are currently pending by or against the Company, there can be no assurance that litigation will not be initiated in the future which may cause significant litigation expense, liability and a diversion of management's attention which may have a material adverse effect on results of operations.
Dependence on Key Management and Technical Personnel. The Company's success depends to a significant degree upon the continued contributions of its key management, marketing, research and development and operational personnel including Dr. Truchard, Mr. Kodosky and other members of senior management and key technical personnel. The Company has no agreements providing for the employment of any of its key employees for any fixed term and the Company's key employees may voluntarily terminate their employment with the Company at any time. The loss of the services of one or more of the Company's key employees in the future could have a material adverse effect on operating results. The Company also believes its future success will depend in large part upon its ability to attract and retain additional highly skilled management, technical, marketing, research and development, and operational personnel with experience in managing large and rapidly changing companies as well as training, motivating and supervising the employees. In addition, the recruiting environment for software engineering, sales and other technical professionals is very competitive. Competition for qualified software engineers is particularly intense and is likely to result in increased personnel costs. Failure to attract or retain qualified software engineers could have an adverse effect on the Company's operating results. The Company also recruits and employs foreign nationals to achieve its hiring goals primarily for entry-level engineering and software positions. There can be no guarantee that the Company will continue to be able to recruit foreign nationals to the current degree if government requirements for temporary and permanent residence becomes increasingly restrictive. These factors further intensify competition for key personnel, and there can be no assurance that the Company will be successful in retaining its existing key personnel or attracting and retaining additional key personnel.
Risk of Product Liability Claims. The Company's products are designed in part to provide information upon which the users may rely. The Company attempts to assure the quality and accuracy of the processes contained in its products, and to limit its product liability exposure through contractual limitations on liability, including disclaimers in its "shrink wrap" license agreements with end-users. If future products contain errors that produce incorrect results on which users rely, customer acceptance of the Company's products could be adversely affected. Further, the Company could be subject to liability claims that could have a material adverse effect on the Company's operating results or financial position. Although the Company maintains liability insurance, there can be no assurance that such insurance or the contractual provisions used by the Company to limit its liability will be sufficient.
Impact of Year 2000. Like many other companies, the Year 2000 computer issue creates risks for the Company. If internal systems do not correctly recognize and process date information beyond the year 1999, there could be an adverse impact on the Company's operations. There are two other related issues which could also lead to incorrect calculations or failures: i) some programs assign special meaning to certain dates, such as 9/9/99, and ii) the fact that the Year 2000 is a leap year. To address these Year 2000 issues with its internal systems, the Company has initiated a comprehensive program which is designed to deal with the most critical systems first. These activities are intended to encompass all major categories of systems in use by the Company, including network and communications infrastructure, manufacturing, research and development, facilities management, sales, finance and human resources. The Company's manufacturing equipment and systems are highly automated, incorporating PC's, embedded processors and related software to control activity scheduling, inventory tracking and manufacturing. As of December 1998, the majority of the Company's critical and priority manufacturing systems and non-manufacturing systems were determined to be already Year 2000 capable, or replacements, changes, upgrades or workarounds have been determined and tested. These replacements, changes and upgrades may not yet have been deployed.
The Company is continuing to test, gather and produce information about its products. Certain older products will not be tested. The Company is classifying its tested products into the following categories of compliance: compliant, compliant with minor issues, and not compliant. Most of the products tested are either compliant or compliant with minor issues. If a product is stated to be non-compliant, the Company plans to make information available as to how an organization could avoid possible Year 2000 issues regarding that product. The Company is also providing additional information and references to help other organizations test their products and applications so that end-users' systems are Year 2000 compliant.
A Year 2000 Readiness Disclosure Statement is available at the National Instruments web site. Information on the Company's web site is provided to customers for the sole purpose of assisting in planning for the transition to the Year 2000. No assurances can be made that problems will not arise such as customer problems with other software programs, operating systems or hardware that disrupt their use of the Company's products. There can be no assurances that such disruption would not negatively impact costs and revenues in future years.
The Company is also actively working with suppliers of products and services to determine the extent to which the suppliers' operations and the products and services they provide are Year 2000 capable and to monitor their progress toward Year 2000 capability. Highest priority is being placed on working with suppliers that are critical to the business. The Company has made inquiry of its major suppliers and to date has received written responses to its initial inquiries from 72% of critical suppliers. Follow-up activities seek to determine whether the supplier is taking all appropriate steps to fix Year 2000 problems and to be prepared to continue functioning effectively as a supplier in accordance with National Instruments' standards and requirements. Contingency plans are being developed to address issues related to suppliers that are not considered to be making sufficient progress in becoming Year 2000 capable in a timely manner. The Company is also developing contingency plans to address possible changes in customer order patterns due to Year 2000 issues. As with suppliers, the readiness of customers to deal with Year 2000 issues may affect their operations and their ability to order and pay for products.
The Company believes that its most likely worst case Year 2000 scenarios would relate to problems with the systems of third parties rather than with the Company's internal systems or its products. It is clear that the Company has the least ability to assess and remediate the Year 2000 problems of third parties and the Company believes the risks are greatest with infrastructure (e.g. electricity supply, water and sewer service), telecommunications, transportation supply chains and critical suppliers of materials.
A worst case scenario involving a critical supplier of materials would be the partial or complete shutdown of the supplier and its resulting inability to provide critical supplies to the Company on a timely basis. The Company does not maintain the capability to replace most third party supplies with internal production. Where efforts to work with critical suppliers to ensure Year 2000 capability have not been successful, contingency planning generally emphasizes the identification of substitute and second-source suppliers, and includes a planned increase in the level of inventory carried.
The Company is not in a position to identify or to avoid all possible scenarios; however, the Company is currently assessing scenarios and taking steps to mitigate the impacts of various scenarios if they were to occur. This contingency planning will continue through 1999 as the Company learns more about the preparations and vulnerabilities of third parties regarding Year 2000 issues. Due to the large number of variables involved, the Company cannot provide an estimate of the damage it might suffer if any of these scenarios were to occur.
In 1994, the Company commenced the replacement of its legacy information systems with a new generation of integrated applications. Since that time, the Company has progressively replaced its manufacturing distribution, order entry and financial systems in the U.S., Europe and Japan. These changes were made to improve management's control of the organization and increase operational efficiency. This early replacement of many of the Company's legacy systems has reduced the extent of the Company's internal Year 2000 exposure.
The Company's Year 2000 efforts have been undertaken almost entirely with its existing personnel. In some instances, consultants have been engaged to provide specific guidance or services. Activities with suppliers and customers have also involved their staffs and consultants.
