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NATIONAL INSTRUMENTS CORP /DE/ - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[October 31, 2014]

NATIONAL INSTRUMENTS CORP /DE/ - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Any statements contained herein regarding our future financial performance or operations (including, without limitation, statements to the effect that we "believe," "expect," "plan," "may," "will," "project," "continue," or "estimate" or other variations thereof or comparable terminology or the negative thereof) should be considered forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of important factors, including those set forth under the heading "Risk Factors" beginning on page 36, and in the discussion below. Readers are also encouraged to refer to the documents regularly filed by us with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended December 31, 2013, for further discussion of our business and the risks attendant thereto.



Overview National Instruments Corporation ("we", "us" or "our") designs, manufactures and sells tools to engineers and scientists that accelerate productivity, innovation and discovery. Our graphical system design approach to engineering provides an integrated software and hardware platform that speeds the development of systems needing measurement and control. We believe our long-term vision and focus on technology supports the success of our customers, employees, suppliers and stockholders. We sell to a large number of customers in a wide variety of industries. We have been profitable in every year since 1990.

The key strategies that we focus on in running our business are the following: Expanding our broad customer base We strive to increase our already broad customer base and to grow our large order business by serving a large market on many computer platforms, through a global marketing and distribution network. We also seek to acquire new technologies and expertise from time to time to open new opportunities for our existing product portfolio.


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

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

We sell into test and measurement ("T&M") and industrial/embedded applications in a broad range of industries and are subject to the economic and industry forces which drive those markets. It has been our experience that the performance of these industries and our performance are impacted by general trends in industrial production for the global economy and by the specific performance of certain vertical markets that are intensive consumers of measurement technologies. Examples of these markets are semiconductor capital equipment, telecom and mobile devices, consumer electronics, defense, aerospace and automotive.

Leveraging a worldwide sales, distribution and manufacturing network We distribute our software and hardware products primarily through a direct sales organization. We also use independent distributors, OEMs, VARs, system integrators and consultants to market our products. We have sales offices in the U.S. and sales offices and distributors in key international markets. Sales outside of the Americas accounted for approximately 58% and 56% of our revenues during the three month periods ended September 30, 2014 and 2013, respectively, and 60% and 59% for the nine month periods ended September 30, 2014 and 2013, respectively. The vast majority of our foreign sales are denominated in the customers' local currency, which exposes us to the effects of changes in foreign currency exchange rates. We expect that a significant portion of our total revenues will continue to be derived from international sales. (See Note 12 - Segment information of Notes to Consolidated Financial Statements for details concerning the geographic breakdown of our net sales, operating income, interest income and long-lived assets).

21 -------------------------------------------------------------------------------- We manufacture a substantial majority of our products at our facilities in Debrecen, Hungary and Penang, Malaysia. Additional production, primarily of RF products and of low volume, complex or newly introduced products is done in Austin, Texas, however, we will be transitioning substantially all of our Austin, Texas based manufacturing activities to our manufacturing facilities in Hungary and Malaysia over the next 12 to 18 months. In 2014, our site in Malaysia is expected to produce approximately 20% to 30% of our global production. This production is being generated by transferring existing products from our Hungarian production facility in support of anticipated growth in our business and introducing new products directly into our Malaysian facility. Our site in Hungary is expected to produce approximately 65% to 75% of our global production in 2014. Our product manufacturing operations can be divided into four areas: electronic circuit card and module assembly; chassis and cable assembly; technical manuals and product support documentation; and software duplication. Most of the electronic circuit card assemblies, modules and chassis are manufactured in house, although subcontractors are used from time to time.

The majority of our electronic cable assemblies are produced by subcontractors; however, we do manufacture some on an exception basis. Our software duplication, technical manuals and product support documentation is primarily produced by subcontractors.

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

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

Current business outlook Many of the industries we serve have historically been cyclical and have experienced periodic downturns. In assessing our business, we consider the trends in the Global Purchasing Managers' Index ("PMI"), global industrial production as well as industry reports on the specific vertical industries that we target. In the three months ended September 30, 2014, the average of the PMI was 52.4 and the average of the new order element of the PMI was 53.5, both indicating economic expansion.

During the three month periods ended September 30, 2014 and 2013, we received $12 million and $3.8 million in new orders from our largest customer, respectively, and in the nine month periods ended September 30, 2014 and 2013, we received $51 million and $34 million in new orders from this customer, respectively. During the three month periods ended September 30, 2014 and 2013, we recognized net revenue of $17 million and $4.2 million from these orders, respectively, and recognized net revenue of $44 million and $31 million from these orders during the nine month periods ended September 30, 2014 and 2013, respectively. The timing and amount of orders from this customer are unpredictable and therefore can cause unusual variations in the results and trends of our business. In the third quarter of 2014, we saw 3% year-over-year growth from orders under $20,000, 9% year-over-year growth from orders between $20,000 and $100,000, and 10% year-over-year growth from orders over $100,000.

