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Equity Analysis and Valuation

Project Group Members:

Amy Stone [email protected] Emily Newman [email protected] Jasmijn Janssens [email protected] Jesse Bush [email protected] Michael Cueva [email protected]

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Table of Contents Executive Summary…………………………………………………………………………………….1

Business and Industry Analysis……………………………………………………………..…….9

Company Overview………………………………………………………………...9

Industry Overview………………………………………………………………...10

Five Forces Model…………………………………………………………………………………….12

Rivalry Among Existing Firms……………………………………………………………13

Industry Growth……………………………………………………………………13

Concentration and Balance of Competitors……………………….……..16

Degree of Differentiation……………………………………………………….17

Switching Costs…………………………………………………………………….19

Economies of Scale.………………………………………………………………19

Learning Economies………………………………………………………………21

Excess Capacity…………………………………………………………………….21

Exit Barriers………………………………………………………………………….22

Conclusion………………………………………………………………………………………22

Threat of New Entrants……………………………………………………………………23

Economies of Scale……………………………………………………………….23

First Mover Advantage…………………………………………………………..24

Access to Channels of Distribution………………………………………….25

Legal Barriers……………………………………………………………………….26

Conclusion………………………………………………………………………………………27

Threat of Substitute Products…………………………………………………………..28

Relative Price and Performance………………………………………………28

Buyers’ Willingness to Switch………………………………………………….29

Conclusion………………………………………………………………………………………29

Bargaining Power of Customers………………………………………………………..30

Price Sensitivity…………………………………………………………………….31

Relative Bargaining Power……………………………………………………..31

Conclusion……………………………………………………………………………………..32

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Bargaining Power of Suppliers………………………………………………………….32

Price Sensitivity…………………………………………………………………….33

Relative Bargaining Power……………………………………………………..34

Conclusion……………………………………………………………………………………...35

Value Creation Analysis……………………………………………………………………35

Superior Product Quality………………………………………………………..36

Superior Customer Service and Delivery Turn-around……………….36

Research and Development……………………………………………………37

Creativity and Innovation……………………………………………………….38

Managing Global Currency Risk………………………………………………38

Conclusion………………………………………………………………………………………39

Firm Competitive Advantage Analysis……………………………………………….39


Superior Product Quality/ Service……………………………………………40

Managing Global Currency Risk………………………………………………41

Creativity and Innovation……………………………………………………….43

Conclusion………………………………………………………………………………………44

Formal Accounting Analysis…………………………………………………………………….…44

Key Accounting Policies……………………………………………………………………45


Goodwill………………………………………………………………………………………….48

Operating and Capital Leases…………………………………………………50

Warranties………………………………………………………………………………………50

Foreign Currency…………………………………………………………………..51

Accounting Flexibility………………………………………………………………………52


Goodwill………………………………………………………………………………………….54


Warranties………………………………………………………………………………………55

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Evaluate Accounting Strategy………………………………………………………….57


Goodwill………………………………………………………………………………………….58


Warranties………………………………………………………………………………………59


Conclusion………………………………………………………………………………………60

Quality of Disclosure………………………………………………………………….……60


Goodwill…………………………………………………………………………………………61


Warranties………………………………………………………………………………………62

Foreign Currency………………………………………………………………….63

Conclusion……………………………………………………………………………………..63

Quantitative Analysis……………………………………………………………………….64

Sales Manipulation Diagnostic…………………………………………………65

Net sales/Cash from Sales……………………………………………66

Net Sales/Net Accounts Receivables………………………………68

Net Sales/Unearned Revenue……………………………………….69

Net Sales/Inventory…………………………………………………….71

Net Sales/Warranty Liabilities……………………………………….72

Conclusion…………………………………………………………………………….74

Core Expense Manipulation Diagnostics…………………………………..76

Asset Turnover……………………………………………………………76

CFFO/OI……………………………………………………………………………….77

CFFO/NOA…………………………………………………………………………….79

Accruals/Net Sales……………………………………………………….81

Conclusion…………………………………………………………………………….82

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Potential Red Flags……………………………………………………………….84

Undoing Accounting Distortions or Irregularities……………………..86

Goodwill…………………………………………………………….....................87



Financial Analysis, Forecasting Financials, and Cost of Capital Estimation..........91

Financial Analysis......................................................................91 Liquidity Ratios…............................................................92 Current Ratio..................................................................92 Quick Asset Ratio….........................................................94 Working Capital Turnover………………………..………………….95 Accounts Receivable Turnover.........................................97 Day Sales Outstanding…………………………………………………98 Inventory Turnover……..………………………………………………99 Days’ Supply of Inventory………………………………………..…100 Cash to Cash Cycle…………….………………………………………101 Conclusion………..………………………………………………………102

Profitability Ratio Analysis……………………………………………………103 Gross Profit Margin…………………..………………………….……104 Operating Profit Margin………………………………………………105 Net Profit Margin………………………………………………………106 Return on Assets………………………………………………………107 Return on Equity………………………………………………………108 Asset Turnover…………………………………………………………109 Operating Expense Ratio……………………………………………110 Conclusion…………………………………………………………………111

Capital Structure Analysis……………………………………………………………….113 Debt to Equity……………………………………………………………………113 Times Interest Earned………………………………………………………….115 Debt Service Margin…………………………………………………………….116 Altman Z-Score……………………………………………………………………116

Firm Growth Rates……………………………………………………………………….117 IGR……………………………………………………….…………………………..118 SGR……………………………………………………………………………………119

Financial Statement Forecasting……………………………………………………..120 Income Statement…….………………………………………………………..121 Balance Sheet……………………….……………………………………………126 Statement of Cash Flows……………………………………………………..132 Conclusion………………………………………………………………………….133

Estimating Cost of Capital………………………………………………………………136 Cost of Equity……………………………………………………………………..136

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Regression Results………………………………………………………………138 Back Door Method……………………………………………………………….139

Cost of Debt…………………………………………………………………………………140 WACC………………………………………………………………………………………….141

Valuation Analysis…………………………………………………………………………………..142

Method of Comparables…………………………………………………………………142

Price/Earnings Trailing…………………………………………………………143

Price/Earnings (Forward)…………………………………………………….144

Price/Book…………………………………………………………………………………….145

Price Earnings Growth (P.E.G.)……………………………………………..146

Price/EBITDA………………………………………………………………………………...147

Enterprise Value/ EBITDA…………………………………………………….148

Price/ Free Cash Flows………………………………………………………..150

Dividends/ Price………………………………………………………………….150

Conclusion………………………………………………………………………………….…151

Intrinsic Valuation Models……………………………………………………………….152

Discounted Dividend Model…………………………………………………..152

Discounted Free Cash Flows Model……………………………………….153

Residual Income Model………………………………………………………..155

Abnormal Earnings Growth Model (A.E.G)………………………………158

Long Run Residual Income Model…………………………………………160

Analyst Recommendations……………………………………………………………………….163

Appendices………………………………………………………………………………………….…166

References……………………………………………………………………………………………..193

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52 Week Range: $20.39‐$36.06 2003 2004 2005 2006 2007Revenue: $823.24 Million As Stated Scores: 5.775 5.937 5.831 5.929 5.531Market Capitalization: $1.9 Billion Restated Scores: 6.515 6.805 6.705 6.956 6.526Shares Outstanding: 78830

Current Market Share Price: $25.09As Stated Restated

Book Value Per Share: $10.38 $10.89Return on Equity: 17.90% 50.30% As Stated RestatedReturn on Assets: 14.80% 43.00% Trailing P/E: 18.92 57.34

Forward P/E: 16.97 38.39Lower Upper Price to Book: 4.55 13.85

Upper and Lower Bounds 9.60% 26.90% P.E.G. Ratio 23.08 47.58Price to EBITDA: 10.14 31.63

Estimated R‐Squared Beta Ke Enterprise Value/EBITDA: 37.15 8.723 month 0.312 1.42 15.66 Price to Free Cash Flows: 35.12 ‐2 Year 0.308 1.406 15.57 Dividends to Price: ‐ ‐5 Year 0.306 1.4 15.517 Year 0.305 1.395 15.4910 Year 0.304 1.427 15.71 As Stated Restated

Discounted Dividends 5.59 ‐Back Door Ke: 10.34% Free Cash Flows: 3.39 2.89Published Beta: 1.16 Residual Income: 12.15 17.6Cost of Debt: 2.46% Long Run Residual Income: 12.17 19.8WACC (BT): 13.11% Abnormal Earning Growth: 14.21 26.49

Altman Z‐Scores

Financial Based Valuations

Size Adjusted Cost of Capital

NATI‐NYSE‐November 3, 2008

Intrinsic Values

Executive Summary

Investment Recommendation: Overvalued Sell as of November 3rd, 2008.

Industry Analysis

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National Instruments was started in 1976 by three men, James Truchard,

Jeff Kodusky, and Bill Nowlin. National Instruments is an Austin, Texas based

corporation with an international branch in Tokyo, Japan and a manufacturing

facility in Debrecen, Hungary. Throughout the 1980’s, 1990’s, and 2000’s,

National Instruments has been developing instrumentation that has made the

collection of data and creation of simulations much easier for engineers and

scientists.

The main competitors for National Instruments are Agilent, Teradyne and

Synopsys. The industry competes with product differentiation, which is a key

factor in this highly competitive industry. Firms in this industry produce similar

hardware and software. In order to differentiate themselves from competition

and gain a customer base, it is important to invest a significant amount in

research and development. Firms focus on innovative products, customer

relations, and differentiation from competitors’ products. The analysis of the five

forces model shown below allows for a better understanding of the degree of

competition in the technical and system software industry.

Five Forces Competition Level

Rivalry Among Existing Firms High

Threat of New Entrants Low

Threat of Substitute Products Low

Bargaining Power of Buyers Mixed

Bargaining Power of Suppliers High

Overall Mixed

Since the technical and system software industry is highly competitive

based on differentiation, research and development plays a key role for any firm

in this industry. Strategic alliances between customers and suppliers are also

extremely important to maintain a competitive advantage. In this industry, the

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threat of new entrants is low because of its specialized nature. An extensive

amount of capital is needed to stay afloat in this industry because such a large

amount is required for investment in research and development so that the most

innovative products can be developed. Another reason this industry is not

threatened by new entrants is because it is already well developed and key

customer alliances have already been established. Legal barriers also play a key

role in keeping out new entrants because of the extensive use of patents and

trademarks. Switching costs associated with this industry are very low because

once you have settled on a particular software product, switching can be high in

cost and is usually not done. The low price sensitivity in this industry gives

suppliers the power, not customers.

Accounting Analysis To appropriately evaluate the firm, a potential investor must formally look

at the firm’s financial records. This is the reason why companies must have full

disclosure when it comes to their financial statements. When a company has full

disclosure in their 10-K, an analyst is able to obtain an accurate depiction of

where the company stands with regard to their accounting standards.

Unfortunately, some companies will try to hide or not fully disclose their

accounting policies causing an inflation/deflation in certain numbers making

them to look better to their investors. Some companies might also only disclose

the minimum information required by the SEC. This can lead to potential

accounting distortions which can cause “red flags”.

A vital step for accounting analysis is to identify the firm’s key success

factors. In order to assess the firm properly, the key success factors must be

directly linked to its key accounting policies. Some of the key success factors that

help differentiate this industry are research and development, superior product

quality, enhanced customer service and delivery turnaround, creativity and

innovation, and managing global risk. The key accounting policies that have a

direct effect on the key success factors mentioned are research and

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development, management and goodwill, operating and capital leases,

warranties, and the gains or losses from foreign currency. The manner in which

these firms choose to represent these policies can show some flexibility,

sometimes resulting in a false representation of the firm. The level of disclosure

the firm uses for these key accounting policies can expose flaws in the firm’s

financials, thus revealing if the firm’s financials are truly transparent.

In general, National Instruments uses a moderate accounting strategy. A

more aggressive accounting style is utilized when it comes to research and

development and impairment of goodwill. A conservative style is used with

regard to their warranties, capital leases, and foreign currency. National

Instruments uses a large portion of capital in its research and development

costs, and does a sufficient job disclosing the information.

National Instruments also does a good job with the disclosure of their

foreign currency policy. This has allowed potential investors to understand

exactly how this company handles its foreign currency when there are

fluctuations in the currency market. When it comes to the disclosure of

warranties, capital leases and goodwill, National Instruments is not clear and

does not go into much detail or description of any of these topics. Regarding

warranties, they are consistent with the industry with the quality of disclosure.

National Instruments does not give much information on its capital leases, which

is also consistent with the industry. We believe this has been done to make the

books look better for tax purposes. As far as goodwill, the company is very

uninformative and does not impair any amount of the goodwill, although tested

every year. This has raised a “red flag” and has caused us to restate the goodwill

with impairment. Companies may show little disclosure on this topic to help

inflate their net income. Overall, National Instruments again shows a moderate

strategy with respect to its disclosure and could stand to improve in certain

areas.

Quality of Disclosure

Research & Development

Warranties Goodwill Foreign Currency

Capital Leases

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National Instruments

HIGH MODERATE LOW MODERATE LOW

Industry HIGH MODERATE LOW LOW LOW *Packaging Industry: Teradyne, Synopsys, Agilent

Financial Analysis, Cost of Capital Estimation, and Forecasting

The intent of performing a financial analysis is to evaluate and measure a

firm’s performance throughout time and against industry averages. We utilized

financial ratios such as: liquidity, profitability, capital structure analysis, and firm

growth. By using these ratios, it was easier to compare the industry and find

trends or outliers that should be thrown out. Liquidity ratios exhibit how capable

a firm is at meeting its short term commitments. In other words, how quickly a

firm can turn assets into cash in order to cover their liabilities. Although National

Instrument’s current ratio was above the industry average, the remaining ratios

of National Instruments were about average with the industry. The profitability

analysis ratios are important because they compare the revenues and income to

the amount of sales and expenses that the company incurs over a period of time.

National Instruments has shown its ability to keep up with the industry average

and maintain low cost with high profits. The main purpose of a capital structure

analysis is to review liabilities and owner’s equity of a firm to find if the firm

acquires their assets through debt or equity. When it comes to these ratios,

National Instruments seems to be performing below the industry average. Next,

we studied the sustainable growth rate and the internal growth rate of the firm

to help get an understanding of future profitability.

The cost of capital estimation was the next step in the prospective

analysis. To find the discount rate appropriate for our valuations we had to

obtain the weighted average costs of debt and equity. We calculated the CAPM

model to obtain the cost of equity; the inputs for the model were calculated

using several different methods. We performed a regression analysis in order to

obtain an estimate of beta. In order to get a risk free rate, we used the 10-year

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interest rate on a U.S. Treasury Bill. Our market risk premium was inferred to be

7% which was outlined in the Business Analysis and Valuation textbook. After

gathering these terms, we calculated the cost of equity to be 13.96% before the

CAPM size adjustment and 15.66% after the adjustment. We also calculated the

cost of equity using the back door method and found it to equal 10.34%. We can

see that the CAPM cost of equity is different from to the back door method and

should, therefore, be considered in the valuation models. The largest

significance for the models will lie between 10.34% and 15.66% Ke.

In order to calculate the cost of debt, we simply took the interest rate of

each liability and multiplied it times the weighted average that each item holds in

relation to total liabilities. Then you add each weighted average cost of debt to

get the total cost of debt. Our cost of debt equated to 2.46%. With the cost of

equity and the cost of debt amounts calculated, we were able to solve for the

weighted average cost of capital (WACC). The WACC before tax was equal to

13.11% and the WACC after tax was calculated to be 13.08%. Upon

readjustments, we attained WACC amounts equal to 13.36% before tax and

13.34% after tax.

One of the most important steps in financial analysis is forecasting the

financial statements. First the income statement was forecasted out 10 years.

The first item on the Income Statement is Net Sales, which can be looked upon

as the most imperative factor in determining future earnings. Because the sales

growth of National Instruments appears to differ significantly over the years and

with the added factor of the recent downturn in the economy, we were

conservative in our projections for the future. We forecasted sales growth for

2008 would actually drop to 7%. In 2009, we predicted a slight increase in sales

growth of 7.5%. We decided on this number simply due to the fact that we

foresee that this downturn will pick up slightly in 2009. We continued by

increasing sales growth in 2010 because we envision this recession lasting only

two years, which would lead to its end in 2010. From there, a slightly steady

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growth was predicted for the remaining years 2011 to 2017, eventually ending at

a rate of 17%. In order to end arrive at a reliable number for gross profit, cost of

goods sold must also be forecasted. When looking at the cost of goods sold

average established through the numbers of the past six years, we came up with

a rate of 26%. This number seemed relatively high, so the decision was made

that a 24% rate was the best estimate. This seemed more reasonable

considering the recession, which results in less sales and eventually leads to a

decrease in cost of goods sold. In order to get forecasted numbers on the

balance sheet, we were able to use our liquidity and profitability ratios. For

example, in order to get total assets, the asset turnover ratio average was used,

which equated to 1. With this number, future total assets were forecasted by

taking net sales and dividing it by this asset turnover ratio. When applying

different ratios to line items on the financial statements, we were able to forecast

relevant items such as inventory and accounts receivable. When it comes to the

accuracy of the forecasted financial statement of cash flows, it is important to

keep in mind this financial statement is highly unreliable and inaccurate. This is

due to the fact that many items on the cash flows statement have no trends.

Also, many line items included only occur once and therefore are impossible to

forecast.

Valuation The last part of the analysis is to find the true value of the firm. The

ultimate objective of this analysis is to give the true market share price. This is

done by dividing the valuation into two sections, method of comparables and

intrinsic valuation models, which ultimately gives us the expected stock price per

share. Next we compared the estimated stock price to the share price of $25.09

as of November 3rd, 2008. We continued by setting a conservative margin of

error equal to 20%. This margin of error gave us share price amounts of $20.07

and $30.11. If the estimated price was calculated to be below $20.07, we

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declared the company was overvalued. On the other hand, if the stock price was

above $30.11, we stated the firm was undervalued.

Our beginning valuation measure was the method of comparables. To get

an implied stock price for National Instruments, we had to determine the

performance of competitors in the industry. The competitor’s ratios are

calculated and an industry average is formed from these numbers. If any firm’s

ratio amounts were seen as extreme, we had to label them as an outlier and

ensure they would not be used to calculate the industry average. Once we found

the industry average, we took National Instrument’s related factor and multiplied

it by the industry average to arrive at the firm’s implied stock price per share.

There are pros and cons of using the method of comparables. One benefit is

they are fast and effortless to apply. Nevertheless, the figures are determined

with little or no room for explanation and often produce inconsistent outcomes

because they are based on an average of companies in the industry.

We used the intrinsic valuation models as a second valuation measure.

These models are a better way to determine if a company is over, under, or

fairly valued than the method of comparables because the models offer a more

effective insight into the basis of the company and also take into account the

current financial situation. We used our forecasted financial statements to

forecast company performance and then discounted it back to the present day

by using the present value term that was calculated. We followed by creating a

sensitivity analysis. This allowed us to change growth rates and discount rates to

determine a time consistent price. The sensitivity analysis also allowed us to

interpret how small changes in growth rates and discount rates affect a

company’s stock price. This price was then compared to the margin of error to

see if the company was primarily over, under, or fairly valued. The only potential

concern this valuation method may possess, is the fact it relies on assumptions

rather than objective facts. Based on this valuation, National Instruments was

found to be overvalued.