The Company currently expects that the total cost of these programs, including both incremental spending and redeployed resources, will not exceed $3.7 million. Approximately $2.4 million has been spent on the programs to date. Expected Year 2000 costs for manufacturing and non-manufacturing internal systems in 1998 represent 37% of the total information technology budget for 1998. No significant internal systems projects are being deferred due to the Year 2000 program efforts. The estimated costs do not include any potential costs related to customer or other claims, or potential amounts related to executing contingency plans, such as costs incurred on account of an infrastructure or supplier failure. The Company has adequate general corporate funds with which to pay for the programs' expected costs. All expected costs are based on the current assessment of the programs and are subject to change as the programs progress.
As we get closer to December 31, 1999, certain of the Company's customers may decide to delay purchases of the Company's products as part of a general restriction on new system implementations. Should a significant number of the Company's customers adopt this strategy, this could have a material impact on the Company's operating results.
Based on currently available information, management does not believe that the Year 2000 matters discussed above related to internal systems or products sold to customers will have a material adverse impact on the Company's financial condition or overall trends in results of operations; however, it is uncertain to what extent the Company may be affected by such matters. In addition, there can be no assurance that the failure to ensure Year 2000 capability by a supplier, customer or another third party would not have a material adverse effect on the Company's financial condition or overall trends in results of operations.
Euro Conversion. Effective January 1, 1999, eleven of the 15 member countries of the European Union adopted a single European currency, the euro, as their common legal currency. Like many companies that operate in Europe, various aspects of the Company's business and financial accounting will be affected by the conversion to the euro. The Company has adopted the euro currency as its main operating currency for its European operations. The transition from many different pricing arrangements to one standard price list, in euros, for all of Europe allows for European pricing. In addition, the Company does not believe that the conversion to the euro will result in the cancellation of any significant contracts, or cause it to incur significant adverse tax consequences, or significantly affect its foreign currency risk management operations. The Company will continue to evaluate the impact of the euro conversion going forward. The Company believes that its internal accounting, order management and finance and banking systems will accommodate the conversion with minimal modification. There can be no assurances that the conversion will not adversely impact the Company's pricing, tax, currency hedging strategies or other systems and processes in the future.
ITEM 7(a). MARKET RISK
Response to this item is included in "Item 7 - Management's Discussion of Analysis of Financial Condition and Results of Operations - Market Risk" above.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is incorporated by reference to the Consolidated Financial Statements set forth on pages through hereof.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
Certain information required by Part III is omitted from this Report in that the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission (the "Proxy Statement") relating to its annual meeting of stockholders not later than 120 days after the end of the fiscal year covered by this Report, and such information is incorporated by reference herein.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning the Company's directors required by this Item is incorporated by reference to the Company's Proxy Statement under the heading "Election of Directors."
The information concerning the Company's executive officers required by this Item is incorporated by reference to the Company's Proxy Statement under the heading "Executive Officers."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the Company's Proxy Statement under the heading "Election of Directors."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the Company's Proxy Statement under the heading "Election of Directors."
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents Filed with Report
1. Financial Statements. See Index to Consolidated Financial Statements at page of this Form 10-K and the Financial Statements and Notes thereto which are included at pages to of this Form 10-K.
2. Exhibits
Exhibit Number Description
3.1* Certificate of Incorporation of the Company. 3.2* Bylaws of the Company. 4.1* Specimen of Common Stock certificate of the Company. 4.2* Rights Agreement dated as of May 19, 1994, between the Company and The First National Bank of Boston. 10.1* Form of Indemnification Agreement. 10.2* 1994 Incentive Plan. 10.3* 1994 Employee Stock Purchase Plan. 10.5** Loan Agreements dated as of June 30, 1998, between the Company and NationsBank of Texas, N.A., as amended and supplemented. 11.1 Computation of Earnings Per Common Share. 21.1 Subsidiaries of the Company. 23.1 Consent of Independent Accountants. 24.0 Power of Attorney (see page 32). 27.0 Financial Data Schedule (see Part II, Item 6).
* Incorporated by reference to the Company's Registration Statement on Form S-1 (Reg. No. 33-88386) declared effective March 13, 1995. ** Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.
(b) Reports on Form 8-K.
Not Applicable.
(c) Exhibits
See Item 14(a)(2) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Registrant
NATIONAL INSTRUMENTS CORPORATION
March 11, 1999 BY: /s/ James J. Truchard Dr. James J. Truchard Chairman of the Board and President
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Dr. James J. Truchard and Alexander M. Davern, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and conforming all that each of said attorneys-in-fact, or his substitute or substitutes, any do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. - --------------------------------------------------------------------------------
Signature Capacity in Which Signed Date
- --------------------------------------------------------------------------------
/s/ James J. Truchard Chairman of the Board and Dr. James J. Truchard President (Principal Executive March 11, 1999 Officer) - --------------------------------------------------------------------------------
/s/ Alexander M. Davern Chief Financial Officer Alexander M. Davern and Treasurer (Principal Financial March 12, 1999 and Accounting Officer) - --------------------------------------------------------------------------------
/s/ Jeffrey L. Kodosky Director March 11, 1999 Jeffrey L. Kodosky - --------------------------------------------------------------------------------
/s/ William C. Nowlin Director March 11, 1999 William C. Nowlin, Jr. - --------------------------------------------------------------------------------
/s/ L. Wayne Ashby Director March 11, 1999 L. Wayne Ashby - --------------------------------------------------------------------------------
/s/ Donald M. Carlton Director March 12, 1999 Dr. Donald M. Carlton - --------------------------------------------------------------------------------
/s/ Ben G. Streetman Director March 12, 1999 Ben G. Streetman - --------------------------------------------------------------------------------
NATIONAL INSTRUMENTS CORPORATION
Page No. Financial Statements: Report of Independent Accountants Consolidated Balance Sheets as of December 31, 1998 and 1997 Consolidated Statements of Income for the Three Years Ended December 31, 1998 Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1998 Consolidated Statements of Stockholders' Equity for the Three Years Ended December 31, 1998 Notes to Consolidated Financial Statements
Financial Statement Schedules: For the Three Years Ended December 31, 1998 Schedule II - Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
-F1-
Report of Independent Accountants
To the Board of Directors and Stockholders of National Instruments Corporation
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income and stockholders' equity and of cash flows, present fairly, in all material respects, the financial position of National Instruments Corporation and its subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP Austin, Texas January 22, 1999
-F2-
Consolidated Balance Sheets (In thousands, except share data)
Assets
December 31, --------------------- 1998 1997 --------- --------- Current assets:........................... Cash and cash equivalents................ $ 51,538 $ 31,943 Short-term investments................... 49,158 51,067 Accounts receivable, net................. 45,622 37,411 Inventories.............................. 16,454 15,505 Prepaid expenses and other current assets 6,687 5,387 Deferred income tax, net................. 4,937 7,900 --------- --------- Total current assets.................. 174,396 149,213
Property and equipment, net............... 66,131 46,805 Intangibles............................... 9,259 8,472 ========= ========= Total assets.......................... $ 249,786 $ 204,490 ========= =========
Liabilities and Stockholders' Equity
Current liabilities:...................... Current portion of long-term debt........ $ 849 $ 851 Accounts payable......................... 17,242 16,946 Accrued compensation..................... 7,895 8,219 Accrued expenses and other liabilities... 5,011 2,455 Income taxes payable..................... 5,893 4,871 Other taxes payable...................... 3,996 3,729 --------- ---------- Total current liabilities............. 40,886 37,071
Long-term debt, net of current portion.... 4,379 5,151 Deferred income taxes..................... 337 514 --------- ---------- Total liabilities..................... 45,602 42,736 --------- ----------
Commitments and contingencies............. --- --- Stockholders' equity: Common stock: par value $.01; 60,000,000 shares authorized; 32,942,740 and 32,656,473 shares issued and outstanding, respectively.......................... 329 326 Additional paid-in capital................ 51,662 47,160 Retained earnings......................... 153,601 116,215 Accumulated other comprehensive loss...... (1,408) (1,947) --------- ---------- Total stockholders' equity............ 204,184 161,754 --------- ---------- Total liabilities and stockholders' equity $ 249,786 $ 204,490 ========= ==========
The accompanying notes are an integral part of these financial statements.