Excluding our largest customer, orders over $100,000 were down 4% year over year.

The average of the global PMI during the first nine months of 2014 was 52.5 compared to an average of 51.0 during the first nine months of 2013. While this is an indication of overall improvement in the economic climate for the broad industrial economy, we remain concerned with other economic and political events as we move into the final quarter of 2014 and as we look ahead to 2015. We continue to be concerned with the impact of the sanctions against Russia by the European Union (EU) and the U.S. During the three month period ended September 30, 2014, orders in our Emerging Markets region decreased by 1%, year over year, driven in large part by a sharp decline in orders in Russia. These sanctions may continue to limit access by Russian financial institutions to capital markets, impose embargoes on certain goods, or restrict sales of sensitive technologies, which alone or in combination may continue to have a material adverse effect on our revenues and the financial results of our operations. In addition, we remain concerned about the geopolitical instability in the Middle East as well as the continued volatility of the energy, equity and currency markets. These factors as well as others we may not contemplate could have a material adverse effect on the spending patterns of businesses including our current and potential customers which could have a material adverse effect on our revenues and our results of operations. See "Our Revenues are Subject to Seasonal Variations" on page 41 for discussion of the potential impact of seasonality on our business.

22 -------------------------------------------------------------------------------- Results of Operations The following table sets forth, for the periods indicated, the percentage of net sales represented by certain items reflected in our Consolidated Statements of Income: Three Months Ended September 30, NineMonths Ended September 30, (Unaudited) (Unaudited) 2014 2013 2014 2013 Net sales: Americas 41.5 % 44.1 % 40.1 % 41.3 % Europe 25.7 25.7 27.2 26.2 East Asia 24.7 20.0 24.1 22.9 Emerging Markets 8.0 10.2 8.6 9.6 Consolidated net sales 100.0 100.0 100.0 100.0 Cost of sales 25.8 26.0 25.7 26.3 Gross profit 74.2 74.0 74.3 73.7 Operating expenses: Sales and marketing 37.2 38.5 38.2 38.8 Research and development 18.8 21.0 18.7 20.7 General and administrative 7.2 7.4 7.6 7.6 Acquisition related 0.0 adjustment - - (0.2) Total operating expenses 63.3 66.9 64.4 66.9 Operating income 10.9 7.1 9.9 6.8 Other income (expense): Interest income 0.1 0.0 0.1 0.1 Net foreign exchange (0.1) 0.2 (0.1) (0.2) (loss) gain Other income, net 0.0 0.1 0.0 0.1 Income before income taxes 10.9 7.4 9.9 6.7 (Benefit from) provision (1.8) 2.0 0.8 1.1 for income taxes Net income 12.7 % 5.5 % 9.1 % 5.6 % Figures may not sum due to rounding.

Results of Operations for the three and nine month periods ended September 30, 2014 and 2013 Net Sales. Our net sales were $314 million and $289 million for the three month periods ended September 30, 2014 and 2013, respectively, an increase of 8%. For the same periods, product sales were $287 million and $270 million, an increase of 7%, and software maintenance sales were $26 million and $20 million, an increase of 35%. Software maintenance sales grew at a faster rate than our overall net sales as a result of a greater mix of software sales during the three month period ended September 30, 2014, compared to the three month period ended September 30, 2013.

For the nine month periods ended September 30, 2014 and 2013, our consolidated net sales were $911 million and $872 million, respectively, an increase of 5%.

For the same periods, product sales were $838 million and $811 million, respectively, an increase of 3%, and software maintenance sales were $73 million and $61 million, respectively, an increase of 20%. Software maintenance sales grew at a faster rate than our overall net sales as a result of a greater mix of software sales during the nine month period ended September 30, 2014, compared to the nine month period ended September 30, 2013.

We do not typically maintain a large amount of order backlog as orders typically translate to sales quickly. As such, any change in the pattern of our orders will typically have an impact on our net sales in the short term.

During the nine month period ended September 30, 2014, we implemented moderate pricing changes which had less than a 1% positive impact on our net sales.

23 -------------------------------------------------------------------------------- Large orders, defined as orders with a value greater than $100,000, increased by 10% year over year during the three months ended September 30, 2014, compared to the year over year increase of 8% in the three month period ended September 30, 2013. In the nine month period ended September 30, 2014, large orders increased by 13% year over year compared the to year over year decrease of 1% during the nine month period ended September 30, 2013. A significant amount of our large order growth in the three month and nine month periods ended September 30, 2014, compared to the comparable periods in 2013, was the result of orders from our largest customer. Year over year, orders from this customer increased by 225% in the three month period ended September 30, 2014, and increased by 52% in the nine month period ended September 30, 2014. Excluding the impact of our largest customer, large orders decreased by 4% year over year during the three month period ended September 30, 2014, and increased by 4% year over year during the nine month period ended September 30, 2014,. Orders from our largest customer are discussed in more detail below. During the three month periods ended September 30, 2014 and 2013, large orders were 22% and 21% of our total orders, respectively, and for the nine month periods ended September 30, 2014 and 2013, large orders were 23% and 21% of our total orders, respectively. Larger orders are more volatile, are subject to greater discount variability and may contract at a faster pace during an economic downturn.