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Company Overview

National Instruments (NATI) is a competitor in the technical and system

software industry. “National Instruments Corporation is a leading supplier of

measurement and automation products that engineers and scientists use in a

wide range of industries (National Instruments 10-K).” The company

manufactures software for many different industries in order to make the

collection of data easier for engineers and scientists. National Instruments is

“transforming the way engineers and scientists design, prototype and deploy

systems for measurement, automation and embedded applications”

(www.wsj.com “6”). National Instruments is an Austin, Texas based corporation,

with an international branch in Tokyo, Japan and a manufacturing facility in

Debrecen, Hungary. The company was started in 1976 by three men, James

Truchard, Jeff Kodusky, and Bill Nowlin. These three previously worked for the

University of Texas at Austin’s Applied Research Laboratories, performing

research for the United States Navy. After working there for some years, they

soon became frustrated with the ineffective data collection techniques they were

using and decided to create a product that could easily perform this task, thus a

company was established, National Instruments. The three worked in Trushard’s

garage diligently with a $10,000 loan from the bank to create their first product,

a GPIB interface for PDP-11/04 micro-computer. Throughout the 1980’s, 1990’s,

and 2000’s, National Instruments has been developing instrumentation that has

been helping engineers and scientists collect data and create simulations much

easier. With this new technology came patents and lawsuits. As of December 31,

2007 National Instruments held 402 United States patents and 27 patents in

foreign countries and 300 patents pending in the U.S. and foreign countries.

The main competitors for National Instruments are Agilent, Teradyne, and

Synopsys who are all in the technical software industry. The industry competes

with product differentiation, which is a key factor in this highly competitive

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industry. As National Instruments is growing in size, it is also growing in name

recognition. In National Instrument’s profile from the Wall Street Journal, “For

the past nine years, FORTUNE magazine has named NI one of the 100 best

companies to work for in America” (www.wsj.com “6”). With this great success

National Instruments should see a steady growth rate in the technical and

system software industry. National Instruments has also expanded and is a

strong competitor here in the Unites States but also has “direct operations in

nearly 40 countries” (www.wsj.com “6”). National Instruments went public in

1995 on the NASDAQ as NATI. Stock price performance in past five years has

been steady with a high of $49.27 in January of 2004 and a low of $21.20 in

June 2005.

Industry Overview

The technical and system software industry is a segmented industry that

is growing quickly with the ever-changing technology advances. The industry is

segmented due to the immense amount of different software programs that each

firm partakes in. “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” (National Instruments

10-K). National Instruments is a supplier of measurement and automation

products that are used by scientists and engineers in various fields. National

Instruments states that “the following industries and applications are served by

us worldwide: 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”

(National Instruments 10-K). These industries make up a diverse market for

design, control and test applications.

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The competitors in the market with National Instruments are Agilent,

Teradyne, and Synopsys. The measurement and automation applications that

these firms supply have unique features that make the products appealing. In

the past few years these industries seem to have experienced a mix of growth.

Taken from a sample of the four firms in this industry, net sales in 2005 took a

dive from net sales of 7.5 billion in 2004 to net sales of close to 7.3 in 2005.

Since this decrease, sales have increased to nearly 8.1 billion in 2006 and 8.4 in

2007. This was an all time high for this industry. According to the tech-research

company Gartner, “worldwide, Gartner’s forecasts that tech spending will

grow 6% in 2009” (www.wsj.com “11”). These numbers show that there has

been a definite boom in previous years and if demand continues to grow then so

will this industry. With the extensive costs to defend the many patent, copyright

and infringement laws this seems to be a closed market to new competitors.

With the costs devoted to legal issues, this industry also devotes a large

amount of capital to research and development. On average, a firm in this

industry spends close to 200 million for the smaller firms such as National

Instruments to as much as 700 million for the larger firms like Agilent. The

existing firms are willing to invest so much of their company’s capital to research

and development so that they will have the most innovative product on the

market and gain market share. These costs are essential to ensure a company’s

first mover advantage. Without the proper research a competitor will bypass a

rival firm solely on new and upcoming information.

In the end, to succeed and thrive in the technical and system software

industry, a firm must be willing to devote a lot of time, effort, and money. A firm

must have an experienced team of scientists and engineers willing to spend time

to develop the most up to date software and hardware. A firm in this industry

must also be prepared for the threat of lawsuits. With several patents and

copyrights involved in this industry, a large amount of capital and time is devoted

to defending these legal issues. Research and development costs are prevalent in

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this industry as well. A company that does not commit a large portion of their

wealth to research and development costs will not succeed. In order to gain

customers and market share, a company must have a more innovative product

than their competitors.

Five Forces Model

When trying to value a firm it is important to understand the industry.

The five forces model is a way to apply five components to look at the degree of

competition within an industry which allows an analyst to assess profitability of

each firm in the industry. The model describes certain factors which help to

evaluate the “degree of actual and potential competition as well as the

bargaining power in input and output markets” (Business Analysis and Valuation

pg. 2-2). To analyze the competition in an industry the components rivalry

among existing firms, threat of new entrants and threat of substitute products

can be used. The other two parts of this model, bargaining power of customers

and bargaining power of suppliers analyze an industries ability to influence these

two markets as an industry. Using these five components can allow an analyst

to see the degree of competition in a particular industry.

Five Forces Competition Level

Rivalry Among Existing Firms High

Threat of New Entrants Low

Threat of Substitute Products Low

Bargaining Power of Buyers Mixed

Bargaining Power of Suppliers High

Overall Mixed

*This information was taken from Palepu and Healy, Business Analysis and Valuation (Ohio: Thomson-Southwestern, 4th Edition, 2008).

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Rivalry Among Existing Firms

In order to gain a better understanding of a firm, it is important to look at

its competitors. Many times when analyzing profitability of a firm within a

particular industry, competition and rivalry among existing firms is the most

common factor. In some industries the competition is based upon keeping costs

near marginal cost. This is aggressive competition between existing firms. In

other industries competition shifts to non-price dimensions which include

research and development findings to benefit a firm’s strategy for differentiation.

This rivalry between firms can be summed up into 5 basic categories of

classification such as: industry growth rate, concentration and balance of

competitors, degree of differentiation and switching costs, scale/learning

economies and the ratio of fixed to variable costs, and excess capacity and exit

barriers.

In the technical and system software industry, overall profitability and

rivalry derives from technology, sales and marketing, warranty sustainability, and

the ability to reach customers efficiently across geographic boundaries. Existing

firms always try to acquire strategic alliances with customers and suppliers. In

an industry with such competition, maintaining your customers and market share

is key. Watching emerging markets is also important, since the technical and

system software industry is expanding overseas.

Industry Growth Rate

An industry can be growing at a fast pace so existing firms do not

compete against each other because demand is exceeding supply. If an industry

is dormant then supply exceeds demand. In this dormant type of industry, a

firm can only continue to stay profitable by taking customers away from their

competitors and growing in sales.

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*This information was taken from the 10K of National Instruments, Teradyne, Synopsys, and Agilent.

The graph above shows the growth within the technical and system

software industry. The industry sales increased from 2003 to 2004. The

industry’s growth declined in 2005. In 2006 the industry picked up again but

finished with a decrease in 2007. It appears that this industry was very cost

competitive in 2005 because of the great decrease in sales for this industry.

Teradyne and Synopsys both had decreases in sales during this year. This

brought the industry growth average down significantly to a negative growth

rate. In 2005, Teradyne introduced a new product, FLEX Test Platform

Architecture. This could be one of the factors that led to a negative sales growth

in this year. Also, Synopsys acquired a company, Accelerant Networks, Inc. This

acquisition of over 23.8 million dollars could possibly lead customers hesitant to

‐5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

2003 2004 2005 2006 2007

Percen

tage

Cha

nge

Industry Sales Growth

2003 2004 2005 2006 2007 Percentage

Change 7.38% 15.45% -3.23% 10.85% 4.82%

21

purchase equipment as they had in the past. In such a dormant industry only

top players can survive. Other than the year 2005, this industry has had about

the same numbers of sales throughout. Excluding the slight variances up and

down, the competition does not seem to rely so much on cost rather other

elements such as innovation and differentiation.

Below is a graph showing the percentage of Non-U.S. Sales. It is apparent

that all four companies rely heavily on sales made outside of the U.S. These

numbers are accounted for in each firm’s financials by translating foreign

currency into U.S. currency. It is crucial that all firms are accurate when

calculating these foreign currency numbers in order to avoid any conflicting

numbers which can lead to understating or overstating sales which ultimately

affects net income.


0%

20%

40%

60%

80%

100%

120%


Agilent Teradyne Synopsys

Percentage of Non-U.S. Sales

2005

2006

2007

22

Concentration and Balance of Competitors

The degree of concentration in an industry is determined by the number

of firms in a particular industry as well as their relative size (Palepu & Healy).

Understanding the degree of concentration will allow firms to organize prices and

other competitive strategies. If there are a few equally sized competitors in a

particular market then the firms can coordinate with each other to avoid price

competition. Finally, if there is a dominant player in an industry then that firm

can set the prices and rules as they want them and have complete control over

their industries competitive strategies.


0%

10%

20%

30%

40%

50%

60%

70%

2003 2004 2005 2006 2007

Percentage Market Share


Agilent

Teradyne

Synopsys

23

Percentage Market Share National Instruments Agilent Teradyne Synopsys

2003 7% 60% 15% 18% 2004 7% 60% 18% 14% 2005 8% 64% 14% 14% 2006 8% 62% 17% 14% 2007 9% 64% 13% 14%


In the technical and system software industry there seems to be one

dominant player, Agilent, while the other firms, National Instruments, Teradyne,

and Synopsys are lagging in comparison. In this industry Agilent has the market

control. Synopsys and Teradyne are on the same playing field when it comes to

their percentage of market share, while National Instruments is struggling with

size and numbers. As seen in the table above, it can be inferred that National

Instruments is a much smaller company when compared to the other firms.

Degree of Differentiation

If a firm can set itself apart from its competitors in a particular industry by

a large degree of differentiation then that particular firm will have a competitive

advantage in their industry. If the products in a market are very similar to each

other the basis of a customer’s decision on what product to buy is based on

price. Since the products in this industry are highly specialized, cost competition

is not what the firms compete on. The products that are produced by the

technical and systems software firms are highly specialized because in any

software industry the focus is on obtaining the most innovative product. The

software and measurement products are ever changing and highly specific for

certain consumers. Medical industry and pharmaceutical research, automotive,

commercial aerospace and government are just a few of the customers that use

24

products created by these firms. The firms in this industry are very knowledge

based and success is dependent upon having the innovative product. When a

consumer is searching for the best product to meet their companies needs they

will find the most efficient product on the market. Things such as research and

development and innovation play key roles in a firm’s differentiation. You must

have a high degree of differentiation to compete in the technical and system

software industry. With measurement and automation software, the most

efficient and innovative product always wins the market over. Engineers and

scientists that invest in this software are looking for the latest software to

improve their company. For example, virtual instrumentation is the latest

breakthrough in this industry. “A virtual instrument consists of an industry-

standard computer or workstation equipped with powerful application software,

cost-effective hardware such as plug-in boards, and driver software, which

together perform the functions of traditional instruments” (NI.com). According

to the Wall Street Journal, “virtualization is a big deal in the tech industry

these days” (www.wsj.com “10”). Agilent and National Instruments are two of

the firms that have implemented this software technique. This is taking over the

industry because it increases a firm’s production up to 10 times and also is much

more cost efficient. This new idea of virtual instrumentation is making it easier

for consumers to choose a supplier. It is obvious that consumers would want

the most cost efficient and the fastest product available. This new product

makes it hard for firms who have not implemented this idea to gain market

share. For firms to remain successful and differentiate themselves from

competitors they must continue to stay ahead of the market.

25

Switching Costs

Switching costs can help measure specialization in a particular industry. If

the assets owned by a company only serve one particular task then they are

highly specialized and could not be sold in the marketplace easily. The technical

and system software industry involves a large amount of capital to be invested

into plant and equipment. This plant and equipment is specific to the creation of

software and hardware devices for the consumers. It is not easy for firms to use

their machinery for other uses which concludes that there are high switching

costs in this industry.

Economies of Scale

If a particular industry has high economies of scale then the size of each

firm matters. The firms existing in the industry are usually large in size and very

profitable. All firms in the technical and system software industry have a large

amount of capital used for costly assets highly specialized for this industry. This

leads to are very high economies of scale.

26


Looking at the chart above, every firm competing in this industry has a

substantial amount of assets that belong to the company. For any firm to stay a

competitor they must have a great source of capital. All of these companies

need highly specialized systems to design products and software for the

measurement and automation communities. Creating and designing software is

a very detail- oriented process using many computers and different test to run

analysis all costing the firm a great deal. If looking only at the numbers than

Agilent, the firm with the largest amout of assets and capital, would be

considered the dominant firm in the industry. Agilent and the competing firm

spend a tremendous amount of money reseach and testing. For example, “the

maker of testing and measurement equipment reported net income of $169

million” (www.wsj.com “8”). This shows that to remain a rival in this industry

the firms must keep and obtain a large amount of capital each year. This just

proves the assumption that large economies of scale do exist in the technical and

system software industry.

0

1000000

2000000

3000000

4000000

5000000

6000000

7000000

8000000

2003 2004 2005 2006 2007

Total Assets in Thousands


Agilent

Teradyne

Synopsys

27

Learning Economies

A learning economy is one in which knowledge is power. The technical

and system software industry requires extensive comprehension of difficult

engineering and production processes. This in turn requires staff knowledgeable

in these fields. Loss of revenues and failure could result with a staff unaware of

distinct processes within the software spectrum. There is a steep learning curve

within this highly technical field. This consequentially leads to a first mover

advantage. A company that enters the industry first and successfully hires and

trains new employees will have a major advantage over other firms trying to

enter the industry. They will acquire higher revenues and earnings which

sequentially help the company obtain shareholders to further their business. This

can lead to an increase in revenue and a possibility to gain market share, also

can cause the firm to have a lower production cost and a lower variable cost

also. In this industry National Instruments and its competitors use research and

development in order to differentiate themselves from each other and in order to

increase revenue and market share.

Excess Capacity

If capacity exceeds demand then there is a large incentive to lower

capacity to meet the needs of demand, but in the technical and system software

industry, that is not the case. Excess capacity is low in this industry because,

actual production is less than what is achievable and demanded. The customers

of this industry, scientists and engineers, are constantly looking for the next

innovative software for their company so the newest product is constantly

demanded. Medical, power/energy, and automated test equipment industries

are some of the main customers of the measurement software products from our

industry. Acquiring the latest software is always best for their company. So if a

28

firm is late on a new product then they have the risk of losing their cliental to a

rival firm.

Exit Barriers

The exit barriers in the technical and system software are very high

because of the specialized products and knowledge based requirements. The

assets in the software industry are extremely specialized which helps to make

exits costly. Also within this industry there are many patents that must be

acquired to product such specific software products, this can also keep a firm in

a particular industry. It is not easy to sell machinery that specifically makes

measurement and automation products to other buyers. It would cost a great

deal of money to try to exit the market since most of the firms make specialty

items that would be worthless to anyone who did not need one.

Conclusion

The technical and system software industry is one that strives for

innovative products and the latest software on the market. The firms are

constantly competing with one another for differentiation. The industry has very

high economies of scale because of the specialized nature of this knowledge

based industry. There are also high exit barriers and low excess capacity. The

technical and system software is highly competitive with existing firms leading to

constant competition and strive for the most innovative product. This industry is

highly competitive with each firm trying to produce new and innovative products

leaving the industry hard to enter.

29

Threat of New Entrants

The technical and system software industry is an industry without many

threats of new entrants into the market because of its specialized nature.

Software development requires extensive research and development, which can

lead to extremely high costs. These costs help to prevent new entrants into the

software market. For a new company to enter this specific market and be

competitive, they must break the following barriers: economies of scale, first

mover advantage, access to channels of distribution and relationships, and legal

barriers.

Economies of Scale

Economies of scale can be defined as the decrease in cost because of an

increase in production. There are large economies of scale in the technical and

system software industry that make it hard for new competitors to successfully

gain market share. The industry has very high costs that would make it difficult

for new firms to cover. Some of these high costs include: sales and marketing

and research and development. Resulting from these extensive costs, new firms

are faced with the decision of how much capital to invest. If a firm enters with

large capital, they could face many problems such as not fully utilizing their

capital. On the other hand, a firm that enters the market with less than optimal

capital may face a substantial disadvantage, which can lead to bad productivity

and the potential downfall of the firm.

New firms trying to enter the technical and system software industry often

face the challenge of slow growth resulting in little to no revenue in the first few

years. This can be contributed to the fact that a large amount of capital goes to

research and development as well as plant and equipment which are necessary

in order to produce software products. This could potentially lead to problems

30

when trying to build a customer base while competing against existing

powerhouses in the technical and system software industry. Since established

companies in this industry have such control of the market, it becomes near

impossible for new firms to compete.

Total Assets in Thousands National Instruments Agilent Teradyne Synopsys

2003 525,151 6,297,000 1,785,362 2,307,353 2004 582,093 7,144,000 1,922,562 2,092,187 2005 608,336 6,751,000 1,859,732 2,141,476 2006 721,220 7,369,000 1,721,055 2,157,822 2007 818,812 7,554,000 1,555,288 2,617,337


First Mover Advantage

Existing firms in the technical and system software industry have many

first mover advantages over new entrants. In the industry, cost-efficiency is

essential. Not being able to offer your products at a low cost will result in failure.

Existing firms are able to use their resources to effectively produce their products

at a low cost. This is because of the relationships that current firms in the

industry have with suppliers. The existing relationships with suppliers allow for

cheaper goods and services which in turn are transferred to cheaper products to

customers. Another first mover advantage that existing firms in the technical

and system software industry hold is their ample supply of components and

materials. Their inventory and manufacturing facilities provide for fast turn

around and quick shipment of customer orders. New entrants have a hard time

establishing a large inventory base because they are still testing the waters and

trying to locate which suppliers are the most suitable, which may result in slower

31

shipment of orders and dissatisfied customers. Also, many established firms have

patents on various products and attempt to protect them by effective use of

intellectual property laws. New entrants must find new ways to make similar

products without crossing legal boundaries which can prove to be a difficult to

near impossible process.

Access to Distribution Channels and Relationships

Existing firms in the technical and system software industry require strong

relationships with suppliers, marketers, and customers to survive. Having access

to distribution channels as well as maintaining relationships with key

organizations and networks provides a huge advantage to existing firms. Without

a powerful relationship with suppliers, companies within the technical and system

software industry are bound to encounter several problems that could ultimately

lead to failure. New entrants coming into the software industry are faced with

creating a network of suppliers. Before ultimately settling on a network, they

must do extensive research in order to ensure that they will be able to offer low

cost finished products to their customers. Existing firms however, already have

suppliers at hand and have established strong relationships with these suppliers.

Along with trying to gain a network of suppliers, new entrants are also faced

with the task of creating an image for themselves.

Finding the correct marketers for the technical and system software

industry can prove to be an intimidating task for new entrants. While already

established firms have marketing teams that have helped them establish a

positive image for themselves, new entrants have to find marketers that are

willing and able to help them create their image. National Instruments uses

marketing “to educate engineers and scientists about the benefits of our virtual

instrumentation philosophy, products and technology, and to highlight the

performance, ease of use and cost advantages of our products” (National

32

Instruments 10-K). Without a successfully implemented marketing plan, National

Instruments would not be as successful about providing knowledge to customers

explaining why their product is better than competitors.

The issue of marketing directly ties into relationships with customers. New

entrants must differentiate themselves from existing firms in order to gain a

customer base. This can frequently be a difficult task for newcomers. Without

proper marketing efforts, customers will more often than not stick with their

existing relationship. Synopsys states that they “rely on a small number of

customers for a large portion of our revenue and the loss of one of such

customers could have an adverse effect on our subsequent revenue and/or

earnings” ( Synopsys 10-K). New entrants have a hard time establishing such

large scale customers because most already have a supplier.

Overall, it has become increasingly difficult for new entrants in the

software industry to flourish. They must gain trustworthy suppliers and

marketers who will ultimately help them build their customer base, which in turn

creates profits.