-F3-
Consolidated Statements of Income (In thousands, except per share data)
For the Years Ended December 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ----------
Net sales....................... $ 274,230 $ 240,879 $ 200,715 Cost of sales................... 65,187 55,096 49,755 ---------- ---------- ---------- Gross profit................... 209,043 185,783 150,960 ---------- ---------- ----------
Operating expense: Sales and marketing.......... 100,783 87,096 72,067 Research and development..... 34,757 30,296 24,387 General and administrative... 20,455 18,508 17,129 ---------- ---------- ---------- Total operating expenses..... 155,995 135,900 113,583 ---------- ---------- ----------
Operating income............. 53,048 49,883 37,377
Other income (expense): Interest income.............. 3,439 3,455 2,405 Interest expense............. (463) (502) (844) Net foreign exchange loss ... (224) (2,649) (899) ---------- ---------- ---------- Income before income taxes... 55,800 50,187 38,039 Provision for income taxes...... 18,414 16,562 12,553 ========== ========== ========== Net income................... $ 37,386 $ 33,625 $ 25,486 ========== ========== ==========
Basic earnings per share........ $ 1.14 $ 1.03 $ 0.79 ========== ========== ==========
Weighted average shares outstanding-basic............... 32,832 32,563 32,359 ========== ========== ==========
Diluted earnings per share...... $ 1.10 $ 1.00 $ 0.77 ========== ========== ==========
Weighted average shares outstanding-diluted............. 34,100 33,656 32,943 ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
-F4-
Consolidated Statements of Cash Flows (In thousands)
For the Years Ended December 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ----------
Cash flow from operating activities: Net income............................... $ 37,386 $ 33,625 $ 25,486 Adjustments to reconcile net income to cash provided by operating activities: Charges to income not requiring cash outlays: Depreciation and amortization........ 11,638 8,715 9,210 Provision for (benefit from) deferred income taxes......................... 1,529 (3,072) (779) Purchase of in-process research & development.......................... --- 1,400 1,000 Changes in operating assets and liabilities: Increase in accounts receivable...... (5,678) (4,059) (4,715) (Increase) decrease in inventory..... (605) (4,335) 3,275 Increase in prepaid expenses and other assets......................... (1,162) (5,753) (402) Increase in accounts payable......... 1,128 4,741 2,582 Increase in accrued expenses and other liabilities.................... 1,730 1,199 4,620 ---------- ---------- ---------- Net cash provided by operating activities 45,966 32,461 40,277 ---------- ---------- ----------
Cash flow from investing activities: Payments for acquisitions, net of cash received................................ (1,519) (2,000) (1,200) Capital expenditures..................... (27,985) (21,998) (6,811) Additions to intangibles................. (2,667) (2,102) (1,568) Purchases of short-term investments...... (52,188) (48,408) (68,790) Sales of short-term investments.......... 54,097 46,298 57,619 ---------- ---------- ---------- Net cash used in investing activities..... (30,262) (28,210) (20,750) ---------- ---------- ----------
Cash flow from financing activities: Repayments of long-term debt............. (824) (4,640) (3,017) Net proceeds from issuance of common stock under employee plans.............. 4,505 2,874 1,891 ---------- ---------- ---------- Net cash provided by (used in) financing activities............................... 3,681 (1,766) (1,126) ---------- ---------- ----------
Effects of translation rate changes on cash 210 (753) (206) ---------- ---------- ----------
Net increase in cash and cash equivalents. 19,595 1,732 18,195 Cash and cash equivalents at beginning of period................................... 31,943 30,211 12,016 ========== ========== ========== Cash and cash equivalents at end of period $ 51,538 $ 31,943 $ 30,211 ========== ========== ==========
Cash paid for interest and income taxes Interest................................. $ 499 $ 451 $ 904 ========== ========== ========== Income taxes............................. $ 16,008 $ 21,490 $ 11,135 ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
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Consolidated Statements of Stockholders' Equity (In thousands, except share data)
The accompanying notes are an integral part of these financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Operations and summary of significant accounting policies
National Instruments Corporation (the "Company") was incorporated on May 14, 1976 under the laws of the State of Texas. On June 10, 1994, the Company was reincorporated in Delaware. On March 13, 1995, the Company completed an initial public offering of shares of its common stock. The offering and the exercise of the over-allotment option by the underwriters generated net cash proceeds of $39.6 million.
The Company engages in the design, development, manufacture and marketing of instrumentation software and specialty interface cards for general commercial, industrial and scientific applications. The Company offers hundreds of products used to create virtual instrumentation systems. The Company has identified two major markets for its products: test and measurement and industrial automation. The Company's products may be used in either environment, and consequently, specific application of the Company's products is determined by the customer and often is not known to the Company at the time of sale. The Company approaches both markets with essentially the same products which are used in a variety of applications from research and development to production testing and industrial control. The following industries and applications are served worldwide by the Company: advanced research, automotive, commercial aerospace, computers and electronics, continuous process manufacturing, education, government/defense, medical research/pharmaceutical, power/energy, semiconductors, automated test equipment, telecommunications and others.
Principles of consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of estimates
Judgments and estimates by management are required in the preparation of financial statements to conform with generally accepted accounting principles. The estimates and underlying assumptions affect the reported amounts of assets and liabilities, the disclosure of contingencies at the balance sheet date and the reported revenues and expenses for the period. Actual results could differ from those estimates.