With respect to our largest customer, we are serving several different applications for this customer, each involving the use of LabVIEW and the NI PXI platform. During the three month periods ended September 30, 2014 and 2013, we received $12 million and $3.8 million, respectively, in new orders from our largest customer. During the nine month periods ended September 30, 2014 and 2013, we received $51 million and $34 million, respectively, in new orders from this same customer. In the three month periods ended September 30, 2014 and 2013, we recognized net revenue of $17 million and $4.2 million, respectively, from these orders, and in the nine month periods ended September 30, 2014 and 2013, we recognized net revenue from these orders of $44 million and $31 million.

For the three month periods ended September 30, 2014 and 2013, net sales in the Americas were $130 million and $128 million, respectively, an increase of 2%.

Sales in the Americas, as a percentage of consolidated sales were 42% and 44% in the three month periods ended September 30, 2014, and 2013, respectively. In Europe, net sales were $81 million and $74 million in the three month periods ended September 30, 2014, and 2013, respectively, an increase of 8%. Sales in Europe, as a percentage of consolidated sales were 26% in each of the three month periods ended September 30, 2014 and 2013. In East Asia, net sales were $78 million and $58 million in the three month periods ended September 30, 2014 and 2013, respectively, an increase of 34%. Sales in East Asia, as a percentage of consolidated sales were 25% and 20% in the three month periods ended September 30, 2014 and 2013, respectively. In Emerging Markets, net sales were $25 million and $29 million in the three month periods ended September 30, 2014, respectively, a decrease of 14%. Sales in Emerging Markets, as a percentage of consolidated sales were 8% and 10% in the three month periods ended September 30, 2014 and 2013, respectively.

For the nine month periods ended September 30, 2014 and 2013, net sales in the Americas were $365 million and $360 million, respectively, an increase of 2%.

Sales in the Americas, as a percentage of consolidated sales were 40% and 41% in the nine month periods ended September 30, 2014 and 2013, respectively. In Europe, net sales were $248 million and $228 million in the nine month periods ended September 30, 2014 and 2013, respectively, an increase of 9%. Sales in Europe, as a percentage of consolidated sales were 27% and 26% in the nine month periods ended September 30, 2014 and 2013, respectively. In East Asia, net sales were $220 million and $200 million in the nine month periods ended September 30, 2014 and 2013, respectively, an increase of 10%. Sales in East Asia, as a percentage of consolidated sales were 24% and 23% in the nine month periods ended September 30, 2014 and 2013, respectively. In Emerging Markets, net sales were $78 million and $84 million in the nine month periods ended September 30, 2014 and 2013, respectively, a decrease of 7%. Sales in Emerging Markets, as a percentage of consolidated sales were 9% and 10% in the nine month periods ended September 30, 2014 and 2013, respectively.

We expect sales outside of the Americas to continue to represent a significant portion of our revenue. We intend to continue to expand our international operations by increasing our presence in existing markets, adding a presence in some new geographical markets and continuing the use of distributors to sell our products in some countries.

Almost all of the sales made by our direct sales offices in the Americas (excluding the U.S.), Europe, East Asia, and Emerging Markets are denominated in local currencies, and accordingly, the U.S. dollar equivalent of these sales is affected by changes in foreign currency exchange rates. For the three month period ended September 30, 2014, in local currency terms, our consolidated net sales increased by $22 million or 8%, Americas sales increased by $2.9 million or 2%, European sales increased by $3.5 million or 5%, East Asia sales increased by $19 million or 33%, and Emerging Markets sales decreased by $3.7 million or 12%, compared to the three month period ended September 30, 2013. During this same period, the change in exchange rates had the effect of increasing our consolidated sales by $1.9 million or 1%, decreasing Americas sales by $251,000 or 0.2%, increasing European sales by $2.4 million or 3%, increasing East Asia sales by $253,000 or 0.4%, and decreasing sales in Emerging Markets by $481,000 or 1.6%.

24 -------------------------------------------------------------------------------- For the nine month period ended September 30, 2014, in local currency terms, our consolidated net sales increased by $39 million or 5%, Americas sales increased by $8 million or 2%, European sales increased by $12 million or 5%, East Asia sales increased by $20 million or 10%, and Emerging Markets sales decreased by $701,000 or 1%, compared to the nine month period ended September 30, 2013.

During this same period, the change in exchange rates had the effect of decreasing our consolidated sales by $1.0 million, decreasing Americas sales by $2.5 million or 0.7%, increasing European sales by $9 million or 4%, decreasing East Asia sales by $2.8 million or 1.4%, and decreasing sales in Emerging Markets by $5.1 million or 6%.