Legal Barriers

In this research intensive and knowledge based industry, many legal

barriers exist. This is one of the factors that make this industry a low threat to

new competitors. Some of these legal barriers include the time, cost and

expense of applying for and obtaining; the potential costs of defending patents,

trademarks, and copyright infringement claims by competitors, including legal

fees and court costs. There is a possibility of complete loss of a company’s

product of service if it is found to infringe upon an existing patent or copyright.

Firms in this industry often have to be involved in a very expensive litigation to

protect the different intellectual property rights of the firm. Even sometimes

firms are notified that they have infringed on a patent of another firm, such as

33

building a product much too similar to a competitors, which might result in that

firm having to pay court costs because they were at fault. The experience of the

firms that are already in the technical and systems software industry have the

knowledge to deal with legal issues and they have already gone through the

process of obtaining different things such as patents and copyrights.

Another risk of entering this industry is having to worry about regulations

regarding the industries that these measurement and automation products serve.

These industries include; “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” (National Instruments 10-K).

Finally, there is a lot of legal risk when selling and manufacturing

overseas. Many times firms must comply with “different governmental

regulations related to the use, storage, discharge and disposal of toxic, volatile or

otherwise hazardous chemicals used in our manufacturing operations” (National

Instruments 10-K). New and entering firms must have a large amount of capital

and industry knowledge to even stay profitable.

Conclusion

In the end, new entry into the technical and system software industry is

relatively low. New entrants must overcome several obstacles in order to

succeed including: large start up costs, first mover advantages, finding reliable

suppliers and marketers, as well as conquering legal barriers. The potential to

gain profits and thrive in the software industry is dampened by the

overwhelmingly large amount of complications and difficulties that could occur.

Ultimately, this drives away new entrants and potential competition for existing

firms.

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Threat of Substitute Products

The majority of industries throughout the world today run into the issue of

substitute products. The technical and system software industry is no exception.

Although many industries protect their products with legal barriers such as

copyrights, a product within one company may perform the same function as a

different product in another company. This leads to increased competition. The

threat of substitute products is mainly influenced by relative price and

performance as well as the buyers’ willingness to switch.

Relative Price and Performance

Price competition differs among industries. If products within an industry

perform their function identically, then their prices tend to be close, if not the

same. However, if the products differ substantially, then product prices tend to

be very different. In the technical and system software industry, performance

among different firms tends to be relatively close. This can be credited to the

large percentage firms allocate to developing new and innovative products in this

industry. This makes it difficult for firms to compete on price and more so on

product. If a firm has the one sector of the market taken; it is relatively difficult

for any of the other firms to compete with them. The other firms would then

have to develop a newer better product that is comparable in price as the rival

firms. There is a tendency for products in different firms competing in the

software industry to have a price that is relatively the same.

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Buyers’ Willingness to Switch

Although price and performance are factors that influence the threat of

substitute products, customers’ willingness to switch is often the most important

aspect when calculating threat of substitutes. Buyers base their perception of a

firm on several things including price, image, and functionality. In the technical

and system software industry, since the firms are not competing on price buyers’

willingness to switch in the industry is low to mix. This can be found true

because buyers become accustomed to dealing with a particular firm in an

industry and how their business is conducted. It can become especially important

to make sure and take care of the customer. The disadvantage when an industry

is not competing on cost a firm might lose a buyer if the buyer feels as though

they are not being treated fairly. Since none of the other firms are selling at a

significant higher/lower cost customers can switch to a different firm. Customers

are often unwilling to change once a customer is used to a certain program or

technique, especially if the customer enjoys dealing with that firm.

Conclusion

All in all, most every industry will encounter the threat of substitute

products. Some industries may have higher threats than others. However in the

technical and system software industry, the threat of substitute products is

relatively low. Although the threat is low, this does not imply that the firm does

not have any responsibility to maintain their customer base. It is important to

keep customers satisfied by offering fair prices and excellent performance which

ultimately helps keep buyers’ willingness to switch low to mix. If ever the

customer does not feel important or does not feel as though they are being

taken care of they could switch to a different firm. This make it ever so

36

important for firms in the technical and system software industry to maintain

great customer service.

Bargaining Power of Customers

In the technical and system software industry, the most important

relationship to look at is the relationship between firms and their customers. If

an industry is highly concentrated then there will be a very large threat of

substitution. In this type of industry, customers can move about different

products freely because of the similarity of the products. In opposition, if an

industry has high switching costs and low concentration there will be high

switching costs for the customers and a choice to invest in one company’s

products will be much more permanent, not allowing them to switch from firm to

firm.

The technical and system software industry is a low concentrated industry

with high switching costs. There is one dominant player, Agilent, which seems to

set standards and competition for this industry. Based upon numbers from their

financial statements they are a powerhouse when compared to the smaller firms.

Other firms in this industry seem to be struggling with expansion because they

are required to compete based on Agilent’s statistics. To stay in the market, the

smaller firms National Instruments, Synopsys and Teradyne will have to continue

to invest in Research and Development so that they will gain market share and a

customer base. Customers will continue to look for the most innovative product

on the market and base their decision on a firm that provides the best product.

To analyze the bargaining power of customers there are two key factors to

examine. These include, price sensitivity and relative bargaining power.

37

Price Sensitivity

Price sensitivity is best explained as the effort and expense that buyers

are willing to express in order to obtain a product. For example, how much is a

consumer actually willing to spend on a product relative to other products? If

they feel like they can purchase a similar product that is cheaper from a different

source, they will do so. If they feel like they cannot find a cheaper product

elsewhere, then they product is not very price sensitive. In the technical and

system software industry, the consumer’s main concern is the quality and

effectiveness of the product. This is displayed in the type of customers that this

industry serves. For example, many medical industries turn to the technical and

system software industry to provide the most innovative product to perform

different measurement and medical research tests. The aerospace industry also

utilizes this industry’s devices. Both the medical and aerospace industries require

quality in the products they choose to buy and desire a company which can

provide the ultimate level of quality. Since quality is such an important factor, all

companies in this industry are willing to pay for superiority. Basically, customers

are willing to pay a higher price for higher quality since it is such a large portion

of their company’s status. This infers that the overall industry has low price

sensitivity.

Relative Bargaining Power

Relative bargaining power is defined as how much a consumer would

suffer if it did not do business with the company and vice versa. If it would be a

major cost to the company if the buyer took his business elsewhere, then the

buyer has a strong bargaining position.

38

When looking at the basis to determine the bargaining power of buyers,

we first will want to look at the number of buyers and how much each buyer

purchases. The quantity of customers that shop within the technical and system

software industry consists of a wide market. Engineers and scientists make up a

majority of the customer base because they buy the software applications and

hardware for their companies. Therefore, the number of buyers is high with a

low amount of purchases per buyer. Also, the switching costs are extremely high

in the technical and system software industry because there are strong

relationships that are built between the customer and supplier. It would be

difficult for the buyer to break that relationship and switch to another supplier.

Because the technical and system software industry is so customizable, it is hard

to find exact substitute products to fit into an individual companies needs. This

also leads to a high bargaining power.

Conclusion

In conclusion, the technical and system software industry has high

bargaining power for buyers and low price sensitivity. This is because the

industry focuses on the quality of the product with strong customer relationships

rather than competing on selling software with the lowest prices.

Bargaining Power of Suppliers

All firms are dependent on suppliers who offer labor, raw materials, and

finances, to carry out their business. The economic power of these suppliers

drives industry profitability. Suppliers have an advantage when there are only a

few companies and substitutes that their customers can choose from. Suppliers

also uphold an advantage when a supplier’s services/materials are significant to

a buyer. If a buyer needs the suppliers goods to create their product, than it is

likely that suppliers will drive up prices. When a lot of suppliers are present

39

within an industry, the industry has an advantage by being able to control prices.

National Instruments, Agilent, Teradyne, and Synopsis have the ability of making

most of its components in-house, but whatever it can’t make they have to

outsource to different entities. Suppliers have the power over these firms

because there are limited entities to outsource labor to. Since most of the

products are specialty items it would be hard to get them from any other source.

Price Sensitivity

In the technical and system software industry, price sensitivity for

suppliers is relatively low. Suppliers, rather than firms, have the power to set

costs. This outcome is explained by the idea of switching costs. The technical

and system software industry has high switching costs, meaning that the cost to

switch to a new supplier would be detrimental and expensive for the firm;

because of this, a firm rarely switches suppliers fearing that it would harm their

business rather than help it. All the firms in this industry depend on their

suppliers to be able to produce their goods. If their suppliers are not able to

supply them with the goods they need, the firms are forced to either scrap that

project or pay another supplier more money. National Instruments makes most

of its components, but what it cannot make it outsources to their suppliers that

are mostly in the United States but does have some in Europe and Asia.

Synopsis, Teradyne, and Agilent use similar supply chains in order to make their

goods.

Differentiation in the technical and software industry is high. Products that

different suppliers produce are not alike which leads to this high differentiation.

Firms must be wise in choosing their suppliers, for their suppliers are a major

facet in their business. This high differentiation leads to another advantage

suppliers have over firms. They are able to set their costs at higher levels

40

because they know that buyers need their services to survive and would not be

able to find a similar product elsewhere.

Relative Bargaining Power

The technical and system software industry provides suppliers with

bargaining power. Although there are several suppliers in the software industry,

suppliers that offer exact products that a firm needs to survive are hard to come

by, which leads to sole sourced suppliers. Many firms in our industry use sole

suppliers in order to ensure that their products will be up to par and to the

precise specifications that the firm needs. National Instruments, Teradyne,

Agilent and Synopsis must have suppliers that deliver very specific electronic

components for these firms to produce their product. When all firms in the

industry require the same types of products to be delivered to the firms, it

becomes easy for the suppliers to gain the bargaining power.

As suppliers start to gain good rapport with the buyers, it becomes hard

for the firms to switch to another company. When the suppliers gain this

advantage it will obviously lead to high switching costs for the firms in the

industry. This is because the buyers need such a specific product to develop their

own; they will not want to switch to another firm due to high costs. In the

beginning of the supplier and buyer relationship, both parties need to give up

something in order to gain something. However, as time passes, the suppliers

gain more and more power eventually leading to a huge advantage for suppliers

and a disadvantage for the firms. The technical and system software industry

has proven to not be any different were suppliers like ASIC has gained the

bargaining power of the industry firms.

41

Conclusion

Overall, the bargaining power of suppliers is high. Suppliers have the

ultimate authority to set prices and control volume. Several issues are to blame

for this industry’s supplier advantage. Firms in the software industry are faced

with finding a supplier who meets their qualifications, which can be a hard task;

this leads to sole sourcing. It is nearly impossible for a specific company in the

technical and system software industry to switch suppliers because the level of

differentiation. Software instruments are highly specialized in nature which

makes it difficult to find one let alone two or three suppliers willing to offer a firm

their products. Also, switching costs in the software industry are high, another

advantage suppliers possess. Unfortunately, suppliers have the imperative right

to set and maintain prices, which mostly leads to a firm disadvantage.

Value Creation Analysis

In the technical and system software industry, differentiation is the

strategy used to gain a competitive advantage. Customers of this industry are

looking for the software product that is the easiest to use and the most cost

efficient. When creating products for this industry, all firms try to distinguish

their product because with such high switching costs for the firm and customer

once a choice is made a customer must stay with that firm. This knowledge

based industry requires highly specialized products to gain market share and

maximize value. When an existing firm is trying to gain a competitive advantage,

two key strategies usually come into play, cost leadership and differentiation.

Since the technical and system software industry is so highly specialized, cost

leadership is not the deciding factor for a measurement and automation product,

rather to create value in this industry differentiation is the key strategy. When a

firm is able to distinguish themselves from their competitors and gain market

42

share they are creating value for the company. To do this firms focus on a few

key factors including; superior product quality, customer service, efficient

product delivery turn one word around, research and development, creativity and

innovation, and also managing global currency risk are all key factors for success

of the firm.

Superior Product Quality

In this ever-changing industry, to be a lucrative player, a firm must be on

top of their game. Superior product quality is essential to keep/gain market

share. Firms in this industry must continually search for the latest product

because competitors may acquire a patent for a specific product and they may

have to reverse engineer a similar product and somehow make it of better

quality than the other. The firms in this industry have such a competitive rivalry

for the same dominant customers that superior product quality is needed to

retain customer relations. Many of the products are guaranteed for a period of

time under a warranty to ensure the product’s quality. For example, Agilent

offers its customers warranties and extended warranties on their products. To

keep up with this National Instruments offers “a one year limited warranty on

most hardware products, with a two or three year warranty on a subset of our

hardware products” (National Instruments 10-K). Engineers and scientists look

for a product that will be an asset to the company for many years. If a firm’s

product is performing poorly the firm risks losing their cliental to rival firms.

Superior Customer Service & Delivery Turn Around

In the technical and system software industry, customer satisfaction is

often based upon customer service. The main factor of this is quick delivery turn

43

around. Since many of the firms in this industry are based globally, delivery is

crucial to keep consumers satisfied. As discussed before, a warranty on a

company’s product or software is necessary to keep the firm’s customer base.

The consumers in this industry are all in the technological field of study and one

of the deciding factors of what firm to use is the service they provide prior to and

post sale. With a dominant player in this industry, Agilent, every smaller firm

National Instruments, Synopsys, and Teradyne must stay very aware of how

their products compare to the products of their rivals. National Instruments

states that “the markets in which we operate are characterized by intense

competition from numerous competitors, some of which are divisions of large

corporations having far greater resources than we have, and we expect to face

further competition from new market entrants in the future” (National

Instruments 10-K). For smaller companies to gain market share they must

allocate the right amount of capital and time in order to remain successful.

Research and Development

Within this knowledge based industry research and development is one of

the most important factors for each firm. A lot of time and money is allocated to

this specific factor in order to stay a leader in innovation. Research and

development can be very costly when firms are faced with a change in the

industry but well worth it in the end. Even though costs are high, they are

necessary for a firm to stay competitive. Firms in this industry spend anywhere

from 5% to as much as 38% of their net sales on research and development, as

seen in National Instruments numbers, which show that they spent $126,515 on

research and development in 2007 while obtaining a net sales number of

$331,482. Overall, no matter which firm you look at in this industry, the total

number invested in research and development is a large expense, but a

necessity if a firm wants to gain market share and customers.

44

Creativity and Innovation

In the software industry, a firm must have the most innovative product in

order to have some share of the market. With the high cost allocated to research

and development the firms have the first mover advantage on having the most

cutting-edge products. For example, the latest innovation is virtual

instrumentation. “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 computers, networks and the Internet ( National Instruments 10-

K). This new system allows for lower costs and easier use, which customers see

as a major advantage. Firms that use this new form of programming such as

National Instruments and Agilent, are starting to see benefits such as an increase

in customers and market share.

Managing Global Currency Risk

The measurement and automation software industry has expanded

globally because of overwhelming opportunities. Sales have almost doubled in

size after the expansion into global markets. With this great reward comes great

risk. With sales in such varying markets, currency inconsistency becomes a risk

when reporting year-end sales. In financial statements all accounts must be

quoted using the U.S. Dollar currency. The currency risk comes when converting

different currencies based upon the ever-changing currency exchanges.

45

Conclusion

These key tactics that National Instruments, Agilent, Teradyne, and

Synopsys exercise help them claim their niche in the technical software industry.

If not utilized by the firms, they face major setbacks in their industry. The

thriving firms in this industry choose to implement their own key success factors

in order to gain/keep market share. National Instruments focuses on their key

success factors in order to have a competitive advantage over their rivals.

Firm Competitive Advantage Analysis

Firm competitive advantage analysis is an essential part of a company’s

success in a particular industry. It is vital for a firm to know how to be successful

and what drives the industry. In almost any industry it is important to have a

high level of differentiation and an innovative product, the technical and system

software industry is no different. After looking over the industries key success

factors, it is clear that National Instruments has gained their market share by

using four key factors; research and development, superior product

quality/service, managing global currency risk, and also creativity and innovation.

Competing companies, Agilent, Teradyne and Synopsys, have all utilized similar

ideas and therefore have gained the majority of the technical and system

software market.

46


The product strategy that is implemented by National Instruments is to

deliver high quality software and hardware in a timely manner. For this to work

accordingly, National Instruments has used funding to support their 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 and

price/performance” (National Instruments 10-K). The research and development

expense has increased dramatically in recent years, a 26% increase from 2005 to

2006 and another 12% in 2007, increasing the dollar amount to 126.5 million.

The majority of the research and development expense is spent on hiring top

level product development engineers. As part of their competitive strategy,

National Instruments feels as though it is imperative to invest money into

research and development and also to hire engineers. Research and

development is a key factor for making National Instruments a success and it has

played a large role in keeping a competitive edge in this industry.

Superior Product Quality/Service

With the large amounts of research and development that National

Instruments invests in, they expect to deliver a product of superior quality.

National Instruments employs around 1300 people to ensure every product sold

is up to company and industry standards. With the industry customer demands

constantly changing, it is vital to make sure innovative products are being sold to

keep market share. It is very important to the firm that when a product is

purchased, it is delivered and received in a timely manner. All products and

inventory purchased through National Instruments are shipped almost

immediately to keep up with market demands. In an effort to provide superior

47

customer service, “all products purchased are warranted against defects in

materials and workmanship for one year from the date we ship the product”

(National Instruments 10-K). In a constant effort to gain market share and show

differentiation, customers are allowed to return product within 30 days of

purchase less restocking fee. Once all products have arrived to the customer,

National Instruments has employed over 2,000 people to provide customer

support allowing complete customer satisfaction from order to shipping. With

not having a single customer accounting for more than 3% of their sales, it is

essential for the firm to implement and execute this section of the strategic plan

to ensure customer satisfaction.

Managing Global Currency Risk

National Instruments now manufactures a majority of their products in

Debrecen, Hungary, and has clients in Europe and Asia Pacific. With the decision

to go international the firm must accept currency risk. National Instruments is

aware that it is not certain that hedging the foreign currency will offset the

change in currency exchange rates, however, National Instruments has been

right on target with their current hedging positions (National Instruments 10-K).

The ability to successfully hedge foreign currency has been a huge factor for the

consistent growth of National Instruments. The euro, British pound, and

Japanese yen are the three currencies currently being hedged by the firm. As

stated in the 10-K, “We monitor our foreign exchange exposures regularly to

ensure the overall effectiveness of our foreign currency hedge positions”

(National Instruments 10-K).

To avoid serious fluctuations in exchange rates National Instruments uses

forward contracts to hedge up to 90% of their foreign currency, with the

majority of the “receivables” contracts limited to 90 days. From 2005 to 2007

National Instruments experienced serious growth in the net foreign exchange

48

gains, going from a $1.6 million loss to $740,000 gain in 2006 and $1.7 million

gain in 2007.

International sales revenue has totaled to 55%, 52%, and 52% in 2007,

2006, and 2005 respectfully, exposing the importance to accurately hedge

foreign currency exchange rates.

International Sales Revenues 2005 2006 2007 52% 52% 55%

With National Instruments staying on target with foreign currency

exchange rates, this has created value for their firm. They are constantly

keeping track of the exchange rates and their periodical shifts. This is just

another one of the ways that National Instruments is staying on the playing field

with larger players such as Agilent. With most companies in this firm having

dealings in foreign countries, each firm must stay consistent and on top of their

game with the foreign currency exchange rates and dealings overseas.