Cash and cash equivalents
Cash and cash equivalents include cash and highly liquid investments with maturities of three months or less at the date of acquisition.
Short-term investments
Short-term investments consist of state and municipal securities with readily determinable fair market values and original maturities in excess of three months. The Company's investments are classified as available-for-sale and accordingly are reported at fair value, with unrealized gains and losses reported as other comprehensive income. Unrealized losses are charged against income when a decline in fair value is determined to be other than temporary. The specific identification method is used to determine the cost of securities sold.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using standard costs which approximate the first in, first out (FIFO) method. Cost includes the acquisition cost of purchased components, parts and subassemblies, in-bound freight costs, labor and overhead. Market, with respect to raw materials, is replacement cost and, with respect to work-in-process and finished goods, is net realizable value.
Property and equipment
Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from twenty to forty years for buildings and three to five years for equipment. Leasehold improvements are depreciated over the shorter of the life of the lease or the asset.
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Intangible assets
The Company has capitalized costs related to the development and acquisition of certain software products. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 86 "Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed," capitalization of costs begins when technological feasibility has been established and ends when the product is available for general release to customers. Amortization is computed on an individual product basis for those products available for market and has been recognized based on the product's estimated economic life, generally three years. Intangible assets are periodically assessed for impairment of value and any loss is recognized upon impairment.
Concentrations of credit risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of foreign currency forward and option contracts, cash and cash equivalents, short-term investments and trade accounts receivable. In management's opinion, no significant concentration of credit risk exists for the Company.
The Company's counterparties in its foreign currency forward and option contracts are major financial institutions. The Company does not anticipate nonperformance by these counterparties. The Company maintains cash and cash equivalents with various financial institutions located in many countries worldwide. Company policy is to limit exposure in foreign countries by transferring cash to the U.S. The Company's short-term investments are diversified among and limited to high-quality securities with high credit ratings. Concentration of credit risk with respect to trade accounts receivable is limited due to the large number of customers and their dispersion across many countries and industries. The amount of sales and trade accounts receivable to any individual customer was not significant for the periods presented.
Revenue recognition
Sales revenue is recognized on the date the product is shipped to the customer. Provision is made for estimated sales returns. Revenue related to the sale of extended service contracts is deferred and amortized on a straight-line basis over the service period. The Company adopted the AICPA Statement of Position 97-2 "Software Revenue Recognition" which did not have a material impact on the consolidated balance sheet or statement of income.
Accounts receivable are net of allowances for doubtful accounts of $3.7 million and $4.0 million at December 31, 1998 and 1997, respectively.
Warranty expense
The Company offers a one-year limited warranty on most hardware products and a 90-day warranty on software products which is included in the sales price of many of its products. Provision is made for estimated future warranty costs at the time of sale.
Advertising expense
The Company expenses its costs of advertising as incurred. Advertising expense for the years ended December 31, 1998, 1997 and 1996 is $31.3 million, $27.1 million and $22.2 million, respectively.
Foreign currency translation
The functional currency for the Company's international operations is the applicable local currency. The assets and liabilities of these operations are translated at the rate of exchange in effect on the balance sheet date; sales and expenses are translated at average rates. The resultant gains or losses from translation are included in a separate component of other comprehensive income. Gains and losses resulting from remeasuring monetary asset and liability accounts that are denominated in a currency other than a subsidiary's functional currency are included in determining net income.
Foreign currency hedging instruments
The Company enters into foreign currency forward contracts to hedge its exposure on material foreign currency receivables. The Company does not hold or issue financial instruments for trading purposes. These financial instruments are carried at market value, which is measured on the basis of spot rates on the balance sheet date. Realized and unrealized gains and losses on the forward contracts are netted against the related foreign currency loss or gain and included in other income for the period.
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The Company uses foreign currency purchased option contracts to hedge anticipated transactions for periods not exceeding twelve months. Realized and unrealized gains and premiums of foreign currency purchased option contracts that are designated and effective as hedges of anticipated transactions are deferred and recognized in income in the same period as the hedged transaction. The risk of loss associated with purchased options is limited to premium amounts paid for the contracts, which could be significant.
Income taxes
The provision for income taxes is based on pretax financial accounting income. 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.
Earnings per share
Basic earnings per share ("EPS") is computed by dividing net income by the weighted average number of common shares outstanding during each period. Diluted EPS is computed by dividing net income by the weighted average number of common shares and common share equivalents outstanding (if dilutive) during each period. Common share equivalents include stock options. The number of common share equivalents outstanding relating to stock options is computed using the treasury stock method.
The reconciliation of the denominators used to calculate the basic EPS and diluted EPS for the years ended December 31, 1998, 1997 and 1996, respectively is as follows (in thousands):
Years Ended December 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Weighted average shares outstanding-basic................ 32,832 32,563 32,359
Plus: Common share equivalents Stock options.................. 1,268 1,093 584 ---------- ---------- ----------
Weighted average shares outstanding-diluted.............. 34,100 33,656 32,943 ========== ========== ==========
Stock options to acquire 763,124, 14,285 and 3,762 shares for the years ended December 31, 1998, 1997 and 1996, respectively were not included in the computations of diluted earnings per share because the effect of including stock options would have been anti-dilutive.
Stock-based compensation plans
The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." As allowed by SFAS No. 123, the Company continues to apply the provisions of Accounting Principles Board Opinion No. 25 "Accounting for Stock issued to Employees" and related interpretations in accounting for its plans. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock.
Comprehensive income
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income." The standard, which was effective for financial statements issued for periods ending after December 15, 1997, established standards for reporting, in addition to net income, comprehensive income and its components including, as applicable, foreign currency items, minimum pension liability adjustments and unrealized gains and losses on certain investments in debt and equity securities. The Company adopted this standard in the first quarter of 1998 and has reclassified prior year financial statements to reflect the provisions of this statement.
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Note 2: Short-term investments
Short-term investments at December 31, 1998 and 1997, consisting of state and municipal securities, were acquired at an aggregate cost of $49.1 million and $51.1 million, respectively. The contractual maturities of these securities, which are classified as available-for-sale and carried at fair value, are as follows (in thousands):
December 31, ------------------- 1998 1997 -------- -------- 90 days to one year........... $ 26,639 $ 38,724 One year through two years.... 22,519 12,343 -------- -------- $ 49,158 $ 51,067 ======== ========
Note 3: Inventories
Inventories consist of the following (in thousands):
December 31, ------------------- 1998 1997 -------- -------- Raw materials................. $ 7,194 $ 6,985 Work-in-process............... 943 1,315 Finished goods................ 8,317 7,205 -------- -------- $ 16,454 $ 15,505 ======== ========
Note 4: Property and equipment
Property and equipment consist of the following (in thousands):
December 31, ------------------- 1998 1997 -------- -------- Land.......................... $ 4,006 $ 4,006 Buildings..................... 43,894 16,873 Furniture and equipment....... 56,956 40,839 -------- -------- 104,856 61,718 Accumulated depreciation...... (38,725) (30,922) Construction in process....... -- 16,009 -------- -------- $ 66,131 $ 46,805 ======== ========
Depreciation expense for the years ended December 31, 1998, 1997 and 1996, is $8.9 million, $7.1 million and $7.1 million, respectively.