To help protect against changes in U.S. dollar equivalent value caused by fluctuations in foreign currency exchange rates of forecasted foreign currency cash flows resulting from international sales, we have instituted a foreign currency cash flow hedging program. We hedge portions of our forecasted revenue denominated in foreign currencies with average rate forward contracts. During the three month periods ended September 30, 2014 and 2013, these hedges had the effect of increasing our consolidated sales by $999,000 and increasing our consolidated sales by $751,000, respectively. During the nine month periods ended September 30, 2014 and 2013, these hedges had the effect of increasing our consolidated sales by $1.1 million and increasing our consolidated sales by $2.7 million, respectively. (See Note 5 - Derivative instruments and hedging activities of Notes to Consolidated Financial Statements for further discussion regarding our cash flow hedging program and its related impacted on our consolidated sales for 2014 and 2013).

Gross Profit. For the three month periods ended September 30, 2014 and 2013, gross profit was $233 million and $214 million, respectively, an increase of 9%.

As a percentage of sales, gross profit was 74% for each of the three month periods ended September 30, 2014 and 2013. For the nine month periods ended September 30, 2014 and 2013, gross profit was $677 million and $642 million, respectively, an increase of 5%. As a percentage of sales, gross profit was 74% for each of the nine month periods ended September 30, 2014 and 2013. We continue to focus on cost control and cost reduction measures throughout our manufacturing cycle.

For the three month periods ended September 30, 2014 and 2013, the change in exchange rates had the effect of decreasing our cost of sales by $1.2 million and increasing our cost of sales by $1.5 million, respectively. For the nine month periods ended September 30, 2014 and 2013, the change in exchange rates had the effect of decreasing our cost of sales by $1.8 million and increasing our cost of sales by $2.2 million, respectively. To help protect against changes in our cost of sales caused by a fluctuation in foreign currency exchange rates of forecasted foreign currency cash flows, we have a foreign currency cash flow hedging program. We hedge portions of our forecasted costs of sales denominated in foreign currencies with average rate forward contracts. During the three month periods ended September 30, 2014 and 2013, these hedges had the effect of decreasing our cost of sales by $32,000 and increasing our cost of sales by $20,000, respectively. During the nine month periods ended September 30, 2014 and 2013, these hedges had the effect of decreasing our cost of sales by $214,000 and $54,000, respectively. (See Note 5 - Derivative instruments and hedging activities of Notes to Consolidated Financial Statements for further discussion regarding our cash flow hedging program and its related impacted on our consolidated sales for 2014 and 2013).

Operating Expenses. For the three month periods ended September 30, 2014 and 2013, operating expenses were $198 million and $193 million, respectively, an increase of 3%. As a percent of sales, operating expenses were 63% and 67% for the three month periods ended September 30, 2014 and 2013, respectively. For the three month period ended September 30, 2014, the increase in our operating expenses was due to an increase in personnel related expenses of $4.7 million and an increase in travel, building and equipment of $3.5 million offset by a $2.8 million increase in software development costs capitalized. The increase in personnel related expenses was driven by an increase in commissions due to higher sales volume, an increase in variable compensation due to the overall improvement in our operating results compared to the three month period ended September 30, 2013, as well as raises for eligible employees. The decrease in our software development costs coincides with the increase in our capitalized software compared to the three month period ended September 30, 2013. Over the same period, the net impact of changes in foreign currency exchange rates increased our operating expense by $377,000.

For the nine month periods ended September 30, 2014 and 2013, operating expenses were $587 million and $583 million, respectively, an increase of 1%. As a percent of sales, operating expenses were 64% and 67% for the nine month periods ended September 30, 2014 and 2013, respectively. For the nine month period ended September 30, 2014, the increase in our operating expenses was due to an increase in personnel related expenses of $15 million and an increase in travel, building and equipment and marketing and outside services of $2.4 million offset by a $11 million decrease in software development costs. The increase in personnel related expenses was driven by an increase in commissions due to higher sales volumes as well as an increase variable compensation due to the overall improvement in our operating results compared to the nine month period ended September 30, 2013. The decrease in our software development costs coincides with the $11 million increase in our capitalized software compared to the nine month period ended September 30, 2013. The increase in our capitalized software is consistent with our focus on new product development to support future growth in our business. Over the same period, the net impact of changes in foreign currency exchange rates decreased our operating expenses by $1.2 million.

25 -------------------------------------------------------------------------------- We believe that our long-term growth and success depends on developing high quality software and hardware products on a timely basis. We are focused on leveraging recent investments in research and development and in our field sales force and taking actions to help ensure those resources are focused in areas and initiatives that will contribute to future growth in our business. For the three month periods ended September 30, 2014 and 2013, our sales and marketing expenses were $117 million and $111 million, respectively, and research and development expenses were $59 million and $61 million, respectively. For the nine month periods ended September 30, 2014 and 2013, our sales and marketing expenses were $348 million and $338 million, respectively, and research and development expenses were $170 million and $181 million, respectively. Overall headcount for our operating functions decreased by 45 from September 30, 2013 to September 30, 2014.