‐2,000,000

‐1,500,000

‐1,000,000

‐500,000

0

500,000

1,000,000

1,500,000

2,000,000

2005 2006 2007

Change in Net Foreign Gains

Change in Net Foreign Gains

49

Creativity and Innovation

The vast majority of overall success in this industry comes from the ability

to create a new innovative product that will differentiate your firm from the

competition. National Instruments has shown why they are a competitor in this

industry with their constant ability to create an innovative new product. The

most recent success has been with the innovative virtual instrument, “Virtual

Instrumentation”. This is a user friendly computer software application that

allows users to define and change the functionality of their computer device

(handheld PDA, standard computer, laptop). National Instruments states, “Our

products empower users to monitor and control traditional instruments, create

innovative computer-based systems that can replace traditional instruments at a

lower cost” (National Instruments 10-K). With virtual instrumentation, National

Instruments is showing their ability to create new ideas to help engineers and

scientists improve their particular company’s efficiency and design.

Another product introduced by National Instruments is the NI Single-

Board RIO. This product is an “hardware option for deploying embedded control

and data acquisition applications. Engineers and scientists can use the NI

LabVIEW graphical system design platform to customize NI Single-Board RIO

hardware as well as develop all aspects of their embedded systems for increased

productivity and shorter time to market” (www.wsj.com “7”). This product is

also part of the virtual instrumentation movement. Giving the user this type of

flexibility with their computer is an innovative idea that gives National

Instruments a competitive advantage adding market share to the firm. In this

product alone National Instruments practices a couple of their competitive

strategies. This product has a very quick time from order to market and also this

is just another way that they are improving the industry and making constant

improvements to gain/keep market share.

50

Conclusion

By implementing this strategic plan, National Instruments has gained a

competitive advantage in the industry market. With their ability to recognize the

four key factors that drive the technical and system software industry, National

Instruments has differentiated themselves from their competitors. Since National

Instruments utilizes most of their time with research and development and

finding new innovative ways to serve their customer base, they can successfully

compete in this industry market.

Formal Accounting Analysis The United States regulates how corporations report their financial

disclosures by the use of the Generally Accepted Accounting Principles, also

known as GAAP. Within the GAAP principles comes built in accounting flexibility

for the corporation to utilize, which the Security Exchange Committee (SEC)

advises United States’ companies to exercise. Instead of corporations being

forced to use generic accounting principles, GAAP allows corporations to use the

optimum accounting principles for their distinct industry. GAAP permits this

flexibility in order to acquire the most precise financial transparency of the firm.

Even though this accounting flexibility has good intentions, a firm’s accounting

can be influenced by its upper management.

In order to analyze a firm’s accounting practices, an accounting analysis

must be performed in order to conclude if the firm’s financials are indeed

accurate in providing a clear picture of the firm’s economic position. Often, firms

produce hazy financial statements in order to make them seem attractive to

potential investors. After the analysis is over, the analyst must come to a

decision whether the firm’s financials are transparent or if they have to be re-

written in order give a noise free picture of the firm. If not done correctly, a bad

51

accounting analysis may provide investors with a twisted value of what the firm

is really worth, making a non-real comparison to its competitors, thus providing

false financial information. An analyst follows steps to perform an accounting

analysis of a firm. These steps include first identifying key accounting policies of

the firm. Next, the analyst must evaluate the degree of potential accounting

flexibility that was exercised when producing the financials. Third, the analyst

must assess the actual accounting strategy used by this specific firm. They also

evaluate the quality of disclosure of the firm which allows them to see the clarity

of the firm. After the analyst reviews the quality of disclosure, they can then

identify all of the potential red flags or irregularities in the firm’s financial

reporting. In the final step, the analyst must “undo” any accounting distortions

uncovered during their analysis of the firm.

Key Accounting Policies

The initial step in accounting analysis is to classify the firm’s key success

factors. To be able to evaluate the firm correctly, National Instruments’ key

accounting policies must be precisely linked to its key success factors. The strong

key success factors that were established to help differentiate the technological

software industry were research and development, superior product quality,

enhanced customer service and delivery turn around, creativity and innovation,

and managing global currency risk. Accounting policies that directly affect the

key success factors mentioned in this analysis are research and development

expenses, management of goodwill, operating and capital leases, warranties, and

the gains or losses from foreign currency. Approaches that firms use to represent

these policies can show some elasticity in accounting, consequently affecting the

value of the firm. The level of disclosure of these key accounting policies can

reveal if a firm’s financials are indeed transparent or require some examination

to develop a fair and balanced stance.

52


Research and development is essential to gain a competitive edge in this

highly changing competitive market. Research and development gives each firm

a competitive advantage over its competitors. However, with high costs comes

high stakes. Research and development comes with a large amount of risk due

to the fact that some research will never result in anything, just an expensive

notion. Some benefits of research and development are not seen for up to 10

years after a product has been introduced. Also, a firm’s competitors can cause

their research to be worthless or archaic if they stumble on to the same idea

earlier. Amongst competitors in the technological manufacturing industry,

corporations like Agilent, Teradyne, Synopsys, and National Instruments must

adhere to regulations set by GAAP and catalog research and development as an

operating expense on their income statement. GAAP statutes say that research

and development should be handled as an expense; this is due partly because of

the uncertainty of revenue research and development will be able to generate.

Contrary to what GAAP says, many products in this industry are conceived

through research and development spending. Even though research and

development is categorized as an expense through GAAP, the data gained form

this procedure could be regarded as an intangible asset seeing as its outcome is

new products of the firm. The new products are made achievable by the

research and development segment of the firm, thus are the powerful force

behind the business. Research and development should add value to a firm in

the technological software business instead of taking it away. The chart below

shows the research and development expenses reported on the income

statements of Agilent, Teradyne, Synopsys, and National Instruments for the last

five years (in thousands).

53

It is important to find these values of expenses in order to value these

firms in the technological software industry. The expenses that these firms incur

are very high, which in turn lowers their net income for the year. The

ramifications of expensing these costs are missing out on the value that could be

made if they were treated as an asset. If research and development costs were

reported as an asset instead of an expense, there would be higher gains for the

firm, thus giving investors the true value of the firm. When GAAP expenses

research and development, the follow occurs in regards to the balance sheet:

Assets = Liabilities + Equity Revenues - Expenses Net

Income

U N U N O U

If put into an asset account, R&D would have to be depreciated straight

line throughout a 10 year life span, thus making it 20% depreciation a year. This

0

100000

200000

300000

400000

500000

600000

700000

800000

900000

2003 2004 2005 2006 2007


National Instruments Agilent Teradyne Synopsys

54

change of putting R&D costs in an asset account would increase the assets in the

firm while decreasing the expenses, resulting in higher owner’s equity and

earnings for the firm.

Goodwill

Goodwill is considered an intangible asset and is extremely difficult to

measure and account for. Goodwill has a big impact on the financial statements

because it accounts for an immense part of acquisition prices today. Firms are

required to evaluate goodwill for impairment at least once a year. In 2001, FASB

introduced SFAS 142, Goodwill and Other Intangible Assets, which made changes

to the way accountants treated goodwill. All of amortization would stop, no

matter when it was originated, and goodwill would now be an asset and

amortized periodically. If there is impairment of goodwill, the carrying amount

will be reduced and an impairment loss is accepted. This gives a great deal of

flexibility to a firm’s management whether to determine if goodwill is impaired or

not. This fact causes a lot of debate with the firm’s financial statements because

if goodwill is in fact impaired and is not stated it will overstate the assets as

shown below:

When a firm acquires another firm in a merger and acquisition, they also

acquire the assets of that firm. The premium they pay for these assets whether it

be research and development or the brand name is goodwill and recorded as an

asset. In National Instrument’s case, no acquisitions were made.

“The excess purchase price over the fair value of assets acquired is

recorded as goodwill. In accordance with SFAS 142, Goodwill and Other

Intangible Assets, goodwill is tested for impairment on an annual basis, and

between annual tests if indicators of potential impairment exist, using a fair-

Assets = Liabilities + Equity Revenues - Expenses Net Income

O N O N U O

55

value-based approach. Our annual impairment test was performed on February

28, 2007. No impairment of goodwill was identified during any of the periods

presented” (National Instruments 10K). During the years of 2003 to 2007

goodwill and intangibles ranged from the following:

National Instruments jumped from $13,356 in 2004 to $52,533 in 2005

due to an acquisition acquired that year. For 2007 there were no impairments or

acquisitions for the year.

*NOTE: All numbers in this graph are quoted in thousands.

Goodwill

2003

2004

2005

2006

2007


11,893 13,356 52,533 54,111 53,343

Agilent

402,000 345,000 362,000 468,000 736,000

Teradyne

118,203 116,176 69,147 69,147 69,147

Synopsys

550,732 593,706 728,979 735,643 767,087

56

Operating & Capital Leases

Capital and operating leases are important when it comes to a firm.

Knowing the difference between capital and operating leases is essential because

operating leases can sometimes understate assets and liabilities of a company. A

capital lease is one in which payments are treated like a mortgage rather than an

expense, as with an operating lease. In the industry, firms use leases to acquire

plan, property, and equipment. National Instruments only utilizes operating

leases and they fall under the category of long-term liabilities. According to

National Instruments balance sheet, total long-term liabilities amounted to

approximately 11 million dollars in 2007. Later on in the 10-K, National

Instruments goes on to state that its leases amounted to a little over 9 million

dollars. This shows that leases account for over 80% of long term liabilities,

which is a substantial amount. It is important to look closely at this number to

ensure that the company is not losing money in the long run by using an

operating rather than a capital lease.

Warranties

Warranties are important when dealing with manufactured products. A

firm wants to ensure that extra sense of security to the consumer when they sell

a product to them. It also helps build reputation and customer relationships

knowing that if anything goes wrong with a product, it will soon be fixed or

replaced. The firm usually estimates how much money is going to be used for

the warranty expense that year. This gives the firm flexibility with its numbers

and allows its managers to put in the proper or improper estimation.

“We offer a one-year limited warranty on most hardware products, with a

two or three-year warranty on a subset of our hardware products, which is

included in the sales price of many of our products. Provision is made for

estimated future warranty costs at the time of the sale pursuant to SFAS 5,

57

Accounting for Loss Contingencies, for the estimated costs that may be incurred

under the basic limited warranty. Our estimate is based on historical experience

and product sales during this period” (National Instruments 10K). The warranty

beginning balance for the 2007 period was $867,000 with a $1,625,000 addition

for new warranties. Warranties used during 2007 were $1,742,000, either

through new software or cash, leaving 2007 with an ending balance of $750,000.

Foreign Currency

When dealing with a company that sells and manufactures internationally

as National Instruments does, it is important to address the currency risk when

making sales with foreign countries. National Instruments currently operates in

40 countries worldwide and has a manufacturing plant in Debrecen, Hungary.

“We are Subject to Various Risks Associated with International Operations and

Foreign Economies. Our international sales are subject to inherent risks,

including: fluctuation in local economies; fluctuations in foreign currencies

relative to the U.S. dollar; 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

earning; and the burdens of complying with a wide variety of foreign laws”

(National Instruments 10K). The percentages of sales for National Instruments

for 2007 were 44.8% in the United States, 31.2% in Europe, and 24% in Asia

Pacific. This brought totals for the company’s nets sales to $331.5 million in the

United States, $230.9 million in Europe, and $178 in Asia Pacific. Knowing that

half or more of the firm’s income comes from abroad, it is more important for a

firm to discuss how they account for these transactions. Firms assume

tremendous risk when they sell their products in foreign markets.

According to National Instruments’ 10K, they mange foreign currency risk

by implementing a management strategy that uses derivative instruments to

58

guard earnings and cash flows from instability that can be caused by the

unpredictability in currency exchange rates. These derivatives can help prevent

liquidity problems when performing transactions by locking into fixed exchange

rates. National Instruments also uses foreign currency fair value and cash flow

hedges to help them reduce that risk. “We purchase foreign currency forward

and purchased options contracts as hedges of forecasted sales that are

denominated receivables” (National Instruments 10K). By performing foreign

exchange options, it helps by diversifying away any possible foreign interest rate

fluctuations when handling business transactions from abroad.

Accounting Flexibility A firm’s financial statements are highly dependent on accounting

standards and policies that help to accurately display a firm’s profitability.

Although a firm’s accounting standards are typically set by GAAP (Generally

Accepted Accounting Principles), there are certain circumstances that allow for

accounting flexibility. Without this opportunity for flexibility, some firm’s financial

statements that rely solely on research and development, marketing, and other

related activities would be severely understated and uninformative. However, the

opposite could occur as well. A company could take flexibility for granted and

overstate their financial reports in order to seem more appealing and profitable

to investors and customers. The following paragraphs outlay accounting flexibility

issues that National Instruments faces when it comes to their key accounting

policies.


Research and development is a key success factor for many firms,

especially those involved in the software industry. According to GAAP, firms are

required to record transactions in comparable ways; included in these

transactions are research and development. GAAP states that research and

development should be expensed as incurred, which can create a problem for

59

many firms. It leads to overstated expenses and understated net income, which

makes a firm seem less profitable than it actually is. This is where accounting

flexibility comes into play. In order to offset overstated expenses, firms are

allowed to capitalize some research and development costs over time.

National Instruments states that they “capitalize software development

costs in accordance with Statement of Financial Accounting Standards” (National

Instruments 10-K). They continue by saying that they “amortize such costs over

the related product’s estimated economic useful life, generally three years,

beginning when a product becomes available for general release” (National

Instruments 10-K). Teradyne’s 10-K includes a snippet of this issue of capitalized

software development costs as well. They state “software development costs

incurred subsequent to the establishment of technological feasibility are

capitalized until the product is available for release to customers” (Teradyne 10-

K). Synopsys also declares that they exclude software development costs from

research and development but choose to capitalize these costs instead.

Agilent on the other hand, explains that “costs related to research, design

and development of our products are charged to research and development

expense as they are incurred” (Agilent 10-K). They choose not to capitalize

software development costs but rather include them as a research and

development expense.

Overall, it can be concluded that managers in the software industry have a

considerable amount of accounting flexibility when it comes to research and

development. Due to the choice firms have of being able to capitalize software

development charges rather than expensing them as research and development,

numbers included in the financial statements of these companies can be seen as

reasonably informative and accurate.

60

Goodwill

Goodwill can be defined as “the excess purchase price over the fair value of

assets acquired” (National Instruments 10K). GAAP states that goodwill is

recorded as an asset and is not amortized but rather tested for impairment on an

annual basis. The criteria for testing whether a product is impaired however, is

somewhat vague and impractical. Finding the exact fair market value of an

element of goodwill is challenging. Even with the opinion of several analysts, a

value that everyone can agree on is impossible to find. This leads to an unclear

picture of whether goodwill is actually impaired.

National Instruments, Agilent, Synopsys, and Teradyne all claim no

impairment of goodwill. This is questionable due to the large amount of flexibility

that is allowed when computing goodwill. Each company could have inaccurately

stated their goodwill in order to seem more appealing to the public. It is

necessary to closely analyze goodwill to ensure that no false figures are

displayed in a company’s financial statements.

Operating & Capital Leases

A firm has the option of using capital or operating leases. An operating

lease is correlated with an expense and the owner does not assume

responsibility of ownership. On the other hand, a firm that chooses to use capital

leases takes on full ownership and responsibility and is accountable for the risks

that come along with this ownership. Although both have their pluses and

minuses, the ultimate decision on which leasing type to use is up to the firm’s

managers and decision makers.

Even though National Instruments prefers to use operating leases rather

than capital leases, the balance sheet shows other long term liabilities as

approximately 11 million in 2007. The future rent payment in 2008 is forecasted

as around 9 million. These numbers show that the impact of a capital lease could

be extremely noteworthy which could be a reason that National Instruments

61

chooses to use operating leases. Note 13 in National Instrument’s 10-K displays

future lease payments, which are recorded in thousands of dollars. Because

these lease payments are so high relative to other liabilities the firm encounters,

they can be seen as significant. Overall, National Instruments is allowed a great

deal of flexibility when it comes to leases.

Warranties

Warranties are classified as loss contingencies and are “accrued by a charge

to income if a loss contingency is probable and the amount of the loss can be

reasonably estimated” (http://cpaclass.com/gaap/sfas/gaap-sfas-5.htm). The

software industry often provides warranties to ensure customer satisfaction and

loyalty. National Instruments and its competitors are no exception. Below is a

graph displaying National Instruments’ warranty reserves based on “historical

experience and product sales” ( National Instruments 10-K) as seen in their 2007

10-K (in thousands):

2006 2007

Balance at the beginning of the period $915 $ 867

Accruals for warranties issued during the period 1593 1625

Settlements made (in cash or in kind) during the period (1641)

(1742)

Balance at the end of the period 867 750

The chart above shows that National Instruments increased accruals for

warranties from 2006 to 2007. It follows up by demonstrating the exact amount

of settlements that are made to customers during the period. Even though this

allows investors to see how National Instruments handles warranties, there is no

way of knowing whether these numbers are indeed accurate.

62

Although GAAP states that the amount of a loss contingency must be

probable and reasonably estimated, a firm’s managers have some flexibility when

it comes to this estimation. The term “reasonably estimate” allows for some

flexibility in itself. A reasonable estimation to one manager may equate to an

unreasonable estimation to another manager. An analyst must look closely at

loss contingencies in order to guarantee that a firm is using the most reasonable

number to estimate losses.

Foreign Currency

National Instruments and its competitors retain a substantial amount of

activity overseas. This leads to the issue of foreign currency translation and

adjustments. GAAP possesses a considerable amount of information relating to

the recognition of foreign currency. It suggests that U.S. based firms must use

U.S. accounting standards, even if conducting business overseas. This means

that American firms must convert foreign currency into domestic currency based

on the effective rate of exchange. The “results of operations can be adversely

affected when the U.S. dollar weakens relative to other currencies, including the

Euro, the Japanese yen and the Canadian dollar, as a result of the conversion of

revenue and expenses of our foreign operations denominated in foreign

currencies into the dollar” ( Synopsys 10-K). Since exchange rates are available

to the public, it is extremely difficult for firms, including National Instruments, to

possess a great deal of flexibility when calculating foreign currency translation.

63

Evaluate Accounting Strategy

A firm’s accounting strategy is directly based upon its accounting flexibility.

Firms can either use accounting flexibility to accurately portray their performance

or use it to their advantage by misinterpreting facts and figures to make their

firm seem more profitable than it actually is. In terms of strategy, a firm is

usually either conservative or aggressive. A firm that possesses a conservative

accounting strategy understates assets and overstates liabilities, which ultimately

results in lower net income and owner’s equity. A manager that uses an

aggressive accounting strategy uses his/her powers to influence the financial

statements in order to satisfy investors. The financial statements may report

higher net income and earnings than were actually achieved in order to make the

company seem more lucrative. This persuades investors to invest money into

stocks that may actually be declining rather than improving. By being able to

spot abnormalities within accounting strategies, an investor should end up with a

truthful representation of a firm’s overall economic position.


Research and development is one of the most important aspects of firms

competing in the software industry. It leads to new and innovative products that

attract investors, which eventually lead to increased market share and

profitability. Research and development, with relation to the software industry,

consumes a large part of the expense portion of a balance sheet. This is because

GAAP requires that research and development expenses be expensed as incurred

rather than recorded as an asset on the balance sheet, which can lead to the

understatement of net income. When it comes to research and development in

the software industry however, there is a certain amount of flexibility that is

allowed, as mentioned earlier in the accounting flexibility section. Software

development costs can be capitalized rather than expensed. National

Instruments chooses to use this strategy. Instead of expensing all research and

development costs, National Instruments prefers to record software development

64

as an asset. This decreases expenses and increases assets, which leads to higher

net income and owner’s equity. This can be looked upon as an aggressive

accounting strategy.

Goodwill

National Instruments’ 10-K provides a small level of disclosure when it

comes to the subject of goodwill. Although stating that goodwill is tested for

impairment annually, it further explains that there was no impairment identified

in the years 2007, 2006, 2005, and 2004. This is doubtful considering the fact

that there is no way for an average investor to prove this statement is correct.