Note 5: Intangibles
Intangibles at December 31, 1998 and 1997 include capitalized software development costs of $3.9 million and $3.4 million, respectively, which are net of accumulated amortization of $3.8 million and $7.1 million, respectively. Total amortization costs were $2.8 million, $1.6 million and $2.1 million for the years ended December 31, 1998, 1997 and 1996, respectively. Substantially all of these amounts were amortization of software development costs.
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Note 6: Debt
Debt consists of the following (in thousands): December 31, ---------------- 1998 1997 ------- ------- Short-term debt: Revolving line, LIBOR (5.63% at December 31, 1998), $20,000,000 commitment, matures December 31, 1999.......................... $ --- $ --- ======= ======= Long-term debt: Manufacturing facility loan, LIBOR (5.63% at December 31, 1998), $8,480,000 commitment, half the principal is payable, together with interest, in equal quarterly installments over a five-year term, beginning September 1995, remainder due at maturity at February 28, 2001..... $ 5,151 $ 6,002
Other............................................. 77 --- ------- ------- Total debt........................................ 5,228 6,002 Less current portion........................... 849 851 ------- ------- Long-term portion................................. $ 4,379 $ 5,151 ======= =======
The terms of the Company's debt agreements include various covenants which require, among other things, a minimum tangible net worth of $154.0 million. First security interests are in land and building of the manufacturing and corporate headquarter site.
Long-term debt maturing in years 1999 and 2000 is $849,000 per year and $3.5 million in 2001.
Note 7: Income taxes
The components of income before the provision for income taxes are as follows (in thousands):
Years Ended December 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Domestic.......... $ 46,817 $ 42,400 $ 35,108 Foreign........... 8,983 7,787 2,931 ---------- ---------- ---------- $ 55,800 $ 50,187 $ 38,039 ========== ========== ==========
The provision for income taxes charged to operations is as follows (in thousands):
Years Ended December 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Current tax expense U.S. federal... $ 11,945 $ 15,140 $ 10,234 State.......... 1,109 1,468 985 Foreign........ 3,831 3,026 2,113 ---------- ---------- ---------- Total current..... 16,885 19,634 13,332 ---------- ---------- ---------- Deferred tax expense (benefit) U.S. federal... 2,352 (2,719) (201) State.......... 329 (227) (180) Foreign........ (1,152) (126) (398) ---------- ---------- ---------- Total deferred.... 1,529 (3,072) (779) ---------- ---------- ---------- Total provision... $ 18,414 $ 16,562 $ 12,553 ========== ========== ==========
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Deferred tax liabilities (assets) at December 31, 1998 and 1997 are as follows (in thousands):
December 31, ---------------------- 1998 1997 ---------- ---------- Capitalized software.......... $ 1,068 $ 735 Unrealized exchange gain...... 192 --- ---------- ---------- Gross deferred tax liabilities 1,260 735 ---------- ---------- Depreciation and amortization. (311) (842) Operating loss carryforwards.. (1,774) (272) Vacation and other accruals... (1,358) (1,385) Inventory valuation and warranty (1,246) (2,225) provisions.................... Doubtful accounts and sales (1,311) (1,362) provisions.................... Unrealized exchange loss...... --- (649) Intercompany profit........... (599) (762) Undistributed earnings of foreign (525) (364) subsidiaries.................. Other......................... (615) (615) ---------- ---------- Gross deferred tax assets.. (7,739) (8,476) ---------- ---------- Valuation allowance........... 303 269 ---------- ---------- Net deferred tax asset........ $ (6,176) $ (7,472) ========== ==========
The increase in the deferred tax assets valuation allowance in 1998 of $34,000 is attributable to the operating losses in foreign jurisdictions the benefits of which are not assured of realization at December 31, 1998.
A reconciliation of income taxes at the U.S. federal statutory income tax rate to the effective tax rate follows: Years Ended December 31, ------------------------ 1998 1997 1996 ------ ------ ------ U.S. federal statutory tax rate.............. 35% 35% 35% Foreign sales corporation benefit............ (2) (1) (2) Loss from unconsolidated foreign subsidiaries --- --- 1 Foreign tax credits utilized................. --- (1) (2) Tax exempt interest.......................... (2) (2) (2) State income taxes, net of federal tax benefit 2 2 2 Other........................................ --- --- 1 ------ ------ ------ Effective tax rate........................ 33% 33% 33% ====== ====== ======
As of December 31, 1998, seven of the Company's subsidiaries have available, for income tax purposes, foreign net operating loss carryforwards of approximately $4.2 million, of which $3.5 million expire during the years 2000 - 2008 and $654,000 of which may be carried forward indefinitely.
A deferred income tax benefit of $161,000 was provided in 1998 for the estimated foreign tax credits that will be utilized upon the anticipated future repatriation of approximately $3.6 million of foreign undistributed earnings in the form of dividends. The Company has not provided for U.S. federal income and foreign withholding taxes on approximately $1.2 million of non-U.S. subsidiaries' undistributed earnings as of December 31, 1998, because such earnings are intended to be reinvested indefinitely. These earnings would become subject to U.S. tax and foreign withholding tax, if they are actually or deemed to be remitted to the parent company as dividends or if the Company should sell its stock in these subsidiaries. If these earnings were distributed, foreign tax credits should become available under current law to reduce or eliminate the resulting U.S. income tax and foreign withholding tax liabilities.
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Note 8: Acquisitions
On August 17, 1998, the Company acquired all of the issued and outstanding shares of common stock of DATALOG GmbH/DASYtec GmbH (Datalog) and related subsidiaries for an aggregate purchase price of approximately $2.2 million. The acquisition was accounted for as a purchase. The results of Datalog's operations have been combined with those of the Company since the date of the acquisition. The Company amortized $750,000 of the purchased software during the third quarter of 1998. This amortization period was utilized due to the nature of this technology and timing of the revenue streams associated with it. If this expense had not been taken, net income for the year ended December 31, 1998 would have been $37.9 million or $1.11 per share-diluted.
In 1997, the Company acquired the products, technology and net assets of nuLogic, Inc. for a purchase price of approximately $2.0 million in cash. The acquisition was accounted for as a purchase. The results of nuLogic's operations have been combined with those of the Company since the date of acquisition.