From a regional perspective, the decrease in research and development expenses had a larger impact on the operating expenses of the Americas as the Americas decreased by $2.4 million while the remaining regions increased by $603,000. In the nine month period ended September 30, 2014, the Americas decreased by $11.1 million while the remaining regions increased by $693,000.

Operating Income. For the three month periods ended September 30, 2014 and 2013, operating income was $34 million and $21 million, respectively, an increase of 67%. As a percentage of net sales, operating income was 11% and 7%, respectively, in these same periods. For the nine month periods ended September 30, 2014 and 2013, operating income was $90 million and $59 million, respectively, an increase of 53%. As a percentage of net sales, operating income was 10% and 7%, respectively, in these same periods. The increases in operating income in absolute dollars and as a percentage of sales for the three and nine month periods ended September 30, 2014, compared to the three and nine month periods ended September 30, 2013, are attributable to the factors discussed in Net Sales, Gross Profit and Operating Expenses above.

Interest Income. For the three month periods ended September 30, 2014 and 2013, interest income was $362,000 and $133,000, respectively. For the nine month periods ended September 30, 2014 and 2013, interest income was $793,000 and $495,000, respectively. We continue to see low yields for high quality investment alternatives that comply with our corporate investment policy. We do not expect yields in these types of investments to increase significantly during the remainder of 2014.

Net Foreign Exchange Gain (Loss). For the three month periods ended September 30, 2014 and 2013, net foreign exchange loss was $(452,000) and gain of $456,000, respectively. During the nine month periods ended September 30, 2014 and 2013, net foreign exchange loss was $(1.0) million and $(2.1) million, respectively. These results are attributable to movements in the foreign currency exchange rates between the U.S. dollar and foreign currencies in subsidiaries for which our functional currency is not the U.S. dollar. During the three month period ended September 30, 2014, there was sharp volatility in the exchange rates between the U.S. dollar and most of the major currencies in the markets in which we do business characterized by broad and sharp strengthening of the U.S. dollar against most currencies. We cannot predict the direction or degree of future volatility in these exchange rates. In the past, we have noted that significant volatility in foreign currency exchange rates in the markets in which we do business has had a significant impact on the revaluation of our foreign currency denominated firm commitments, on our ability to forecast our U.S. dollar equivalent revenues and expenses and on the effectiveness of our hedging programs. In the past, these dynamics have also adversely affected our revenue growth in international markets and may pose similar challenges in the future. We recognize the local currency as the functional currency in virtually all of our international subsidiaries.

We utilize foreign currency forward contracts to hedge our foreign denominated net foreign currency balance sheet positions to help protect against the change in value caused by a fluctuation in foreign currency exchange rates. We typically hedge up to 90% of our outstanding foreign denominated net receivable or payable positions and typically limit the duration of these foreign currency forward contracts to approximately 90 days. The gain or loss on these derivatives as well as the offsetting gain or loss on the hedged item attributable to the hedged risk is recognized in current earnings under the line item "Net foreign exchange gain (loss)". Our hedging strategy decreased our foreign exchange losses by $2.2 million in the three month period ended September 30, 2014 and decreased our foreign exchange gains by $1.3 million in the three month period ended September 30, 2013. Our hedging strategy decreased our foreign exchange losses by $1.4 million in the nine month period ended September 30, 2014 and decreased our foreign exchange losses by $533,000 in the nine month period ended September 30, 2013. (See Note 5 - Derivative instruments and hedging activities of Notes to Consolidated Financial Statements for a further description of our derivative instruments and hedging activities) 26 -------------------------------------------------------------------------------- Provision for Income Taxes. For the three month periods ended September 30, 2014 and 2013, our provision for income taxes reflected an effective tax rate of (16%) and 26%, respectively. For the nine month periods ended September 30, 2014 and 2013, our provision for income taxes reflected an effective tax rate of 8% and 16%, respectively. We recognized a tax benefit of $14 million in the three and nine month periods ended September 30, 2014 related to a settlement with the Internal Revenue Service of the examination of our U.S. income tax returns for 2010 and 2011. The factors that caused our effective tax rate to change year-over-year are detailed in the table below: Three Months Ended Nine Months Ended September 30, 2014 September 30, 2014 (Unaudited) (Unaudited) Effective tax rate at September 30, 2013 26 % 16 % Change in profit in foreign jurisdictions with (6) reduced tax rates (5) Change in enhanced deduction for certain 3 research and development expenses 3 Change in intercompany profit 1 1 Change in tax benefit from equity awards - 1 Change in research and development tax credit 4 9 Decrease in unrecognized tax benefits (41) (15) Other (3) (2) Effective tax rate at September 30, 2014 (16) % 8 % (See Note 9 - Income taxes of Notes to Consolidated Financial Statements for further discussion regarding changes in our effective tax rate and a reconciliation of income taxes at the U.S. federal statutory income tax rate of 35% to our effective tax rate).