Although the 10-K states the amount of net goodwill on its consolidated balance

sheet, nowhere is there a description of what the goodwill entails or

encompasses. This lack of information regarding goodwill makes it hard to tell if

National Instruments is actually recording goodwill truthfully and can be seen as

an aggressive accounting strategy.

Operating and Capital Leases

Operating leases and capital leases are a major component of the software

industry. National Instruments and Agilent both use operating leases rather than

capital leases to account for their warehouses and facilities. Synopsys uses

capital and operating leases, with operating leases outweighing capital leases by

a mile. It can be inferred that National Instruments uses an aggressive

accounting strategy when it comes to leases. Leases account for such a major

part of National Instrument’s balance sheet that it is necessary to assume that

aggressive tactics are taking place. Also, the norm across industries is to use

operating leases rather than capital leases which also proves that National

Instruments is involved in an aggressive accounting strategy when it comes to

operating and capital leases.

65

Warranties

National Instruments claims that they reasonably estimate warranty

reserves by looking at past performance and historical data. Looking at National

Instruments 10-K’s the past four years, it can be concluded that warranty

reserves are generally increasing year by year. This indicates that there is likely a

conservative strategy coming into play. If National Instruments were to

participate in an aggressive warranty strategy, it is likely that they would reduce

warranty liabilities in order to make their financial statements look healthier.

Instead, National Instruments increases warranty liabilities little by little each

year to adjust for inflation and increasing costs. It can be inferred that National

Instruments uses a conservative accounting strategy rather than an aggressive

one when it comes to warranty estimations.

Foreign Currency

National Instruments partakes in a variety of business activities that take

place overseas. Although foreign currency is accumulated through these

ventures, National Instruments is required to accurately portray these figures

using relative exchange rates. They state that the assets and liabilities of

overseas “operations are translated at the rate of exchange in effect on the

balance sheet date” (National Instruments 10-K). They also state “ gains and

losses resulting from re-measuring monetary asset and liability accounts that are

denominated in a currency other than the subsidiary’s functional currency are

included in net foreign exchange gain (loss) and are included in net income”

(National Instruments 10-K). These quotes, along with the significant amount of

information outlaid in the 10-K, demonstrate National Instruments’ ability to

follow the rules of GAAP when it comes to recording foreign currency which

suggests a conservative accounting strategy.

66

Conclusion

Overall, National Instruments accounting strategy is comprised of both

conservative and aggressive measures. Although the company partakes in

aggressive accounting when it comes to research and development goodwill and

operating and capital leases, it is countered with conservative warranties and

foreign currency strategies. This infers that National Instruments’ participates in

moderate accounting strategies.

Quality of Disclosure

Disclosures by firms are regulated by GAAP. Within these specific rules

and regulations there is a certain amount of flexibility with which manager’s can

choose what they wish to disclose on their financial statements. This information

acts as a reference to quantitative data that may be unclear. Manager’s have

the power to disclose the extent of information that they choose. There could be

incentives to withhold information to analyst’s and the public. Some of these

could be compensation based on performance of the firm, promotional bonuses,

and stock option incentives.


In the software and technology industry, research and development plays

a key role. The 10-K’s all reflect the major capital that is devoted to making

research and development competitive for their industry. In an industry that

relies so heavily on factors such as differentiation, research and development is

necessary for each firm. In National Instrument’s 10-K they state that, “we

believe that our long-term growth and success depends on delivering high

quality software and hardware products on a timely basis. We intend to focus

our research and development efforts on enhancing existing products and

developing new products…to be competitive with respect to technology and

67

price/performance” (National Instruments 10-K). National Instruments is so

devoted to research and development that they spent 126.5 million on research

and development in 2007.

Disclosure regarding research and development is usually extremely

accurate because investors want to see that the firm they choose is allocating an

appropriate amount to have the latest and most innovative products on the

market. Because of GAAP regulations, research and development is on the

income statement as an expense. But firms such as National Instruments

“capitalize software and development costs, in accordance with SFAF 86, which is

accounting for the costs of computer software to be sold, leased or otherwise

marketed” (National Instruments 10-K).

Goodwill

National Instrument’s overall disclosure regarding goodwill can be looked

upon as aggressive. Their explanation of their methods for testing for

impairment is somewhat vague and uninformative. In 2007 National Instruments

had a goodwill balance of almost 53 million dollars. The goodwill was then tested

for impairment and National Instruments claimed that no problems surfaced.

This creates a potential problem for an investor researching the firm. An investor

must assume that no goodwill impairment was found without having official

proof. National Instruments’ disclosures about the impairments of goodwill are

hard to interpret and unclear which leads an investor to obtain a blurred image

of the firm’s stance when it comes to the issue of goodwill.

68


National Instruments overall disclosure about leases is aggressive. When

looking at the financial statements of National Instruments, operating leases

count for a large portion of long term liabilities. National Instruments has “non-

cancelable operating leases primarily for office facilities” (National Instruments

10-K). They discuss how some of the operating leases require them to pay

property taxes, insurance, and routine maintenance but they do not go into great

detail. Agilent, one of the main competitors, also discusses working under the

same operating leases and listed the same information about the insurance,

taxes or maintenance fees with no disclosure. Both companies discussed the

routine rent payments and forecasted for the next 5 years. Their disclosure on

this expense is vague and concludes that the amount expensed each month

accounts for a major part of the income statement. National Instruments holds

only operating leases so the book value of a possible asset if capital leases were

used never reaches the balance sheet. This could be a concern for the investors

because it may appear the National Instruments is expensing something only to

make their books look better for tax purposes.

Warranties

National Instruments does not disclose extensive information on

warranties. They are included when a warranty account is discussed. They

state, “we offer a one-year limited warranty on most hardware products, with a

two or three-year warranty on a subset of hardware products, which is included

in the sales price of many of our products” (National Instruments 10-K). This

account balance is an estimate made in accordance to the SFAS 5 (Accounting

for Loss Contingencies). At the beginning of each year, the account balance is

re-estimated in accordance with their sales and historical experience. This

69

disclosure seems to be consistent with most firms in this industry as well as the

warranty conditions and time period.

Foreign Currency

Foreign Currency disclosure by National Instrument’s is very extensive.

The company effectively discloses issues of foreign currency by stating the

procedures of recording the exchange rate on their financial statements. A large

amount of National Instrument’s business comes from foreign companies;

therefore, it is crucial for them to explain in detail the effects of fluctuations, as

well as translations on the financial statements. “The assets and liabilities of

these operations are translated at the rate of exchange in effect on the balance

sheet date and sales and expenses are translated at average rates. The extra

amounts of gains or losses resulting from translation are included in a separate

component of other comprehensive income” (National Instruments 10K). This

quote, taken from the 10K of National Instruments, shows how they effectively

record excess money earned or lost on their financial statements. This enables

investors to view the gains and losses from doing business overseas separately

from the overall gains and losses for the company. It is a better view to analyze

whether foreign currency is profitable. National Instruments uses its derivative

instruments to estimate future currency cash inflows to decrease the excess

amount of inflows and outflows caused by exchange rate changes. Unlike excess

income or loss in the translation changes being recorded in comprehensive

income, these changes will be recorded in current earnings. (National

Instruments 10K)

Conclusion

National Instruments does a good job of disclosing almost all of their accounting

information. The only issue that was found was that operating leases were used

instead of practicing using capital leases. However, National Instruments does

disclose research and development costs very extensively because of the

70

importance within this industry. Foreign Currency is also disclosed very well

within the 10-K leaving almost nothing behind that could potentially be a red flag

on that issue. Overall, National Instruments utilizes high-quality disclosure

methods, as seen in their 10-K.

Quantitative Analysis

The quantitative data provided by a company can be used to provide a

better picture of a company’s current standings in their industry. Quantitative

analysis is performed to assess the credibility of reported net income. The

financial statements are a way for investors and shareholders to get an inside

view of the company and get a better understand of how the company is doing

financially. These statements are written in accordance with GAAP principles.

However, within GAAP principles there is a small amount of flexibility. With this

flexibility may come faulty management decisions. Some disclosure decisions

made by the management may reflect choices made to solely benefit the

company instead of show the truth in the numbers causing the actual image of

the company to be vague. With this in mind, it is important to not always trust

what you see and to do further research into what numbers a company has

provided. One way to accomplish this is to run a series of diagnostic ratios that

might potentially show grey areas and throw up “red flags”.

The analyst must use two different quantitative measures to show if the

financial statements are accurately showing the economic consequences made

from business activities. The first measure to look at is the sales manipulation

diagnostics. All of these ratios show different measures versus the company’s

net sales. To accurately measure this we will divide net sales by many different

factors to show the affect each of them have on each other. The factors we will

use are cash from sales, unearned revenue, accounts receivable, warranty

liabilities and inventory. If there is a definite outlier than it may be a clear

71

picture that the books have been manipulated to make the company appear

better than it really is. Second, the ratios for expense manipulation diagnostics

will be examined. These ratios will aid in seeing whether or not there are

unexplained changes in the company’s expense reports. These ratios will help to

show the accuracy of the numbers and determine if the firm is manipulating

numbers.

Sales Manipulation Diagnostics:

To be able to fully analyze the balance sheet and income statement of

National Instrument’s and their competitors for the past 5 years, a series of sales

manipulation diagnostics will be used. For this process we will use the following

ratios; net sales to cash from sales, the net sales to accounts receivable, and the

net sales to inventory. The ratios being used will directly deal with the net sales

and how they will changed using different current assets. The patterns illustrated

by these numbers and graphs will help to identify industry trends and help to

identify the specific performance of National Instruments, this will be done by

looking for outliers and potential red flags. By using these ratios, we will be able

to analyze the effect of current assets and current liabilities and determine

whether or not a manipulation on the numbers was committed. This process is

the key way to correctly analyze a company against the industry, and look at the

red flags that are shown, if any.

72

Net Sales/ Cash from Sales:

The first ratio that was calculated was Net Sales divided by Cash from

Sales. This ratio will accurately measure how much cash the company has

actually received verses the amount of revenue that is recognized on their books

currently as accounts receivable. This ratio should always stay around “1”

because when a company sells its products they want to reflect actual payment

instead of accounts receivable that could potentially go to the allowance for

doubtful accounts with result of no payment. If this number was not “1” a red

flag would be raised because the company is either recognizing too much sales

or not enough.

0.860

0.880

0.900

0.920

0.940

0.960

0.980

1.000

1.020

1.040

1.060

1.080

2003 2004 2005 2006 2007

Net Sales/Cash From Sales(Raw)


Agilent

Teradyne

Synopsys

73

As illustrated in the chart above, all firms in this industry have a ratio that

stays around 1. There do not seem to be any drastic increases or decreases that

would raise red flags, so the recognition of both net sales and cash from sales

seem to be accurate. National Instruments demonstrates the overall best net

sales/cash from sales ratio, by not having any serious declines or drop-offs and

consistently staying above “1”. This is a very favorable trait to obtain over the

five year course because it demonstrates the company’s ability to maintain a

high level of cash actually received. This would lead an investor to believe that

National Instruments, and the competitors in the industry, have good

relationships with their buyers. Another observation is that they all seem to be

staying with the industry trends, which shows that over the course of the past 5

years, the company’s performances have been similar and follow the same

pattern. National Instrument’s as well as the other competitors seemed to have

good disclosure and accurate numbers for this ratio.

0.000

0.500

1.000

1.500

2.000

2.500

3.000

3.500

4.000

2003 2004 2005 2006 2007

Net Sales/Cash From Sales(Change)


74

Net Sales / Net Accounts Receivable

By dividing Net Sales by Net Accounts receivable we can accurately

analyze what portion of sales are actually credit sales versus how many of them

are accounts receivable. In the technical and system software industry, the

amount of credit sales are very high, thus we can conclude that in this specific

industry the net sales to net accounts receivable ratio will be high. Companies in

the technical and system software industry have large credit sales because firms

generally sale in large volumes. The firms in this industry will want a high net

sales/net accounts receivables ratio because this means that the company is very

successful in converting their credit sales into cash. By looking at the graph,

Synopsys is the industry leader in converting their credit sales into cash. While

National Instruments remains on the bottom of the competitors graphs which

means they are having more difficulty collecting cash for their sales. This could

be due to the fact that National Instruments is a fairly smaller company

compared to the industry competitors and is accepting more sales on credit, in

percentage,, in percentage, then the competitors.

0.000

2.000

4.000

6.000

8.000

10.000

12.000

2003 2004 2005 2006 2007

Net Sales/Net Accounts Receivable(Raw)


Agilent

Teradyne

Synopsys

75

When examining National Instruments balance sheet and income

statement, you can see that the accounts receivable were steadily increased by

about 10 million every year from 2003 to 2007. By analyzing this chart, it shows

that for every $5 dollars of Net Sales there is only $1 of accounts receivable.

This accounts for approximately 20% of total sales that are accounts receivable,

which is a relatively good ratio. By looking at this graph there appears to be no

“red flags” because all the firms are right with each other on numbers and

disclosures.

Net Sales/Unearned Revenues

Net sales divided by unearned revenue is a chart that accurately shows

how much of net sales is accounted for by unearned revenue. If there is a high

percentage of unearned revenue versus accounts receivable, a company could

be at risk of not actually doing the work for work they have already received

compensation for.

(60.000)

(40.000)

(20.000)

‐

20.000

40.000

60.000

80.000

100.000

2003 2004 2005 2006 2007

Net Sales/Net Accounts Receivable(Change)


76

By looking at the graph, National Instruments and Teradyne had a ratio of

about $1 of Unearned Revenue for every $50 of Net Sales in 2003. However,

over the course of the 5 year period as each company became more competitive

in the industry they ended with a ratio in conjunction with that of Agilent of

approximately $1 of Unearned Revenue for every $20 of Net Sales in 2007. This

0.000

10.000

20.000

30.000

40.000

50.000

60.000

2003 2004 2005 2006 2007

Net Sales/Unearned Revenue (Raw)


Agilent

Teradyne

Synopsys

(200.000)

(150.000)

(100.000)

(50.000)

‐

50.000

100.000

150.000

2003 2004 2005 2006 2007

Net Sales/Unearned Revenue(Change)


77

change can be explained by companies gaining market share and brand image

and being hired and paid on the spot for specialty jobs for clients. It looks as if

most of the companies are right on track with the unearned revenue ratio with

the exception of Synopsys. This just shows that Synopsys is involved in many

transactions that require cash up front and this will not become an issue unless

the company went bankrupt and was not able to repay debts that they owe.

Net Sales/Inventory

The ratio of net sales divided by inventory lets the analysts see how much

of net sales are supported by the inventory of the company. If a company has an

increase in net sales or a decrease in inventory a higher ratio will result. The

graphs below show the net sales/inventory that is experienced in the technical

and system software industry. In this analysis, Synopsys could not be

represented in this graph because they are a firm with high-unearned revenue

for specific jobs and they do not keep excess inventory because it would not be

effective for their firm.

0.000

2.000

4.000

6.000

8.000

10.000

12.000

14.000

16.000

2003 2004 2005 2006 2007

Net Sales/Inventory(Raw)


Agilent

Teradyne

78

By looking at this chart both National Instruments and Agilent seem to

have a steady growth rate between inventory and net sales. The only firm that

raises a red flag is Teradyne because they had a major decrease in inventory

from 2005 to 2007 explaining the outlier on this graph. There seems to be no

red flags without explanation on these graphs so the industry is operating well

when considering inventory.

Net Sales/Warranty Liabilities

The net sales/warranty liabilities graph lets the analyst see how much of their

net sales are supported by warranty liabilites. If you analyzed this graph

normally for each firm if sales increased you should see an increase in warranty

liabilities. Even though this graph looks drastically different each firms

warranty’s only count for approximately 1% of their sales. National Instrument’s

graph seems draw a red flag because as sales have increased their warranty

(2,000)

(1,500)

(1,000)

(500)

‐

500

1,000

1,500

2003 2004 2005 2006 2007

Net Sales/Inventory(Change)


Agilent

Teradyne

Synopsys

79

liabilites have stay almost the same causing some confusion with the disclosure

the firm is willing to put on the books. Since warranties is such a small part of

the percentage of the companies sales it is of little importance.

‐

200.000

400.000

600.000

800.000

1,000.000

1,200.000

2003 2004 2005 2006 2007

Net Sales/Warranty Liabilities(Raw)

National Instruments Agilent Teradyne

(2,000)

(1,500)

(1,000)

(500)

‐

500

1,000

1,500

2003 2004 2005 2006 2007

Net Sales/Warranty Liabilities(Change)


80

After looking at both the change and raw graphs, you can see that there

are some outliers that are difficult to explain. This is because of the denominator

of this ration which is warranty liabilities. Because you have such a large number

in the numerator, little changes in either the net sales or warranty liabilities will

cause great volatility.

Conclusion

In general, National Instruments was right on track when compared to

other firm’s sales manipulation diagnostics. The Net Sales/Cash from Sales ratios

were all approximately 1 which means that all firms have a good turn around on

cash collections. The Net Sales/Accounts Receivable ratios all seemed to be

fairly similar and on the same track. Since this ratio shows how effectively a firm

is utilizing its’ assets, it can be concluded that all firms in this industry use their

assets in approximately the same way. The Net Sales/Unearned Revenue charts

showed that National Instruments and Teradyne both grew significantly over the

past 5 years raising their accounts receivables numbers and bringing their ratios

closer to that of Agilent. However, Synopsys was the only firm that had a

different ratio than the rest only because they operated mainly around unearned

revenue instead of credit sales. Finally, the Net Sales/Inventory ratio showed

that National Instruments and Agilent both had similar growth rates in

comparison with Teradyne having a minor outlier because of their decrease in

inventory over the years 2005-2007. Synopsys was not included in this graph

because they do not hold inventory.

81

Sales Manipulation DiagnosticsNational Instruments 2003 2004 2005 2006 2007

Net Sales/Cash from Sales

1.036 1.019 1.015 1.034 1.019

Net Sales/ Net Accounts Receivable

5.462 5.888 6.548 8.310 8.257


52.270 44.575 35.700 29.737 20.514

Net Sales/ Warrant Liabilities

595.653 630.783 624.963 761.715 987.171

Net Sales/Inventory 10.973 9.513 9.102 8.561 8.955

Agilent 2003 2004 2005 2006 2007 Net Sales/Cash from

Sales 0.993 0.992 0.993 1.003 1.008


4.114 6.548 6.222 7.186 7.374


17.053 22.731 22.854 22.102 21.767


42.962 44.483 34.704 39.157 38.440


Teradyne 2003 2004 2005 2006 2007 Net Sales/Cash from

Sales 1.042 0.996 1.064 0.949 1.032


5.894 8.310 4.496 8.707 5.817


53.281 48.071 33.202 30.787 26.290


118.299 113.298 99.572 105.160 118.017


Synopsys 2003 2004 2005 2006 2007 Net Sales/Cash from

Sales 0.995 0.941 0.969 1.021 1.001


5.856 8.257 9.902 8.937 9.786


2.951 2.960 2.386 2.459 2.100

82


N/A N/A N/A N/A N/A

Net Sales/Inventory N/A N/A N/A N/A N/A

Core Expense Manipulation Diagnostics

Core Expense Manipulation Diagnostics help to analyze the firm in the

industry and see if they are utilizing their expenses correctly. These ratios help

relate the statement of cash flows with the income statement. The diagnostics

are a helpful tool to investors because if there are large increases or decreases in

certain ratios, it can raise potential red flags. These potential red flags must be

closely examined in order to understand why these discrepancies exist.

Asset Turnover (Sales/Assets)

Asset Turnover is net sales divided by total assets. This ratio shows how

well the company is utilizing its assets when generating sales; with this ratio the

bigger the better. When analyzing the graph any major fluctuations need to be

fully analyzed to make sure firms are appropriately writing off assets.