In 1996, the Company acquired all of the issued and outstanding shares of common stock of Georgetown Systems, Inc. ("GSI") for an aggregate purchase price of approximately $2.0 million, paid with 91,374 unregistered shares of the Company's common stock and $764,000 in cash. The acquisition was accounted for as a purchase. The results of GSI's operations have been combined with those of the Company since the date of acquisition. Also in 1996, the Company purchased imaging acquisition software technology for $500,000.
Note 9: Stockholders' equity
Common stock
The Company's reincorporation into Delaware on June 10, 1994 resulted in a change in par value from no par to $.01 par value per share. All outstanding stock was exchanged on a one-for-one basis as of the date of reincorporation. The reincorporation increased the Company's authorized stock to 60,000,000 shares of Common Stock and 5,000,000 shares of Preferred Stock. Additionally, the Company effected a six-for-one stock split on January 11, 1995, the date of filing the Company's initial registration statement with the Securities and Exchange Commission.
On October 15, 1997, the Company declared a stock split effected in the form of a dividend of one share of common stock for each two shares outstanding. The dividend was paid on November 12, 1997 to holders of record as of the close of business on October 28, 1997.
All share information included in the accompanying consolidated financial statements and notes has been retroactively adjusted to reflect the exchange and stock splits.
Stock-based compensation plans
At December 31, 1998, the Company has two active stock-based compensation plans and one inactive plan. The two active stock-based compensation plans are the 1994 Incentive Stock Option Plan and the Employee Stock Purchase Plan. No compensation cost has been recognized in the Company's financial statements for the fixed stock option plan and the stock purchase plan. If compensation cost for the Company's two active stock-based compensation plans were determined based on the fair value at the grant date for awards under those plans consistent with the method established by SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share data).
Years Ended December 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Net income As reported $ 37,386 $ 33,625 $ 25,486 Pro-forma 31,281 29,829 23,458
Basic earnings per share As reported $ 1.14 $ 1.03 $ 0.79 Pro-forma 0.95 0.92 0.72
Diluted earnings per share As reported $ 1.10 $ 1.00 $ 0.77 Pro-forma 0.92 0.89 0.71
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Stock option plans
The Company had a 1983 Incentive Stock Option Plan under which options were granted to certain key employees pursuant to award agreements executed in 1983 (exercisable at $0.05 per share), 1985 (exercisable at $0.11 per share) and 1989 (exercisable at $1.55 per share). This plan terminated on November 30, 1993. Under the plan, options were granted at a price not less than fair market value on the date of grant. All options must be exercised within ten years of the date of grant.
The stockholders of the Company approved the 1994 Incentive Stock Option Plan on May 9, 1994. At the time of approval, 4,050,000 shares of the Company's common stock were reserved for issuance under this plan. In 1997, an additional 3,150,000 shares of the Company's common stock were reserved for issuance under this plan. The 1994 Plan, administered by the Compensation Committee of the Board of Directors, provides for granting of incentive awards in the form of stock options to directors, executive officers and employees of the Company and its subsidiaries. Awards under the plan must be granted within ten years of the effective date of the 1994 Plan. Options granted may be 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. Stock options must be exercised within ten years from date of grant. Stock options are issued at market price at the grant date. Shares available for grant at December 31, 1998 were 3,327,089.
Transactions under all plans are summarized as follows:
Number of Weighted shares average under exercise option price ---------------- ---------------- Outstanding at December 31, 1995. 1,028,445 $ 9.07 Exercised..................... (13,763) 10.14 Canceled...................... (88,976) 11.57 Granted....................... 1,081,725 13.58 ---------------- ---------------- Outstanding at December 31, 1996. 2,007,431 11.39 Exercised..................... (62,754) 11.52 Canceled...................... (151,898) 15.47 Granted....................... 1,245,402 22.10 ---------------- ---------------- Outstanding at December 31, 1997. 3,038,181 15.57 Exercised..................... (163,127) 7.67 Canceled...................... (134,875) 21.86 Granted....................... 987,910 33.80 ---------------- ---------------- Outstanding at December 31, 1998. 3,728,089 $ 20.54 ================ ================
Options exercisable at December 31: 1996.......................... 410,841 $ 9.98 1997.......................... 801,970 12.07 1998.......................... 1,237,201 15.43
Weighted average, grant date fair Weighted average value of options granted during: fair value ---------------- 1996.......................... 1,081,725 $ 6.25 1997.......................... 1,245,402 10.15 1998.......................... 987,910 15.50
December 31, 1998 - -------------------------------------------------------------------------------- Options Outstanding Options Exercisable - ---------------------------------------------------- -------------------------
Weighted Weighted average Weighted Number of average remaining Number of average Exercise options exercise contractual options exercise price outstanding price life (yrs) exercisable price - -------------- ----------- --------- ----------- ----------- --------- $ 1.55 - 1.55 18,000 $ 1.55 1 --- $ 1.55 9.67 - 13.17 731,315 9.83 6 455,872 9.82 13.33 - 21.08 929,185 13.74 7 420,615 13.67 21.67 - 21.67 982,356 21.67 8 262,692 21.67 22.25 - 35.00 1,067,233 33.09 9 98,022 32.39 ----------- ----------- 1.55 - 35.00 3,728,089 20.54 8 1,237,201 15.43
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The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
1998 1997 1996 ---------- ---------- ---------- Dividend expense yield 0% 0% 0% Expected life......... 5 years 7.2 years 7.2 years Expected volatility... 33.3% 30.6% 30.6% Risk-free interest rate 5.6% 6.3% 6.3%
Employee stock purchase plan
The Company's stock purchase plan became effective March 13, 1995 upon the first date of registration of the Company's Common Stock. The plan permits substantially all domestic employees and employees of designated subsidiaries to acquire the Company's Common Stock at a purchase price of 85% of the lower of the market price at the beginning or the end of the participation period. The semi-annual periods begin on October 1 and April 1 of each year. Employees may designate up to 15% of their compensation for the purchase of Common Stock. Common Stock reserved for future employee purchases aggregated 1,876,875 shares at December 31, 1998. Shares issued under this plan were 124,258 in 1998. The fair value of the employees' purchase rights was estimated using the Black-Scholes model with the following assumptions:
1998 1997 1996 ---------- ---------- ---------- Dividend expense yield 0% 0% 0% Expected life......... 6 months 6 months 6 months Expected volatility... 40% 50% 60% Risk-free interest rate 5.31% 5.22% 5.22%
Weighted average, grant date fair value of purchase rights granted under the Number of Weighted average Employee Stock Purchase Plan: shares fair value ---------------- ---------------- 1996..................... 140,403 $ 4.77 1997..................... 117,373 7.68 1998..................... 130,119 7.74
Stockholders' rights plan
The Board of Directors and stockholders approved and adopted the Rights Agreement prior to the Company's initial public offering (the "offering"). On March 13, 1995, the effective date of the offering, the Board of Directors declared a dividend distribution of one common share purchase right for each outstanding share of Common Stock. The rights become exercisable under certain conditions involving acquisition of the Company's Common Stock. Under certain other conditions where the Company is consolidated or merged, each holder of a right shall have the right to receive, upon exercise of the right, shares of Common Stock of the Company, or acquiring company, having a value of twice the exercise price of the right. The rights expire on March 13, 2005, and may be redeemed in whole by the Company for $.01 per right. The rights are excluded from earnings per share computations because they qualify as contingent shares and therefore are excluded as long as the conditions that require issuance of the shares are not imminent.