Other operational metrics We believe that the following additional unaudited operational metrics assist investors in assessing our operational performance relative to our others in our industry and to our historical results.

Charges related to stock-based compensation, amortization of acquired intangibles and acquisition related transaction costs. For the three and nine month periods ended September 30, 2014 and 2013, the charges related to stock-based compensation as a component of cost of sales, sales and marketing, research and development, general and administrative, the associated provision for income taxes and the total charges were as follows: Three Months Ended September 30, Nine Months Ended September 30, (In thousands) (Unaudited) (Unaudited) 2014 2013 2014 2013 Stock-based compensation Cost of sales $ 465 $ 390 $ 1,264 $ 1,219 Sales and marketing 2,756 2,908 8,334 8,907 Research and development 2,497 3,803 7,221 9,136 General and administrative 877 889 2,657 2,734 Provision for income taxes (2,284) (2,894) (5,917) (6,585) Total $ 4,311 $ 5,096 $ 13,559 $ 15,411 For the three and nine month periods ended September 30, 2014 and 2013, the charges related to the amortization of acquisition related intangibles as a component of cost of sales, sales and marketing, research and development, other income, net, the associated provision for income taxes and the total charges were as follows: Three Months Ended September 30, NineMonths Ended September 30, (In thousands) (Unaudited) (Unaudited) 2014 2013 2014 2013 Amortization of acquired intangibles Cost of sales $ 2,662 $ 2,672 $ 7,991 $ 8,045 Sales and marketing 433 490 1,351 1,506 Research and development 392 396 1,198 1,638 Other income, net 170 185 507 566 Provision for income taxes (1,207) (1,232) (3,647) (3,850) Total $ 2,450 $ 2,511 $ 7,400 $ 7,905 27 --------------------------------------------------------------------------------For the three and nine month periods ended September 30, 2014 and 2013, the charges related to acquisition transaction costs and restructuring as a component of cost of sales, sales and marketing, research and development, general and administrative, acquisition related adjustments, the associated provision for income taxes and the total charges were as follows: Nine Months Ended September Three Months Ended September 30, 30, (In thousands) (Unaudited) (Unaudited) 2014 2013 2014 2013 Acquisition transaction costs and restructuring Cost of sales $ 547 $ 4 $ 547 $ 7 Sales and marketing (24) 146 152 406 Research and development (42) 281 264 691 General and administrative 38 71 145 246 Acquisition related adjustment - - - (1,316) Provision for income taxes (182) (153) (388) (412) Total $ 337 $ 349 $ 720 $ (378) Liquidity and Capital Resources Working Capital, Cash and Cash Equivalents and Short-term Investments. Cash, cash equivalents and short-term investments increased by $54 million to $448 million at September 30, 2014 from $393 million at December 31, 2013. The following table presents our working capital, cash and cash equivalents and short-term investments: September 30, 2014 December 31, (In thousands) (unaudited) 2013 Increase Working capital $ 657,014 $ 603,240 $ 53,774 Cash and cash equivalents (1) 259,455 230,263 29,192 Short-term investments (1) 188,299 163,149 25,150 Total cash, cash equivalents and $ $ $ short-term investments 447,754 393,412 54,342 (1) Included in working capital During the nine month period ended September 30, 2014, our working capital increased by $54 million. Overall, current assets increased by $78 million while current liabilities increased by $24 million. The increase in our current assets was the result of a $54 million increase in cash, cash equivalents and short-term investments, an increase in accounts receivable of $7 million and an increase in prepaid expense and other current assets of $23 million. These increases were offset by a decrease in inventory of $1.2 million and a decrease in deferred income taxes of $5.0 million. The increase in current liabilities was the result of an increase in accounts payable of $5.3 million, an increase in accrued compensation of $12 million, and an increase in deferred revenue of $5.3 million. The overall increases in working capital can be attributed to our overall profitability during the nine month period ended September 30, 2014.

Accounts receivable increased by $7 million to $188 million at September 30, 2014, from $181 million at December 31, 2013. Days sales outstanding decreased to 55 days at September 30, 2014, compared to 57 days at December 31, 2013. The increase in accounts receivable is consistent with the higher volume of sales during the nine month period ended September 30, 2014.

Inventory decreased by $1.2 million to $171 million at September 30, 2014, from $172 million at December 31, 2013. Inventory turns remained unchanged at 1.8 at September 30, 2014 and December 31, 2013.

Prepaid expenses and other current assets increased $23 million to $72 million at September 30, 2014, from $49 million at December 31, 2013. The increase in the fair value of our derivatives designated as hedging instruments accounted for $7.3 million of this increase. The timing of payments of U.S. federal taxes as well as value added taxes (VAT) in various jurisdictions and insurance and maintenance contracts accounted for the remaining $16 million of this change.