0.000

0.200

0.400

0.600

0.800

1.000

2003 2004 2005 2006 2007

Asset Turnover(Raw)


83

The raw graph shows that National Instruments has the highest asset

turnover ratio. As mentioned before, the higher the ratio the better which

signifies that for each dollar of assets, National Instruments produces the highest

number of net sales. As you can see from the “change” graph, this number

fluctuates for most of National Instrument’s competitors. It increases for

National Instruments and takes a slight decline from 2005 to 2007. This could

be related to several reasons including not depreciating enough of the asset, or a

decrease in sales.

CFFO/OI

Cash flow from operations over operating income is how well a company

is using its operating income to support its operations. Therefore, a ratio that is

close to one is most desirable because this shows that operating cash flows are

mainly collected from earnings from operations.

(4.00)

(2.00)

‐

2.00

4.00

6.00

8.00

2003 2004 2005 2006 2007

Asset Turnover(Change)


84

When analyzing the graph and looking at the industry you can see that all

firms except for National Instruments experience a major fluctuation from 1 in

2005. National Instruments had a slight decline from 2003 to 2004. This is

primarily because they had a significant amount of increase in operating income.

However, National Instruments has been the most efficient out of all of the firms

of keeping this ratio close to 1. Synopsys had a large decrease in this ratio in

2005 mainly because they had an operating loss of $59,845,000. Since this

(6.000)

(4.000)

(2.000)

0.000

2.000

4.000

6.000

8.000

2003 2004 2005 2006 2007

CFFO/OI(Raw)


(2,500.00)

(2,000.00)

(1,500.00)

(1,000.00)

(500.00)

‐

500.00

2003 2004 2005 2006 2007

CFFO/OI(Change)


85

fluctuation is easily explained, no red flags were raised for any of the firms in this

industry.

CFFO/NOA

Changes in cash flow from operations divided by net operating assets

shows how well the company is utilizing its net operating assets to support its

cash flow from operations on a day-to-day basis. Plant, property, and equipment

are a company’s net operating assets. When looking at this ratio, it is important

to make sure that Cash Flow from Operations has taken into account foreign

currency. If foreign currency is misstated, then CFFO could be under or over

stated, which would be unpleasant for a company either way.

(0.500)

0.000

0.500

1.000

1.500

2.000

2.500

3.000

3.500

2003 2004 2005 2006 2007

CFFO/NOA (Raw)


86

An important thing to analyze with this ratio is that if a firm was having

trouble with assets they might choose to increase cash flows from operations or

decrease net operating assets. If there were any large sell offs or inconsistent

variations of cash flows from operations a firm might have dishonestly reported

either of these 2 instances on their financial statements. Therefore, when

analyzing the ratio if it is close to one, then the company is utilizing the assets

that it physically owns. National Instruments starts out with a low ratio in 2003,

however it increases in 2004 and rises steadily thereafter. The increase from

2004 to 2005 is from the 3.7% decrease in operating assets which will increase

the ratio. This is from selling off property, plant, and equipment during 2004.

(900.000)(800.000)(700.000)(600.000)(500.000)(400.000)(300.000)(200.000)(100.000)

‐100.000

2003 2004 2005 2006 2007

CFFO/NOA(Change)


87

Accruals/Net Sales The total accrual calculation involves cash flow from operations and net

earnings. Net earnings are taken out of cash flow from operations. This number

is then divided by net sales to get the final ratio amount. An ideal result would

be around 1, because this would show that accruals are successfully sustained by

net earnings.

‐0.600

‐0.400

‐0.200

0.000

0.200

0.400

0.600

2003 2004 2005 2006 2007

Accruals/Net Sales(Raw)


(15.000)

(10.000)

(5.000)

‐

5.000

10.000

2003 2004 2005 2006 2007

Accruals/Net Sales(Change)

National Instrument Agilent Teradyne Synopsys

88

Looking at the graph, one can assess that the industry trend from years

2004-2005 is increasing while the remainder of the years are decreasing. The

ratio of National Instruments is close to one for most all years showing that

accruals are successfully sustained by net earnings. Because of this, it is believed

that National Instruments is disclosing information sufficiently and is operating

along with industry trends.

Conclusion

After analyzing the core expense manipulation diagnostics, it is safe to say

the National Instruments poses no threats for potential red flags. Their asset

turnover ratios were all positive and relatively close to one. The cash flow from

operations over operating income ratio was also close to one and was much

better than competitors. The cash flow from operations over net operating

assets ratio displays how well the company is using its property plant and

equipment and the graph displays that National Instruments lies in middle of

industry. The accruals over net sales ratio was a negative number, but as you

can see from looking at the competitors, this is also within the industry average.

89

Core Expense Manipulation Diagnostics National Instruments 2003 2004 2005 2006 2007 Asset Turnover (Sales/Assets)

0.811 0.883 0.722 0.734 0.522

Changes in CFFO/OI 1.564 1.047 1.126 1.116 1.444 Changes in CFFO/NOA 0.042 0.438 0.610 0.673 0.973 Total Accruals/Change in Sales

0.342 (0.144) 0.165 (0.015) 0.190

Pension Expense /SG&A N/A N/A N/A N/A N/A Other Employment Expenses N/A N/A N/A N/A N/A

Agilent 2003 2004 2005 2006 2007 Asset Turnover (Sales/Assets)

0.710 0.722 0.694 0.675 0.718

Changes in CFFO/OI 0.219 4.621 4.162 1.366 1.659 Changes in CFFO/NOA (0.109) 0.533 1.051 0.818 1.210 Total Accruals/Change in Sales

(0.775) (1.895) 0.528 (11.267) 6.720


Teradyne 2003 2004 2005 2006 2007 Asset Turnover (Sales/Assets)

0.758 0.734 0.562 0.788 0.709

Changes in CFFO/OI (0.223) 1.641 (0.150) 2.223 3.036 Changes in CFFO/NOA 0.063 0.545 0.032 1.276 0.351 Total Accruals/Change in Sales

(3.721) (2.416) 0.457 1.056 0.791


Synopsys 2003 2004 2005 2006 2007 Asset Turnover (Sales/Assets)

0.510 0.522 0.463 0.508 0.463

Changes in CFFO/OI 2.009 2.956 (4.498) 6.995 3.672 Changes in CFFO/NOA 2.124 1.482 1.582 1.464 3.287 Total Accruals/Change in Sales

0.824 0.614 (0.964) (1.015) 1.042


90

Potential Red Flags Questionable accounting is always a concern when valuating a company’s

financial records. With any company, “red flags” must be raised when an analyst

finds distortions in the accounting records that might inflate or deflate the

company’s balance sheet. These distortions could lead investors to believing in

something other than the truth, and must be examined in further detail or

possibly restated. National Instruments is no exception, while performing a

thorough accounting analysis, three red flags were brought to light. The flags

were impairment of goodwill, expensing research and development costs, and

use of operating leases.

National Instruments has seen an increase of research and development

cost of 67% over the past four years, and has expensed these costs as they

were incurred every year, as is required by GAAP. This raised a flag because in

this type of industry companies compete on developing new products and must

spend large amounts of money in research to do so. When a company thrives

on research and development cost, an analyst must restate the balance sheet

with capitalizing the research and development cost, otherwise investors will see

overstated expenses which will lead to an understatement of net income. Taking

the research and development costs off the income statement and on to the

balance sheet, investors will now see a more accurate asset account and a

correctly stated net income amount for the past four years. In the case of

National Instruments, restating the balance sheet and showing a capitalized

research and development cost is exactly what will need to be done.

The second flag that was raised is the lack of impairment on goodwill.

While National Instruments has close to full disclosure of their financial records

they do lack disclosure of impairment on goodwill. Over the past five years

National Instruments has not declared any impairment of their goodwill.

Although they do state in the 10-K that impairment is tested on an annual basis,

an analyst must wonder if the company is not impairing goodwill to portray

91

themselves as a more profitable company to investors. Since National

Instruments has not impaired any amount of goodwill, they have overstated their

assets and understated their expenses. In conclusion, we are led to believe that

National Instruments has used this aggressive accounting style to overstate their

net income and therefore must be restated to accurately show the value of the

company.

The final red flag is the use of operating leases instead of capital leases.

National Instruments has chosen to use the operating lease, which is recorded as

an expense charge on the liabilities side of the balance sheet. While looking over

the balance sheet it is shown that operating leases are more than 15% of long

term liabilities and therefore needs to be restated. This is a red flag because

National Instruments is understating their liabilities by just expensing their lease

agreement as opposed to using a capital lease which would be structured much

like loan payment.

92

Undo Accounting Distortions

Undo Accounting Distortions

The final step of the accounting analysis is to undo the accounting

distortions that were found in the company’s financial statements. This process

is crucial during valuation because companies can make their statements look

better then what they truly are due to “flexible accounting strategies”. After

thoroughly looking over National Instruments 10-K, we found that not much

information is disclosed on the topic of goodwill. It does however, state that

while tested every year, no impairment was identified in the years of 2003

through 2007. This led us to restate the goodwill with impairment for the past

four years. We also believe that since this industry thrives on new and innovative

products, research and development costs should be capitalized instead of

expensed. Showing these costs on the balance sheet, as opposed to the income

statement, will cause a rise in the net income.

93

Goodwill

*NOTE: All number in this graph are quoted in thousands.

Although impairment of goodwill has been tested annually, National

Instruments has not declared any amount of impairment over the past five

years; therefore, we have restated the intangible asset. The above graph shows

a different look of goodwill with impairment, which shows an economic decrease

in value over a period of time

By amortizing the amount of goodwill at a rate of 20%, the same amount

used for research and development, we have lowered the percentage of total

assets that goodwill consumes. Showing the impairment of goodwill over the

years lets the investor clearly see a less inflated asset side of the balance sheet.

This is illustrated below. After impairment the overall effect on net income

would be a reduction. This is because National Instruments would have to debit

Impairment of Goodwill for 10,823,000 and credit Goodwill for 10,823,000, this is

94

an example for year 2007. Overall this would reduce Net Income for each of the

years that goodwill was impaired and would make investors less likely to invest

in the company.

By analyzing the information in the above table, the goodwill to total assets with

impairment is still fairly close, with a maximum difference of 1.7% in 2005.


For companies like National Instruments, high research and development

costs are vital to continue to make new and innovative products. However,

according to GAAP, all research and development costs must be expensed as

incurred because, “it is believed that the benefits associated with such outlays

are too uncertain” (Business Analysis & Valuation: Using Financial Statements).

Using this method causes expenses to be overstated and net income to be

understated. National Instruments does however record their software and

development costs an asset, which is in accordance to GAAP. Since research and

development plays such a large role in this industry, we will take it off the

income statement and add it to the total assets on the balance sheet.

Goodwill of Total Assets 2003 2004 2005 2006 2007

Restated Goodwill/Total Assets 1.80% 1.80% 6.90% 5.90% 5.30%Goodwill/Total Assets 2.30% 2.30% 8.60% 7.40% 6.60%

Research and Development Expense 2003 2004 2005 2006 2007

Research and Development Expense

70,896 84,692 87,841 113,095 126,515

Research and Development Depreciation Expense

14,179 16,938 17,568 22,619 25,303

95

By removing the research and development costs from the income

statement, one can see the benefit it has on the net income before and after.

When calculating the new net income, we did remove research and development

expenses but added back a 20% depreciation expense. This would be the

amortization charge, to the income statement. In every year you can see that

the net income more than doubles four out of the five years while expensing the

research and development cost as they are incurred. This can be credited to the

fact that National Instruments is dedicated to investing large amounts of money

into developing new and innovative products to keep itself competitive in the

industry.


National Instruments and most all of its competitors use operating leases

rather than capital leases. However, it is important to restate this issue in order

for the firm to be more beneficial in the long run. Rather than treating

contractual payments as an expense, as with an operating lease, it is imperative

that National Instruments treat these payments like a mortgage, which is the

case when using a capital lease. This will ensure a greater return in the long run

and a better outcome overall.

Beg Bal Int Payment Payment Ending Balance

40078450 3807452.75 10200000 33685902.75 33685902.75 3200160.761 9426000 27460063.51 27460063.51 2608706.034 6926000 23142769.54 23142769.54 2198563.107 4369000 20972332.65 20972332.65 1992371.602 2503000 20461704.25 20461704.25 1943861.904 1150000 21255566.16 21255566.16 2019278.785 1080000 22194844.94 22194844.94 2108510.27 1080000 23223355.21 23223355.21 2206218.745 1080000 24349573.96 24349573.96 2313209.526 1080000 25582783.48 25582783.48 2430364.431 1080000 26933147.91 26933147.91 2558649.052 1080000 28411796.97

96

Ending Balance Depreciation

Capital Lease OL-CL NINT

33685902.75 1603138 5410590.75 -4789409.25 -3113116.013 27460063.51 1603138 4803298.761 -4622701.239 -3004755.805 23142769.54 1603138 4211844.034 -2714155.966 -1764201.378 20972332.65 1603138 3801701.107 -567298.8932 -368744.2806 20461704.25 1603138 3595509.602 1092509.602 710131.2412 21255566.16 1603138 3546999.904 2396999.904 1558049.938 22194844.94 1603138 3622416.785 2542416.785 1652570.91 23223355.21 1603138 3711648.27 2631648.27 1710571.375 24349573.96 1603138 3809356.745 2729356.745 1774081.884 25582783.48 1603138 3916347.526 2836347.526 1843625.892 26933147.91 1603138 4033502.431 2953502.431 1919776.58 28411796.97 1603138 4161787.052 3081787.052 2003161.584

*NOTE: Second Spreadsheet is continuance of first.

The first step when transferring from an operating to a capital lease is to

record the lease as being capitalized rather than expensed. To properly adjust

for the initial recognition of the capital lease one would debit leased assets for

$40,078,450 and credit lease liabilities for $40,078,450. With interest rates as

they are currently a rate of 9.5% was assumed for the annual cost of debt.

Looking at the spreadsheet above the overall net income effect made it decrease

for the first 4 years with an overall increase the remaining years. Therefore,

National Instruments would be better off utilizing capital leases rather than

operating leases.

97

Financial Analysis, Forecasting Financials, and Cost of Capital

Estimation

In our analysis we have revealed what drives sales and revenues in a

firm; we have also studied accounting and financial principles to identify any

abnormalities in their financials. To continue our analysis we will go a step

further and study the operations of the firm. By analyzing ratio analysis, we will

be able to assess the liquidity, profitability, and capital structure of a firm. We

will do this by evaluating certain lines of the firm’s financial statements and

forecasting them out by using knowledge of previous years. Finally, with these

assessments we will calculate the firms cost of capital, cost of debt, and WACC,

to eventually value the firm.

Financial Analysis

The intent of performing a financial analysis is to evaluate and measure a

firm’s performance throughout time and against industry averages. “Growth and

value of a firm is dependent greatly on the product market and financial market

strategies” (Palepu Healy and Bernard). The firm’s strategies are measured via

financial ratios that can be weighed against competitors. These ratios are

beneficial to a firm, they can display a change in the firm’s strategy over time if

put in a time series and even help the firm forecast financial statements. These

ratios will also help to determine any “red flags” because of distortions in the

financial statements. The ratios that will help us analyze the firm can be divided

up into three sections: liquidity ratios, profitability ratios, and capital ratios.

98

Liquidity Ratios

The firm’s liquidity ratios exhibit how capable the firm is at meeting its

short term commitments. In other words, how quickly a firm can turn assets into

cash in order to cover their liabilities. The best scenario for the ratios is to have

the highest number possible; it means that the firm is more profitable and

efficient. The best ratios to assess a firm’s operating efficiency are: receivables

turnover, working capital turnover, and inventory turnover. Ratios that are also

measured are the quick ratio and current ratio, because they measure liquid

assets to short term obligations. If the results from the ratios are too low, the

firm could not have enough liquid assets to protect its commitments and if the

results are too high, the firm could be using its assets poorly. This could result

in a firm being denied by a bank for a future or current loan. It has been agreed

upon, the higher the liquidity ratio the better, because in most industries all

ratios assessed are usually strongly related.

Current Ratio

0.000

1.000

2.000

3.000

4.000

5.000

6.000

7.000

2003 2004 2005 2006 2007

Current Ratio


Agilent

Teradyne

Synopsys

Industry Average

Adjusted

99

This ratio is a liquidity ratio that illustrates correlation between the current

assets and current liabilities of the firm. The ratio is calculated by dividing

current assets by current liabilities, the answer we get is usually a good indicator

of the firm’s capability to pay off short term obligations whether it is in cash or

assets that can quickly be converted without losing value. The ideal current ratio

to have is one that is greater than or equal to one, it shows that the firm can

cover its duties with its current assets. National Instruments holds a ratio better

than one for the five years shown, it is also above the industry average for those

years also. Between the 2004 and 2006 it decreases somewhat from $4.745

million to $ 4.135 million in 2005 but climbs back up to 4.900 million in 2006.

This steady stream of cash over the five year period shows that National

Instruments is consistent through time and has a lot of room when it comes to a

margin of safety. The firm in our industry that has an average below the norm is

Synopsys. However, there ratio is consistently equal or above one so this will

probably not cause much of a problem for their company.

100

Quick Asset Ratio

When it comes to the quick asset ratio, or the “acid test ratio”, it works

hand in hand with the current ratio in determining a firm’s coverage of its current

obligations. The quick ratio differs from the current ratio by the removal of

inventory from the calculation, thus current assets-inventory/liabilities. The

reason in removing the inventory from the calculation is to see clearly the

measurement of liquidity; we do this because inventory may or may not be

converted into cash quickly without losing any value. When comparing both

charts, we see that the current asset chart is more in line and looks neater, as

the quick asset chart looks to be all over the place with lower values. Inventories

allow for more debt coverage for the firms. Without inventory adding value to

the, the ratios decreased somewhat, but National Instruments is still able to

cover its debt. Looking at the graph you can see that Agilent and Teradyne are

the top performers for our industry. However, all the firms have an average well

above 1 except for Synopsis. The performance by Synopsis in this graph was

0.000

0.500

1.000

1.500

2.000

2.500

3.000

3.500

4.000

2003 2004 2005 2006 2007

Quick Asset Ratio


Agilent

Teradyne

Synopsys

Industry Average

Adjusted

101

expected because they were a low performer in the Current Ratio as well.

Except for Synopsis all firms in our industry seem to be doing well, especially

National Instruments which does not have a liquidity issue.

Working Capital Turnover

The working capital turnover ratio is the tie between sales and working

capital. The working capital relationship exhibits how much this surplus asset

contributes to sales, and also its profitability. Working capital is more of a sales

effectiveness ratio centered on the amount of money invested in the firm. The

graph shows a steady trend with National Instruments and most of its

competitors. Synopsys is above the industry average. However, in 2006 with a

number of 46 it was so far above the mean that we threw the observation out

because it was an unnecessary outlier in our graph, therefore the result of 0 for

year 2006 was just from taking out that observation. National Instrument’s

Working Capital stays constant for the most part; it jumps from $1.660 million in

‐

1.000

2.000

3.000

4.000

5.000

6.000

7.000

8.000

2003 2004 2005 2006 2007



Agilent

Teradyne

Synopsys

Industry Average

Adjusted

102

2004 to $2.082 million in 2005 back down to $1.739 million in 2006. That is the

only jump within the five year span; it stays pretty constant for National

Instruments and most of its competitors. National Instruments had little or no

irregularities when it came to working capital, they performed along similarity

with most of the industry. Now when you look at the adjusted numbers they look

more like the rest of the industry and not as volatile as the non-adjusted

numbers.