Note 10: Employee retirement plan
The Company has a defined contribution retirement plan pursuant to Section 401(k) of the Internal Revenue Code. Substantially all domestic employees with at least one year of continuous service are eligible to participate and may contribute up to 15% of their compensation. The Board of Directors has elected to make matching contributions equal to 50% of employee contributions, which may be applied to a maximum of 6% of each participant's compensation. Company contributions vest immediately. Company contributions charged to expense were $933,000, $799,000 and $686,000 in 1998, 1997 and 1996, respectively.
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Note 11: Financial instruments
Fair value of financial instruments
The estimated fair value amounts disclosed below have been determined by the Company using available market information and valuation methodologies described below. However, considerable judgment is required in interpreting market data to develop these estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions could have a significant effect on the estimates. For certain financial instruments of the Company, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, the carrying amount approximates fair value due to the short-term maturity of these instruments. The estimated fair values of the other assets (liabilities) of the Company's remaining financial instruments at December 31, 1998 and 1997 are as follows (in thousands):
December 31, ------------------------------------------------ 1998 1997 ---------------------- ---------------------- Carrying Fair Carrying Fair Amount Value Amount Value --------- ----------- --------- ----------- Short-term investments $ 49,158 $ 49,158 $ 51,067 $ 51,067 Other assets/liabilities: Forward contracts (1,151) (1,151) 662 662 Purchased options 1,194 467 740 816 Long-term debt...... (4,379) (3,899) (5,151) (4,379)
The fair values of short-term investments and foreign exchange purchased option contracts were estimated based upon quotes from brokers as of the applicable balance sheet date. Foreign currency forward contracts' fair values are estimates using quoted exchange rates at the applicable balance sheet date. The fair value of long-term debt was estimated by discounting the future cash flows using rates currently available for debt of similar terms and maturity.
Foreign currency hedging
The Company uses foreign currency forward contracts to hedge its exposure on material foreign currency receivables. The risk of loss associated with forward contracts is equal to the exchange rate differential from the time the contract is entered into until the time it is settled. These foreign currency forward contracts are for 90 day periods. At December 31, 1998, the Company held forward contracts with a notional amount of $22.3 million, a carrying amount of ($1.2) million and a net realized loss of $1.2 million.
In addition to utilizing forward contracts to hedge the Company's foreign currency receivables, the Company has entered into foreign currency purchased option contracts to hedge a percentage of planned net foreign currency cash flows. The maturities on these instruments are 12 months or less. At December 31, 1998, the Company held purchased option contracts with a notional amount of $50.5 million, a carrying amount of $1.2 million and a net unrealized deferred loss of $727,000. The carrying amount represents premiums deferred and was recorded in prepaid expenses and other current assets.
Foreign currency forward and purchased option contracts reduced the Company's net foreign exchange gain for December 31, 1998 by $1.9 million, and reduced the net foreign exchange loss for December 31, 1997 and 1996 by $2.0 million and $674,000, respectively.
Note 12: Segment information
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which the Company adopted in the first quarter of 1998. The statement supersedes SFAS No. 14 "Financial Reporting for Segments of a Business Enterprise", replacing the "industry segment" approach with 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 the Company's reportable segments. It also requires disclosures about products and services, geographic areas and major customers.
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While the Company sells its products to many different markets, its management has chosen to organize the Company by geographic areas, and as a result has determined that it has one reportable segment. Substantially all of the interest income, interest expense, depreciation and amortization is recorded in North America. Net sales, operating income and identifiable assets, classified by the major geographic areas in which the Company operates, are as follows (in thousands):
Years Ended December 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Net sales: North America: Unaffiliated customer sales.......... $ 153,435 $ 141,180 $ 114,382 Geographic transfers................. 32,451 29,128 26,388 ---------- ---------- ---------- 185,886 170,308 140,770 ---------- ---------- ---------- Europe: Unaffiliated customer sales.......... 86,961 66,318 58,108 ---------- ---------- ---------- Asia Pacific: Unaffiliated customer sales.......... 33,834 33,381 28,225 ---------- ---------- ---------- Eliminations........................... (32,451) (29,128) (26,388) ---------- ---------- ---------- $ 274,230 $ 240,879 $ 200,715 ========== ========== ==========
Year Ended December 31, ---------- ---------- Operating income: North America.......................... $ 44,669 Europe................................. 29,964 Asia Pacific........................... 13,172 Unallocated: Research and development expenses...... (34,757) ---------- $ 53,048 ==========
The Company's segment operating income disclosure for 1998 has been conformed to the presentation required by SFAS No. 131. Management believes that the cost to develop comparative segment operating income information for prior years would be excessive and accordingly, will not be presented.
December 31, ---------------------- 1998 1997 ---------- ---------- Identifiable assets: North America.......................... $ 204,215 $ 169,895 Europe................................. 29,978 22,472 Asia Pacific........................... 15,593 12,123 ---------- ---------- $ 249,786 $ 204,490 ========== ==========
Note 13: Commitments and contingencies
The Company has commitments under noncancelable operating leases primarily for office facilities and equipment. Future minimum lease payments as of December 31, 1998, for each of the next five years are as follows (in thousands):
1999........................ $ 724 2000........................ 557 2001........................ 337 2002........................ 119 2003........................ 5 Thereafter.................. --- -------- $ 1,742 ========
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Rent expense under operating leases was approximately $2.6 million, $5.0 million and $4.2 million for the years ended December 31, 1998, 1997 and 1996, respectively.