(See Note 5 - Derivative instruments and hedging activities of Notes to Consolidated Financial Statements for a further description of our derivative instruments and hedging activities) 28 -------------------------------------------------------------------------------- Our cash and cash equivalent balances are held in numerous financial institutions throughout the world, including substantial amounts held outside of the U.S., however, the majority of our cash and investments that are located outside of the U.S. are denominated in the U.S. dollar with the exception of $7.6 million U.S. dollar equivalent of German government sovereign debt and $23 million U.S. dollar equivalent of corporate bonds that are denominated in Euro.

Our German government sovereign debt holdings have a maximum remaining maturity of 8 months and carry Aaa/AAA ratings. Our short-term investments do not include sovereign debt from any other countries in Europe. At September 30, 2014, we had $448 million in cash, cash equivalents and short-term investments. Approximately $60 million or 13% of these amounts were held in domestic accounts with various financial institutions and $388 million or 87% was held in accounts outside of the U.S. with various financial institutions. At September 30, 2014, we had cash and cash equivalents of $259 million of which $60 million or 23% was held in domestic accounts and $199 million or 77% was held in various accounts of our foreign subsidiaries. At September 30, 2014, we had short-term investments of $188 million, all of which was held in investment accounts of our foreign subsidiaries. Most of the amounts held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal income taxes, less applicable foreign tax credits. We have provided for the U.S.

federal tax liability on these amounts for financial statement purposes, except for foreign earnings that are considered indefinitely reinvested outside of the U.S. Repatriation could result in additional U.S. federal income tax payments in future years. We utilize a variety of tax planning and financing strategies with the objective of having our worldwide cash available in the locations in which it is needed.

Cash Provided by and (Used in) in the nine month period ended September 30, 2014. The following table summarizes the proceeds and (uses) of cash: Nine Months Ended September 30, (In thousands) (unaudited) 2014 2013Cash provided by operating activities $ 140,716 $ 94,722 Cash used in investing activities (80,088) (36,247) Cash used in financing activities (31,436) (30,263) Net change in cash equivalents 29,192 28,212 Cash and cash equivalents at beginning of year 230,263 161,996 Cash and cash equivalents at end of period $ 259,455 $ 190,208 For the nine month periods ended September 30, 2014 and 2013, cash provided by operating activities was $141 million and $95 million, respectively, an increase of $46 million. This increase was due to an increase in net income of $34 million and an increase in cash provided by our operating assets of $12 million.

Investing activities used cash of $80 million during the nine month period ended September 30, 2014, as the result of capital expenditures of $31 million, capitalization of internally developed software and other intangibles of $22 million, and the net purchase of short-term investments of $25 million. During the nine month period ended September 30, 2013, we were still making payments related to the finishing stages of the construction of our Malaysian manufacturing facility. During the nine month period ended September 30, 2014, we were no longer making significant payments for our Malaysian manufacturing facility and as a result, capital expenditures during the nine month period ended September 30, 2014, declined by $10 million. Capital expenditures during the nine month period ended September 30, 2014, included leasehold improvements, expansion of existing facilities, computers, equipment and furniture and fixtures to support operations throughout our business. Investing activities used cash of $36 million during the nine month period ended September 30, 2013, as the result of capital expenditures of $41 million and capitalization of internally developed software and other intangibles of $11 million, offset by the net sale of $19 million of short-term investments to fund liquidity for operating needs. Capital expenditures during the nine month period ended September 30, 2013 included payments related to additional land use rights and the finishing stages of the construction of our Malaysian manufacturing facility as well as leasehold improvements, computers, equipment and furniture and fixtures to support operations in our Malaysian manufacturing facility as well as other parts of our business.

Financing activities used cash of $31 million during the nine month period ended September 30, 2014, which was the net result of $57 million used to pay our dividends offset by $24 million received from the issuance of our common stock from the exercise of employee stock options and from our employee stock purchase plan. Financing activities used cash of $30 million during the nine month period ended September 30, 2013, which was the result of $29 million received from the issuance of our common stock from the exercise of employee stock options and from our employee stock purchase plan, offset by $9 million used to settle an earn-out payment related to our acquisition of AWR and $52 million used to pay dividends to our stockholders.

From time to time, our Board of Directors has authorized various programs to repurchase shares of our common stock depending on market conditions and other factors. We did not make any purchases under this program during the nine month period ended September 30, 2014. At September 30, 2014, there were 3,932,245 shares remaining available for repurchase under this program. This repurchase program does not have an expiration date.