103

Accounts Receivable Turnover

The accounts receivable turnover ratio compares total sales to accounts

receivables. It is simply a ratio to show how effective each firm is on collecting

debt or accounts receivable. The turnover ratio explains how many times a firm

collects on accounts receivable in a given year. The ideal ratio for this is high

because shows that the firm operates on cash or the credit policies are efficient

in collecting their accounts receivable. When the ratio is low a firm may need to

reassess credit policies to become more efficient on collecting debt. By analyzing

the graph you can see that the industry average ranges from about 6 to 8. This

is a good accounts receivable turnover for this industry. The data in the graph

shows that National Instruments straddles the industry average throughout the

five years shown. National Instruments would be more effective if the accounts

receivable ratio was high. It would be more efficient to receive cash from credit

sales quicker, but National Instruments collect credits at a constant rate over a

period of time. On this particular graph, the adjusted line did not vary from the

0.000

2.000

4.000

6.000

8.000

10.000

12.000

2003 2004 2005 2006 2007

Accounts Receivable Turnover


Agilent

Teradyne

Synopsys

Indsutry Average

104

original National Instruments observations because accounts receivable did not

change when we made adjustments to the financial statements.

Day Sales Outstanding

The Days Sales Outstanding ratio consists of how many days does it take

to collect on accounts receivables. The optimum ratio to get would be a low one;

this is because of time value of money. An analyst could also use this ratio to

calculate the cash to cash cycle in the future. When looking at this graph you can

see that most firm stay with the industry average which is about 60 days. Both

Agilent and Teradyne have outliers over each of these firms immediately went

back to the norm the following year. National Instruments performs right with

the industry average on this ratio. This could be caused by the length of time

National Instruments takes to convert their accounts receivables to cash. In

National Instruments case there is no alarm for the collection of their

receivables, they seem to be doing fine. On this particular graph, the adjusted

‐

10.000

20.000

30.000

40.000

50.000

60.000

70.000

80.000

90.000

100.000

2003 2004 2005 2006 2007

Days Sales Outstanding


Agilent

Teradyne

Synopsys

Industry Average

105

line did not vary from the original National Instruments observations because

accounts receivables did not change when we made adjustments to the financial

statements so the results from that observation do not appear on the graph.

Inventory Turnover

The Inventory Turnover ratio is cost of goods sold over inventory. This

ratio shows how many times a firm sells and replaces their inventory during a

given period. Inventory Turnover is closely connected to the account receivables

turnover ratio in that both measure efficiency and how often a line item is turned

over throughout the year. The higher the Inventory Turnover Ratio is, the

healthier an inventory is managed by a firm. If the turnover is low this shows

that the firm has low sales and will result in the firm having excess inventory.

When looking at the graph is shows that in recent years Teradyne has become

the industry leader. When it comes to this ratio, National Instruments is very

low, halfway out-performing the industry average and the other half below it.

‐

1.000

2.000

3.000

4.000

5.000

6.000

7.000

8.000

2003 2004 2005 2006 2007

Inventory Turnover


Agilent

Teradyne

Industry Average

106

This could be caused by the way National Instruments collects its sales or

manages its inventory. On this particular graph, the adjusted line was identical to

the original National Instruments line so it did not pertain.

Days Supply in Inventory

Days’ supply inventory is a financial ratio that measures how long it takes

to turn inventory into sales. When using this ratio the lower the better. This

means that it is a very short time between when inventory turns into sales. The

inventory is being used efficiently and effectively. However, when the firm has a

high days supply of inventory this can hurt the firm because it means that

inventory is just laying around and no cash is coming in, which hurts the “money

merry-go-round”. When there is no cash coming in the firm they must borrow

because the money must come from somewhere. This will have an overall

negative effect on the firm. National Instrument’s adjusted line has the highest

industry inventory turnover consistently throughout the five years. This could

mean that they had the lowest days supply in inventory. National Instruments’

‐

50.000

100.000

150.000

200.000

250.000

2003 2004 2005 2006 2007

Days Supply of Inventory


Agilent

Teradyne

Industry Average

107

adjusted line was the same as their original observations which were above the

industry average showing that they could possibly manage inventory efficiently,

hence helping them make a better cash to cash calculation.

Cash to Cash Cycle

The Cash to Cash cycle is composed of days supply in inventory and days

outstanding sales this is a measure of time and activity. It shows how the firm

starts with investing in inventory and finally collecting their accounts receivables.

In other words, how long it takes for cash to go in and out of the company.

Synopsys has the lowest industry average but this is because they operate on no

inventory which brings down the cash to cash cycle significantly. The rest of the

firms have higher results especially National Instruments. National Instruments

has had the highest cash to cash cycle. National Instrument’s cash to cash cycle

was 215.3 days, which mean is it takes 215.3 days to earn revenue back from

when the inventory was completed. This can in turn be very bad for the firm

0

50

100

150

200

250

300

2003 2004 2005 2006 2007

Cash to Cash Cycle


Agilent

Teradyne

Synopsys

Industry Average

108

because they are not operating in an efficient manner. In this graph, there is a

trend that seems to have equilibrium at about 160 days in 2005.

Conclusion

The first liquidity ratio that was calculated was the current ratio. The

results of this ratio showed that National Instruments outperformed its

competitors by obtaining a higher ratio. The ratio showed that for every $1 in

liabilities National Instruments maintained a dollar amount of assets anywhere

between 4 and 5. The adjusted ratios showed an even higher number of assets

being anywhere between 5 and 6 dollars. The competitor’s current ratios were all

lower than National Instruments which showed that they had a lower amount of

assets for every liability. The quick asset ratio describes how a firm covers its

current obligations. National Instruments seems to be performing at an average

level but is still well above one which shows that they are able to cover their

current obligations fine.

109

Ratio Performance Current Ratio Over-performed Quick Asset Ratio Average Working Capital Turnover Average Accounts Receivable Turnover Under-performed Days Sales Outstanding Under-performed Inventory Turnover Under-performed Days Supply of Inventory Under-performed Cash to Cash Cycle Under-performed

National Instruments performance when it comes to working capital

turnover is right on track with other companies which proves no inconsistencies.

The accounts receivable turnover ratio showed that National Instruments had

relatively low numbers over the years which means that they may not be as

efficient as its competitors in collecting accounts receivable. The day’s sales

outstanding ratio shows that National Instruments has a ratio that is a little bit

higher than the industry average but maintains a number anywhere between 60

and 70 days. The inventory turnover ratio is lower than its competitors while the

days supply of inventory as well as the cash to cash cycle ratios are much higher

than competitors, all of these show that the firm is underperforming compared to

competitors.

Profitability Ratio Analysis

Running the profitability analysis ratios is important to the firm because it

will compare the revenues and income to the amount of sales and expenses that

the company incurs over a period of time. While doing these ratios we have

compared the profits of our company to the profits our competitors from 2003

through 2007. The seven ratios we ran were gross profit margin, operating

110

profit margin, net profit margin, return on assets, return on equity, asset

turnover, and operating expense ratio.

Gross Profit Margin

To get the gross profit margin the firm’s gross profits is divided by the

total revenues for the given year. The firm’s gross profits are obtained from the

cost of goods sold from the net sales of the firm. This profitability ratio will

explain to investors how much of every dollar a firm keeps as earnings. Gross

profit margin is a good ratio to compare across the industry to see where a

particular company’s gross profits are compared to the competitors. National

Instruments has had great success in controlling their cost, in turn this has led to

a high gross profit margin. In this instance, National Instruments has stayed well

above the industry average and has declared a gross profit margin as high as

75% in the past year, only to be out-performed by Synopsys who hit as high as

80% in the past year.

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

2003 2004 2005 2006 2007

Gross Profit Margin

Agilent

Teradyne

Synopsys

Industry Average

Adjusted


111

Operating Profit Margin

To get the operating profit margin we divided the earnings before interest

and taxes by the sales for each given year. The purpose of this ratio is for the

firm to see at what percent the company stands comparing the operating profits

to the sales, and of course the bigger the percent the more efficient the

company. As you can see from the graph below National Instruments has

steadily outperformed the competitors through the years by not having any deep

peaks or spikes. If you look at the other three firms you will see each company

has had pretty deep spikes and peaks over the five year period. National

Instruments ability to maintain a constant high industry average shows their

ability to keep its fixed and variable costs fairly constant.

‐20.00%

‐10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

2003 2004 2005 2006 2007



Agilent

Teradyne

Synopsys

Industry Average

Adjusted

112

Net Profit Margin

Net Profit Margin is calculated by dividing the net income of the company

to the sales or total revenue for the given period. This ratio can be a critical one

because it involves the net income, often called the “bottom line” of the

company. This is important in the profitability analysis because it show the firm’s

true profits. When investors are evaluating a company they like to see a large

net income because it shows that after all expenses and taxes have been paid,

the firm ideally has a high amount of cash left over. From the graph you see that

National Instruments has kept up with the industry average from 2004 through

2007, while in 2003 they were ahead of the average. Agilent has shown a large

increase over the five years, this could be credited to the fact that Agilent has

been a more efficient company in the past four years. National Instruments

keeping up with the industry average can be seen as favorable, considering the

amount of research and development that has to be expensed annually. The

‐60.00%

‐40.00%

‐20.00%

0.00%

20.00%

40.00%

60.00%

80.00%

2003 2004 2005 2006 2007

Net Profit Margin


Agilent

Teradyne

Synopsys

Industry Average

Adjusted

113

adjusted line shows the restatement of research and development as an asset

rather than an expense. Clearly the net profit margin is higher than the average,

since the expenses are dramatically lower, the net income dramatically rises,

causing the net profit margin to rise.

Return on Assets

The return on asset can be found by taking the current year’s net income

divided by the previous year’s total assets. This ratio will show you how well the

management team is handling their assets and resources. National Instruments

has kept an upward trend for the past five years staying close to the industry. As

seen in the graph, National Instruments has outperformed Synopsys and

Teradyne every year as well as Agilent except in 2006.This is a good indicator

that National Instruments has a good way of managing their assets compared to

its competitors.

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

2003 2004 2005 2006 2007

Return on Assets


Agilent

Teradyne

Synopsys

Industry Average

Adjusted

114

Return on Equity

Return on equity is given by the net income of the current year divided by

the total amount of equity in the previous year. This ratio is also critical for a

potential investor to look at because it will let you know how well management is

doing for their current investors. This number computed is the amount money

compared to every one dollar that is invested into the company. National

Instruments has again kept up with the industry average and shows an upward

trend for the past five years, with its largest increase coming from 2004 to 2007.

The increase over the first year can be looked upon as normal because the

increase was industry wide but steady increase in following years was not

obtained across the industry.

-60.00%

-40.00%

-20.00%

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

2003 2004 2005 2006 2007

Return on Equity


Agilent

Teradyne

Synopsys

Industry Average

Adjusted

115

Asset Turnover

To obtain the asset turnover you have to divide the total revenue by the

amount of total assets for the given period. National instruments has

outperformed the industry in this ratio, this could be to the success they have

had in controlling their assets and the ability to generate sales from these assets.

The restated asset turnover is slightly decreased but still above the average. The

restated decrease comes from the large amount of research and development

we capitalized causing the total asset number to increase and lowering the

turnover amount.

-

0.200

0.400

0.600

0.800

1.000

1.200

2003 2004 2005 2006 2007

Asset Turnover


Agilent

Teradyne

Synopsys

Industry Average

Adjusted

116

Operating Expense Ratio

To achieve the operating expense ratio the firm will divide their operating

expenses; selling, general and administrative, by the net sales. This ratio

indicates what percentage the company spends on expenses to run the business.

In this case National Instruments has a consistent high operating expense ratio.

Over the five year period they have been able to slightly reduce this expense

ratio but have still remained the second highest ratio. Teradyne, over the five

year period, have been able to control their expenses and therefore have the

most favorable overall expense ratio staying well below the industry average.

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

2003 2004 2005 2006 2007



Agilent

Teradyne

Synopsys

Industry Average

Adjusted

117

Conclusion

After running the profitability ratios and comparing the numbers for

National Instruments and their competitors, we have concluded where National

Instruments stands in the industry. The company as shown their ability to keep

up with the industry average and maintain low cost with high profits. The first

ratio that was used in the Profitability ratio analysis was the gross profit margin

that explains how much profit is made from every dollar earned. In this case

National Instruments did extremely well, above industry average, showing they

have great success in controlling costs. The operating profit margin was

calculated to compare operating profits to sales, the bigger the percentage the

more efficient the firm. National Instruments kept constant throughout the years,

not like some of its counter partners with sharp spikes up and down, this meant

National Instruments had the ability to keep its fixed and variable costs stable.

The Net profit margin measures the true profits of the firm. National Instruments

stayed constant with this ratio and even going above the industry average in

2003. The adjusted line was well above the average due to the absence of

Research and development; clearly net profit margin would be higher than

before. National Instruments outperformed the industry average on return on

assets, Return on Equity, and Asset turnover Ratios. National Instruments

however, did not do as well with the Operating Expense Ratio. This ratio

measures how much a firm spends in order to run its business. National

Instruments was well above the industry average, even though they have been

gradually deceasing every year. Over the past five years National Instruments

has excelled past the competition and led the industry in operating profit margin,

asset turnover and gross profit margin. National Instrument’s net profit margin,

return on assets and equity did stay right with the average and never had any

dips or peaks. This shows that overall National Instruments has consistently

executed a good business strategy by controlling cost and assets while making a

good profit

118

Ratios Performance Gross Profit Margin Under-Performed Operating Profit Margin Average Net Profit Margin Average Return on Assets Average Return on Equity Average Asset Turnover Over-Performed Operating Expense Ratio Over-Performed

119

Capital Structure Analysis

Capital Structure analysis will show how well a company finances itself

and overall operations by using different sources of funds. The main purpose of

this analysis is to look over the liabilities and owner’s equity to find if the firm

acquires their assets through debt or equity. These ratios will let an investor

know of the company’s credit worthiness, their ability to pay of debt and financial

leverage the company has. The main ratio that we have examined was debt to

equity.

Debt to Equity

Debt to equity is computed by taking the total liabilities and dividing that

by the total equity. By calculating this simple ratio it is possible to see the

company’s ability to pay off debt with their equity, from our calculations it is

shown that National Instruments has the best overall debt to equity ratio. Having

0.000

0.200

0.400

0.600

0.800

1.000

1.200

1.400

1.600

2003 2004 2005 2006 2007

Debt to Equity


Agilent

Teradyne

Synopsys

Industry Average

Adjusted

120

a lower ratio lets current and potential investors know the company has done a

great job handling debt and as illustrated in the graph investors can see just

that. Obtaining such a low ratio has put National Instruments in great financial

position to acquire new assets and financing, as they have shown to be a small

credit risk and have a balanced capital structure. On the contrary, Agilent has

shown to be a most debt financed firm in 2003 and was able to change to an

equity financed through 2005 catching up to the industry average. From 2005 to

date, Agilent fell right back into a debt financed firm showing they could be a

credit risk with such large dips and spikes. Teradyne however showed the

greatest improvement in the industry going from a 0.88 in 2003 falling to a 0.27

in 2007. This type of improvement shows a complete change in capital structure

for the firm.

121

Times Interest Earned

The times interest earned is used to determine a firm’s capability to cover

its debt obligations. It is calculated by taking the firm’s earnings before interest

and taxes (EBIT) and dividing it by the interest expense. If a company’s ratio is

less than one this could lead to trouble for the firm and ultimately bankruptcy.

Since interest rates are ever changing it is hard for a company to predict future

interest expenses.


2003 2004 2005 2006 2007

National Instruments (650.79) (2,022.45)

Agilent (8.00)

(6.72)

(6.42)

Teradyne 8.45 (10.07) 5.23 (18.31)

(61.26)

Synopsys 4.70 52.80 5.31

Industry Average 6.57 21.37 0.85 (12.52)

(33.84)

Adjusted (2,555.61) (6,853.87)

(8,000.00)

(7,000.00)

(6,000.00)

(5,000.00)

(4,000.00)

(3,000.00)

(2,000.00)

(1,000.00)

‐

1,000.00

1 2 3 4 5



Agilent

Teradyne

Synopsys

Industry Average

Adjusted

122

As seen in the chart above, the technical and system software industry lacks

certain information that would allow us to accurately chart the times interest

earned ratio. The 10-Ks of National Instruments, Agilent, and Synopsys do not

include interest expenses in certain years which made it impossible for us to

come up with a justifiable graph.

Debt Service Margin

To properly calculate the debt service margin for the firm, you must take

the current cash flows from operations and divide it by the previous period’s

current portion of long term debt. This will show the firm’s ability to pay off their

debt using cash received from the day-to-day business. The value states that for

every one dollar in current long term debt, the expense will be covered by the

total amount of the ratio. We could not disclose any relevant graphs because the

only firm in this industry that had current notes payable was Teradyne. Preparing

a graph for this ratio would be irrelevant and give us information that would not

pertain to the industry as a whole.

Altman Z-Score

The Altman Z-Score is a way of comparing companies to determine the

probability of bankruptcy among different firms. The z-score is calculated by a

combination of five ratios which help to determine the likelihood that a company

will enter bankruptcy. A higher z-score is better and a lower rate raises the

chances of bankruptcy, therefore a higher z-score is preferred.

123

The graph above shows the Z-scores of the firms of the Technical and

System Software Industry. According to the graph, it can be seen that National

Instruments has the highest z-score, which is definitely an advantage. It proves

that National Instrument’s competitors have a much higher risk of bankruptcy

than National Instruments. The grey area is between 1 and 3. Anything above 3

shows that the threat of bankruptcy is unlikely. According to the graph, only

Agilent and Synopsys are located in the grey area while Teradyne and National

Instruments are located way above the grey area.

Firm Growth Rate

Growth rates are an important part of a company’s valuation as they can

help to forecast the future aspects of a company’s growth. It is important to

analyze the rates to understand where the company stands within the industry

when forecasted into the future. Internal Growth Rate and the Sustainable

Growth Rate are the two rates we use to analyze the future.

0.000

1.000

2.000

3.000

4.000

5.000

6.000

7.000

8.000

2003 2004 2005 2006 2007

Altman Z‐Score


Agilent

Teradyne

Synopsys

Industry Average

Adjusted

124

IGR

The internal growth rate of a company provides a valuable basis for

determining how much growth a company is capable of attaining without

external sources of funding. In order to calculate this value, one must utilize the

internal growth rate formula. This equation is defined as: Return on Assets * (1-

Dividends/Net Income). Dividends/Net Income can further be described as the

payout ratio. In order to start the calculation of National Instruments IGR, it was

necessary to attain the amount of return on assets. ROA was calculated by

taking Net Income of the current year divided by total assets of the previous

year. Once these were calculated, the next step was to determine the amount of

dividends and net income that was calculated for the current year. Dividends

were attained by information provided by the Statement of Cash Flows and the

net income amounts were found on the Income Statement included in the 10-K

of National Instruments. With the gathering of all these calculations, the total

amount of IGR was found. National Instruments was the only firm in our industry

‐0.300

‐0.200

‐0.100

0.000

0.100

0.200

0.300

0.400

0.500

0.600

2003 2004 2005 2006 2007

Internal Growth Rate


Agilent

Teradyne

Synopsys

Industry Average

National Instruments Adjusted

125

that produced dividends. Our competitors, Agilent, Teradyne, and Synopsys 10-

K’s all claimed that they did not give out dividends for the year.

SGR

Another important growth formula is the sustainable growth rate. This

rate defines the maximum rate of growth that a company can handle without the

addition of extra leverage. In order to achieve this number, we obtain figures

that are included in the formula which is defined as: ROE*(1-Dividends/Net

Income). ROE was calculated by taking Net Income of the current year and

dividing it by total equity from the previous year. The next step is to acquire

dividends from the current year which is derived from the Statement of Cash

Flows and attain net income which is provided on the Income Statement (both

financials were found in National Instruments 10-K). The above information

‐0.600

‐0.400

‐0.200

0.000

0.200

0.400

0.600

0.800

1.000

2003 2004 2005 2006 2007

Sustainable Growth Rate


Agilent

Teradyne

Synopsys

Industry Average


126

allowed us to calculate the quantity of SGR. Once again, since our competitors

do not claim dividends.