Note 14: Quarterly results (unaudited)
The following quarterly results have been derived from unaudited consolidated financial statements that, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of such quarterly information. The operating results for any quarter are not necessarily indicative of the results to be expected for any future period. The unaudited quarterly financial data for each of the eight quarters in the two years ended December 31, 1998 are as follows (in thousands, except per share data):
Three Months Ended ---------------------------------------------- March June Sept. Dec. 31, 30, 30, 31, 1998 1998 1998 1998 ---------- ---------- ---------- ---------- Net sales..................... $ 65,353 $ 67,770 $ 67,874 $ 73,233 Gross profit.................. 49,784 51,681 51,588 55,990 Operating income.............. 12,784 13,033 11,994 15,237 Net income.................... 8,831 9,198 8,527 10,830 Basic earnings per share...... $ 0.27 $ 0.28 $ 0.26 $ 0.33 Weighted average shares outstanding-basic............. 32,668 32,800 32,850 32,934 Diluted earnings per share.... $ 0.26 $ 0.27 $ 0.25 $ 0.32 Weighted average shares outstanding-diluted........... 34,100 34,200 33,950 34,100
Three Months Ended ---------------------------------------------- March June Sept. Dec. 31, 30, 30, 31, 1997 1997 1997 1997 ---------- ---------- ---------- ---------- Net sales..................... $ 54,571 $ 60,092 $ 60,595 $ 65,621 Gross profit.................. 42,278 46,083 46,381 51,041 Operating income.............. 11,569 12,401 10,717 15,196 Net income.................... 7,568 8,581 7,599 9,877 Basic earnings per share...... $ 0.23 $ 0.26 $ 0.23 $ 0.30 Weighted average shares 32,475 32,552 32,572 32,651 outstanding-basic............. Diluted earnings per share.... $ 0.23 $ 0.26 $ 0.23 $ 0.29 Weighted average shares 33,450 33,435 33,750 34,003 outstanding-diluted
Note 15: Subsequent event
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999; the Company has elected to adopt SFAS No. 133 early on January 1, 1999. SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, depending on the type of hedge transaction. For fair-value hedge transactions in which the Company is hedging changes in an asset's, liability's, or firm commitment's fair value, changes in the fair value of the derivative instrument will generally be offset in the income statement by changes in the hedged item's fair value. For cash-flow hedge transactions in which the Company is hedging the variability of cash flows related to a variable-rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument will be reported in other comprehensive income. The gains and losses on the derivative instrument that are reported in other comprehensive income will be reclassified as earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. The ineffective portion of all hedges will be recognized in current-period earnings.
The Company will record an adjustment to reflect all derivative instruments at fair value as of January 1, 1999. This adjustment will be recorded through a net-of-tax cumulative effect type adjustment of approximately $530,000.
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SCHEDULE II
NATIONAL INSTRUMENTS CORPORATION
VALUATION AND QUALIFYING ACCOUNTS(1) (In thousands)
Allowance for doubtful accounts
Balance Provision Balance at for Write-Offs at Year Description Beginning Bad Debt Charged to End of of Period Expense Allowances Period - ---- ---------------------- --------- ---------- ---------- -------- 1996 Allowance for doubtful accounts $ 1,601 $ 1,490 $ 671 $ 2,420 1997 Allowance for doubtful accounts 2,420 1,914 334 4,000 1998 Allowance for doubtful accounts 4,000 183 513 3,670
Valuation allowances for excess and obsolete inventory
Balance Provision Balance at Charged to Write-Offs at Year Description Beginning Cost of Charged to End of of Period Sales Allowances Period - ---- ------------------------ --------- ---------- ---------- -------- 1996 Valuation allowances for excess and obsolete inventory $ 1,801 $ 1,138 $ 1,093 $ 1,846 1997 Valuation allowances for excess and obsolete inventory 1,846 1,829 515 3,160 1998 Valuation allowances for excess and obsolete inventory 3,160 --- 1,356 1,804
(1) Deferred tax assets valuation is omitted as required information. This information is shown in Note 7 to the consolidated financial statements.
EXHIBIT 11.1
NATIONAL INSTRUMENTS CORPORATION AND SUBSIDIARIES
STATEMENTS RE: COMPUTATION OF EARNINGS PER SHARE (In thousands, except per share data)
Years Ended December 31, 1998 1997 1996 ---------- ---------- ----------
Net income $ 37,386 $ 33,625 $ 25,486 ========== ========== ==========
Basic earnings per share $ 1.14 $ 1.03 $ 0.79 ========== ========== ==========
Weighted average shares outstanding-basic 32,832 32,563 32,359 ========== ========== ==========
Diluted earnings per share $ 1.10 $ 1.00 $ 0.77 ========== ========== ==========
Weighted average shares outstanding- diluted 34,100 33,656 32,943 ========== ========== ==========
Calculation of weighted average shares: Weighted average common stock 32,832 32,563 32,359 outstanding-basic Weighted average common stock options, utilizing the treasury stock method 1,268 1,093 584 ---------- ---------- ----------
Weighted average shares outstanding- diluted 34,100 33,656 32,943 ========== ========== ==========
EXHIBIT 21.1
Subsidiaries of the Company
(Unless noted as a Texas corporation, all subsidiaries are formed under local law.)
NI/GSI, Inc., a Texas corporation N.I. Export (Barbados) Ltd., Barbados National Instruments (Ireland) Limited, Ireland National Instruments (Korea) Corporation, Korea National Instruments Australia Corporation, a Texas corporation National Instruments Belgium N.V., Belgium National Instruments Brazil, Brazil National Instruments Canada Corporation, a Texas corporation National Instruments Corporation (UK) Limited, United Kingdom National Instruments de Mexico, S.A. de C.V., Mexico National Instruments Europe Corporation, a Texas corporation National Instruments Finland Oy, Finland National Instruments France Corporation, a Texas corporation National Instruments Germany GmbH, Germany National Instruments Gesellschaft m.b.H., Salzburg, Austria National Instruments Hong Kong Limited, Hong Kong National Instruments India Corporation, a Texas corporation National Instruments International Distribution B.V., Netherlands National Instruments Israel Ltd., Israel National Instruments Italy s.r.l., Italy National Instruments Japan Kabushiki Kaisha, Japan National Instruments Netherlands B.V., Netherlands National Instruments Netherlands Investments B.V., Netherlands National Instruments Scandinavia Corporation, a Texas corporation National Instruments Singapore (PTE) Ltd., Singapore National Instruments Spain, S.L., Spain National Instruments Sweden A.B., Sweden National Instruments Switzerland Corporation, a Texas corporation National Instruments Taiwan Corporation, a Texas corporation NI Cayman Islands, Cayman Islands Shanghai NI Instruments LTD (China) Travis Investments C.V. (a limited partnership), Amsterdam Visual Speed Sdn Bhd, Malaysia (subsidiary of NI Singapore) DATALOG Systeme zur Messwerterfassung GmbH & Co. KG, Germany (subsidiary of NI Germany) DASYTEC USA, Incorporated (a New Hampshire corporation and subsidiary of DATALOG Systeme zur Messwerterfassung GmbH & Co. KG)
EXHIBIT 23.1
Consent of Independent Accounts
We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 of National Instruments Corporation of our report dated January 22, 1999, appearing on page of the Form 10-K.
/s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Austin, Texas March 18, 1999