29 -------------------------------------------------------------------------------- During the nine month period ended September 30, 2014, we received less proceeds from the exercise of stock options compared to the nine month period ended September 30, 2013. The timing and number of stock option exercises and the amount of cash proceeds we receive through those exercises are not within our control and in the future, we may not generate as much cash from the exercise of stock options as we have in the past. Moreover, since 2005, it has been our practice to issue RSUs and not stock options to eligible employees which has reduced the number of stock options available for exercise in the future. Unlike the exercise of stock options, the issuance of shares upon vesting of RSUs does not result in any cash proceeds to us. As of September 30, 2014, there were outstanding options to purchase 58,580 shares of our common stock of which options for 4,550 shares have expiration dates in 2014. These options have weighted average exercise prices of between $14.63 per share and $19.45 per share. As such, we will not generate as much cash from the exercise of stock options during the remainder of 2014 and very little if any after 2014.

Contractual Cash Obligations. Purchase obligations primarily represent purchase commitments for customized inventory and inventory components. At September 30, 2014, we had non-cancelable purchase commitments with various suppliers of customized inventory and inventory components totaling approximately $9 million.

At December 31, 2013, we had non-cancelable purchase commitments with various suppliers of customized inventory and inventory components totaling approximately $11 million.

Guarantees are related to payments of customs and foreign grants. At September 30, 2014, we had outstanding guarantees for payment of customs and foreign grants totaling approximately $13 million. At December 31, 2013, we had outstanding guarantees for payment of customs, foreign grants and potential customer disputes totaling approximately $5.2 million.

Loan Agreement. On May 9, 2013, we entered into a Loan Agreement (the "Loan Agreement") with Wells Fargo Bank, National Association. The Loan Agreement provides for a $50 million unsecured revolving line of credit with a scheduled maturity date of May 9, 2018 (the "Maturity Date"). Proceeds of loans made under the Loan Agreement may be used for working capital and other general corporate purposes. We may prepay the loans under the Loan Agreement in whole or in part at any time without premium or penalty. Certain of our existing and future material domestic subsidiaries are required to guaranty our obligations under the Loan Agreement. We may choose to borrow funds against this line of credit in future periods to have sufficient domestic cash to fund continued dividends to our stockholders, to fund potential acquisitions or other domestic general corporate purposes without the need to repatriate foreign earnings. At September 30, 2014, we did not have any amounts outstanding or due as a result of borrowings under this line of credit.

Off-Balance Sheet Arrangements. We do not have any off-balance sheet debt. At September 30, 2014, we did not have any relationships with any unconsolidated entities or financial partnerships, such as entities often referred to as structured finance entities, which would have been established for the purpose of facilitating off-balance sheet arrangements. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we were engaged in such relationships.

Prospective Capital Needs. We believe that our existing cash, cash equivalents and short-term investments, together with cash generated from operations as well as from the purchase of common stock through our employee stock purchase plan and available borrowings under our Loan Agreement will be sufficient to cover our working capital needs, capital expenditures, investment requirements, commitments, payment of dividends to our stockholders and repurchases of our common stock for at least the next 12 months, although the use of certain of our funds for domestic purposes may require us to repatriate foreign earnings which would be subject to the U.S. federal statutory tax rate of 35%. We may also seek to pursue additional financing or to raise additional funds by selling equity or debt to the public or in private transactions. If we elect to raise additional funds, we may not be able to obtain such funds on a timely basis on acceptable terms, if at all. If we raise additional funds by issuing additional equity or convertible debt securities, the ownership percentages of our existing stockholders would be reduced. In addition, the equity or debt securities that we issue may have rights, preferences or privileges senior to those of our common stock. We may also choose to repatriate foreign earnings which would be subject to the U.S. federal statutory tax rate of 35% and therefore, would likely have a material adverse effect on our effective tax rate and on our net income and earnings per share. We could also choose to reduce certain expenditures or payments of dividends or suspend our program to repurchase shares of our common stock. Historically, we have not had to rely on debt, public or private, to fund our operating, financing or investing activities.

30 -------------------------------------------------------------------------------- Although we believe that we have sufficient capital to fund our operating activities for at least the next 12 months, our future capital requirements may vary materially from those now planned. We anticipate that the amount of capital we will need in the future will depend on many factors, including: · payment of dividends to our stockholders; · difficulties and the high tax costs associated with the repatriation of earnings; · required levels of research and development and other operating costs; · general economic and political uncertainty and specific conditions in the markets we address, including any volatility in the industrial economy in the various geographic regions in which we do business; · our business, product, capital expenditure and research and development plans, and product and technology roadmaps; · the overall levels of sales of our products and gross profit margins; · the levels of inventory and accounts receivable that we maintain; · the inability of certain of our customers who depend on credit to have access to their traditional sources of credit to finance the purchase of products from us, which may lead them to reduce their level of purchases or to seek credit or other accommodations from us; · acquisitions of other businesses, assets, products or technologies; · capital improvements for new and existing facilities; · repurchases of our common stock; · our relationships with suppliers and customers; and · the level of purchases under our employee stock purchase plan.

Recently Issued Accounting Pronouncements See Note 15 - Recently issued accounting pronouncements in Notes to Consolidated Financial Statements.

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