Financial Statement Forecasting

In order to value a company in the future, one must look at the past.

However, it is important to differentiate between useful information and non-

useful information. In order to do this, one must put his/her analytical skills to

good use. When looking at past information, it is crucial to determine which

numbers and averages can be used to forecast the future. This involves

researching the 10-K and relevant company information to determine ups and

downs the company may have incurred in the past. With this information, it

becomes possible to clarify which numbers can indeed be used to forecast the

future, and which numbers are skewed. Skewed numbers are looked at more

deeply and an assumed number is formed.

Although a company may only need to forecast one of the financial

statements, it is more beneficial to forecast them all, seeing as they are all

linked. This includes forecasting the income statement, balance sheet, statement

of cash flows, as well as creating a separate section for ratios. This creates a

clearer picture of the firm’s future performance and is a helpful tool for

companies. Common size statements are also created to ensure accuracy and

dependability.

127

Income Statement

The first step in forecasting is looking at past years of the income

statement and determining which ledgers can be forecasted into the future. It is

necessary to determine averages of each account and then determine if these

numbers can be used to forecast the future, or if an assumption must be made

due to certain circumstances that occurred throughout past years. We used

information obtained from National Instruments 10-K from the past six years,

2002-2007 as well as current 10-Q’s from 2008. With this information, we came

up with certain averages and assumptions that could be used to predict future

information for the next ten years. These averages were looked at in depth to

decipher which were actually usable and which could be seen as causing a

problem for future forecasting, meaning they should not be used. After

researching this information, we determined that we could successfully forecast

net sales, cost of goods sold, operating expenses, and taxes.

The first item on the Income Statement is Net Sales, which can be looked

upon as the most imperative piece in determining future earnings. When looking

at past years sales growth for National Instruments, we found that the growth

increased from 2002-2003 significantly, going from 9% in 2002 to 20.7% in

2003. The percentage dropped off in 2004, declining to a percentage of 11.2%.

2005 led to a 4.3% increase in sales growth followed by another decline in 2006.

There appeared to be slight growth in 2007, ending at 13.7%. Because the sales

growth of National Instruments appears to differ significantly over the years and

the addition of the recent downturn in the economy, we were conservative in our

projections for the future. We forecasted that sales for 2008 would actually drop

to 7%.

We assumed this rate of 7% based on past evidence that was reflected in

sales growth after the 2001 event of September 11th. The sales growth from

2000-2001 resulted in a percentage of 9.3 but we figured that this recent

128

recession would affect the economy more than that of 9/11. We looked at the

years following 9/11 and determined that the economy will indeed pick up. In

2009, we predicted a slight increase in sales growth, 7.5%. We decided on this

number simply due to the fact that we foresee that this downturn will pick up

slightly in 2009. We continued by increasing sales growth in 2010 seeing as we

envision this recession lasting only two years, which would lead to its end in

2010. From there, we predicted steady growth for the remaining years 2011 to

2017, eventually ending at a rate of 17%.

In order to end up with a reliable number for gross profit, cost of goods

sold must also be forecasted. When looking at the cost of goods sold average

established through the numbers of the past six years, we came up with a

percentage of 26. This number seemed relatively high, so ultimately we

concluded that we would use a 24% rate. This seemed more reasonable to us

considering the recession, which results in less sales and eventually leads to a

decrease in cost of goods sold. Gross profit was then calculated by simply taking

net sales and subtracting cost of goods sold.

The next item we were able to forecast was operating expenses. In order

to come up with an accurate prediction, we had to look at each line item and

determine how the recession would affect these. The first item under operating

expenses is sales and marketing; although we came up with an average of

36.7% over the past six years, we determined that an assumed rate of 34%

would be more precise considering the economic slump. Next, we had to come

up with an average for research and development. Even with the looming

recession, we determined that research and development costs would not be

affected since they are such a big aspect of the success of National Instruments.

We decided that an average from the past six years would be appropriate when

forecasting the future research and development expenses National Instruments

will incur. The final item under operating expenses is general and administrative

expenses. As with sales and marketing, we determined that the average rate

129

gotten from the past six years was too high. We decided to assume a rate of

8.7% rather than 9.1%, figuring that this would more accurately depict general

and administrative expenses in the upcoming years.

We were able to forecast taxes by assuming a steady rate of 6% as

mentioned in National Instruments 10-K. National Instruments states that their

“effective tax rate is lower than the U.S. federal statutory rate of 35% primarily

as a result of the research and development tax credit, tax-exempt interest and

reduced tax rates in certain foreign jurisdictions” (National Instruments 10-K).

We assumed that taxes would remain steady over the next ten years and were

able to forecast provision for income taxes by using this specified rate.

Ultimately, this led to an overall assumption of Net Income for the next 10 years.

We were able to take income before taxes and subtract out the taxes we

predicted to come up with a final portrayal of net income.

130

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Nationa

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20.7%

11.2%

15.5%

12.1%

13.7%

Actua

l Finan

cial Statemen

tsForecasted

Finan

cial Statemen

ts

Actua

l Finan

cial Statemen

tsForecasted

Finan

cial Statemen

ts

131

Natio

nal Instrum

ents

Adju

sted

Inco

me S

tate

men

t20

0220

0320

0420

0520

0620

0720

0820

0920

1020

1120

1220

1320

1420

1520

1620

17

Net s

ales

390,

790

$

42

5,89

2$

51

4,08

8$

57

1,84

1$

66

0,40

7$

740,

378

$

79

2,20

4.46

$

851,

619.

79$

92

8,26

5.58

$

1,

030,

374.

79$

1,

148,

867.

89$

1,

298,

220.

72$

1,

500,

743.

15$

1,

737,

860.

56$

2,

015,

918.

26$

2,

358,

624.

36$

Co

st of

sales

105,

086

111,

672

135,

473

149,

309

170,

326

182,

189

190,

129.

07$

20

4,38

8.75

$

222,

783.

74$

247,

289.

95$

275,

728.

29$

311,

572.

97$

360,

178.

36$

417,

086.

54$

483,

820.

38$

566,

069.

85$

Gros

s pro

fit28

5,70

431

4,22

037

8,61

542

2,53

249

0,08

155

8,18

960

2,075.39

$

647,23

1.04

$

705,48

1.84

$

783,08

4.84

$

873,13

9.60

$

986,64

7.74

$

1,14

0,564.79

$

1,32

0,77

4.03

$

1,532,09

7.87

$

1,79

2,55

4.51

$

Oper

ating

exp

ense

s:Sa

les a

nd m

arke

ting

145,

671

160,

478

188,

727

211,

280

235,

072

267,

138

269,349.52

$

289,55

0.73

$

315,61

0.30

$

350,32

7.43

$

390,61

5.08

$

441,39

5.04

$

510,252.67

$

590,87

2.59

$

685,41

2.21

$

801,93

2.28

$

Gene

ral a

nd A

dmini

strat

ive35

,714

42,4

9742

,500

45,1

9954

,192

62,4

4568

,525

.69

$

73,665

.11

$

80,294

.97

$

89,127

.42

$

99,377

.07

$

112,29

6.09

$

129,814.28

$

150,32

4.94

$

174,37

6.93

$

204,02

1.01

$

Rese

arch

and

Dev

elopm

ent A

mor

tizat

ion E

xpen

se14

,179

16,9

3817

,568

22,6

1925

,303

26,221

.97

$

28,188

.62

$

30,725

.59

$

34,105

.41

$

38,027

.53

$

42,971.11

$

49,674

.60

$

57,523

.18

$

66,726

.89

$

78,070

.47

$

Good

will A

mor

tizat

ion e

xpen

se0

9,51

42,

672

10,5

0610

,669

10,8

2310

,377

.88

$

11,156

.22

$

12,160

.28

$

13,497

.91

$

15,050

.17

$

17,006.69

$

19,659

.74

$

22,765

.97

$

26,408

.53

$

30,897

.98

$

Tota

l ope

ratin

g ex

pens

es11

7,42

115

5,77

216

6,14

519

6,71

220

9,45

723

9,19

430

5,949.36

$

328,89

5.56

$

358,49

6.17

$

397,93

0.74

$

443,69

2.78

$

501,37

2.84

$

579,587.00

$

671,16

1.75

$

778,54

7.63

$

910,90

0.73

$

Oper

ating

inco

me

168,

283

158,

448

212,

470

225,

820

280,

624

318,

995

296,126.03

$

318,33

5.48

$

346,98

5.67

$

385,15

4.10

$

429,44

6.82

$

485,27

4.90

$

560,977.79

$

649,61

2.28

$

753,55

0.24

$

881,65

3.79

$

Othe

r inc

ome

(exp

ense

):In

tere

st inc

ome

3,29

52,

511

2,90

53,

758

6,84

79,

822

6,654.52

$

7,15

3.61

$

7,79

7.43

$

8,65

5.15

$

9,65

0.49

$

10,905.05

$

12,606

.24

$

14,598

.03

$

16,933

.71

$

19,812

.44

$

Inte

rest

expe

nse

(128

)(6

2)(3

1)Ne

t for

eign

exch

ange

gain

(los

s)(7

24)

1,12

51,

287

(1,5

66)

740

1,67

2Ot

her i

ncom

e (e

xpen

se),

net

820

568

(2,0

44)

276

(7)

(158

)

Inco

me

befo

re in

com

e ta

xes

171,

546

162,

590

214,

587

228,

288

288,

204

330,

331

302,780.54

$

325,48

9.09

$

354,78

3.10

$

393,80

9.24

$

439,09

7.31

$

496,17

9.96

$

573,584.03

$

664,21

0.31

$

770,48

3.96

$

901,46

6.23

$

Prov

ision

for i

ncom

e ta

xes

12,2

1311

,123

16,2

0319

,163

22,5

946,

394

18,166

.83

$

19,529

.35

$

21,286

.99

$

23,628

.55

$

26,345

.84

$

29,770.80

$

34,415

.04

$

39,852

.62

$

46,229

.04

$

54,087

.97

$

Net in

com

e15

9,33

3$

151,

467

$

198,

384

$

209,

125

$

265,

610

$

32

3,93

7$

284,613.71

$

305,95

9.74

$

333,49

6.12

$

370,18

0.69

$

412,75

1.47

$

466,40

9.16

$

539,168.99

$

624,35

7.69

$

724,25

4.92

$

847,37

8.26

$

Natio

nal Instrum

ents

Adju

sted

Inco

me S

tate

men

t (Co

mm

on S

ize)

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Net s

ales

100.

00%

100.

00%

100.

00%

100.

00%

100.

00%

100.

00%

100.00

%100.00

%100.00

%100.00

%100.00

%100.00

%10

0.00

%10

0.00%

100.00

%100.00

%Co

st of

sales

26.8

9%26

.22%

26.3

5%26

.11%

25.7

9%24

.61%

24.00%

24.00%

24.00%

24.00%

24.00%

24.00%

24.00%

24.00%

24.00%

24.00%

Gros

s pro

fit73

.11%

73.7

8%73

.65%

73.8

9%74

.21%

75.3

9%76

.00%

76.00%

76.00%

76.00%

76.00%

76.00%

76.00%

76.00%

76.00%

76.00%

Oper

ating

exp

ense

s:Sa

les a

nd m

arke

ting

37.2

8%37

.68%

36.7

1%36

.95%

35.6

0%36

.08%

34.00%

34.00%

34.00%

34.00%

34.00%

34.00%

34.00%

34.00%

34.00%

34.00%

Gene

ral a

nd a

dmini

strat

ive9.

14%

9.98

%8.

27%

7.90

%8.

21%

8.43

%8.65

%8.65

%8.65

%8.65

%8.65

%8.65

%8.65

%8.65%

8.65

%8.65

%Re

sear

ch a

nd D

evelo

pmen

t Am

ortiz

ation

Exp

ense

0.00

%3.

33%

3.29

%3.

07%

3.43

%3.

42%

3.31

%3.31

%3.31

%3.31

%3.31

%3.31

%3.31

%3.31%

3.31

%3.31

%Go

odwi

ll Am

ortiz

ation

exp

ense

0.00

%2.

23%

0.52

%1.

84%

1.62

%1.

46%

1.31

%1.31

%1.31

%1.31

%1.31

%1.31

%1.31

%1.31%

1.31

%1.31

%

Tota

l ope

ratin

g ex

pens

es30

.05%

36.5

8%32

.32%

34.4

0%31

.72%

32.3

1%38

.62%

38.62%

38.62%

38.62%

38.62%

38.62%

38.62%

38.62%

38.62%

38.62%

Oper

ating

inco

me

43.0

6%37

.20%

41.3

3%39

.49%

42.4

9%43

.09%

37.38%

37.38%

37.38%

37.38%

37.38%

37.38%

37.38%

37.38%

37.38%

37.38%

Othe

r inc

ome

(exp

ense

):In

tere

st inc

ome

0.84

%0.

59%

0.57

%0.

66%

1.04

%1.

33%

0.84

%0.84

%0.84

%0.84

%0.84

%0.84

%0.84

%0.84%

0.84

%0.84

%In

tere

st ex

pens

eNe

t for

eign

exch

ange

gain

(los

s)Ot

her i

ncom

e (e

xpen

se),

net

Inco

me

befo

re in

com

e ta

xes

43.9

0%38

.18%

41.7

4%39

.92%

43.6

4%44

.62%

38.22%

38.22%

38.22%

38.22%

38.22%

38.22%

38.22%

38.22%

38.22%

38.22%

Prov

ision

for i

ncom

e ta

xes

3.13

%2.

61%

3.15

%3.

35%

3.42

%0.

86%

2.29

%2.29

%2.29

%2.29

%2.29

%2.29

%2.29

%2.29%

2.29

%2.29

%Ne

t inco

me

40.7

7%35

.56%

38.5

9%36

.57%

40.2

2%43

.75%

35.93%

35.93%

35.93%

35.93%

35.93%

35.93%

35.93%

35.93%

35.93%

35.93%

Actual Fina

ncial Statemen

tsForecasted

Fina

ncial Statemen

ts

Actual Fina

ncial Statemen

tsForecasted

Fina

ncial Statemen

ts

132

Balance Sheet

In order to forecast the balance sheet, it is necessary to create a

spreadsheet of ratios, which help to identify past percentages. These ratios in

turn assist in forecasting future items included on the balance sheet. Along with

these ratios, researching the past history of National Instruments and its

competitors provides vital information that is helpful in establishing future trends.

We also established a common size balance sheet, which we included below to

help outlay the total percentage each line item accounts for in relation to either

total assets or total liabilities and stockholders’ equity. National Instruments

10K’s and 10Q’s were imperative when forecasting the balance sheet.

First on our list to forecast when it comes to the balance sheet are assets.

We determined that using the accounts receivable turnover ratio average from

the past six years would help us develop an amount for accounts receivable for

the next ten years. Then, we used the inventory turnover ratio average to get an

average amount of inventory. In order to attain total current assets, we used a

percentage of 63.9. This in turn developed a total amount for current assets. In

order to get total assets, we used our asset turnover ratio average, which

equated to 1. With this number we were able to forecast future total assets by

taking our net sales and dividing it by this asset turnover ratio. Since we came

up with an amount of total assets and an amount for total current assets, we

were able to subtract total current assets from total assets to come up with an

exact amount for total noncurrent assets.

After forecasting assets, we were faced with the task of determining the

future amounts of stockholders equity. The first step was to establish an amount

for retained earnings. This was found by taking the ending balance from retained

earnings from the prior year, or the beginning balance of the current year,

adding net income from the current year and subtracting dividends from the

current year. In 2008, we started by taking our ending balance of retained

earnings from 2007 and then adding net income that we forecast for 2008

133

followed by subtracting the amount of dividends we forecasted for 2008 that we

included in our statement of cash flows. Dividends were found by figuring out a

proper dividend growth rate, which was developed using the increases of

dividends in previous years. This growth rate was then translated into each of

the next ten years in order to determine the proper amount of dividends being

shelled out each year. In order to get the total amount of shareholders equity,

we used the equation: Ending Balance of Shareholder’s Equity from the previous

year (aka beginning balance of the current year) + Net Income from the current

year – Dividends Paid. We continued this equation into each of the next ten

years, which gave us a vision of the total amount of shareholders equity National

Instruments will sustain in the upcoming years.

In order to forecast the last item on the balance sheet, liabilities, it was

necessary to look at the current ratio as well as assets and shareholders’ equity.

In order to determine the future amounts of current liabilities, we used the

current ratio average, 4.5. We set this number equal to the amount of current

assets divided by current liabilities. Since we had already forecasted the amount

of current assets, it was simple to come up with a value for current liabilities.

Since the value of total forecasted shareholders equity is more critical than the

value of total forecasted liabilities, the value of total liabilities was established by

subtracting forecasted total shareholders’ equity from forecasted total assets.

134

Natio

nal I

nstru

men

ts B

alan

ce S

heet

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Asse

ts

Curre

nt as

sets

:Ca

sh an

d cas

h equ

ivalen

ts40

,240

$

53

,446

$

76,21

6$

55

,864

$

100,2

87$

194,8

39$

Shor

t-ter

m inv

estm

ents

113,6

3814

1,227

150,3

9211

9,846

150,1

9093

,838

Acco

unts

rece

ivable

, net

62,98

177

,970

87,31

295

,733

117,2

3513

1,282

138,4

97.28

$ 14

8,884

.58$

16

2,284

.19$

18

0,135

.45$

20

0,851

.03$

22

6,961

.66$

26

2,367

.68$

30

3,821

.78$

35

2,433

.26$

412,3

46.92

$

In

vent

ories

, net

39,24

738

,813

54,04

362

,827

77,13

882

,675

78,24

2.42

$

84,11

0.60

$

91

,680.5

5$

101,7

65.41

$

113,4

68.43

$

128,2

19.33

$

148,2

21.55

$

171,6

40.55

$

199,1

03.04

$

23

2,950

.55$

Prep

aid ex

pens

es an

d oth

er cu

rrent

asse

ts13

,756

9,742

10,25

313

,146

11,39

323

,312

Defer

red i

ncom

e tax

es, n

et8,1

049,9

2714

,088

14,89

020

,851

19,26

4

Tota

l cur

rent

asse

ts27

7,966

331,1

2539

2,304

362,3

0647

7,094

545,2

1050

6,060

.21$

544,0

14.72

$

592,9

76.05

$

658,2

03.42

$

733,8

96.81

$

829,3

03.39

$

958,6

74.72

$

1,110

,145.3

3$

1,2

87,76

8.58

$

1,506

,689.2

4$

Pr

oper

ty an

d equ

ipmen

t, ne

t15

2,133

151,6

1214

9,783

144,3

3014

5,425

151,4

6218

7,859

.72$

201,9

49.20

$

220,1

24.63

$

244,3

38.34

$

272,4

37.25

$

307,8

54.09

$

355,8

79.33

$

412,1

08.27

$

478,0

45.59

$

55

9,313

.34$

Good

will,

net

11,89

313

,356

52,53

353

,343

54,11

1In

tangib

le as

sets,

net

28,61

542

,414

20,82

443

,602

40,06

540

,357

Othe

r lon

g-ter

m as

sets

6,148

5,565

5,293

27,67

2

Tota

l Non

Cur

rent

Ass

ets

180,7

4819

4,026

190,1

1124

6,030

244,1

2627

3,602

286,1

44.25

$ 30

7,605

.07$

33

5,289

.53$

37

2,171

.37$

41

4,971

.08$

46

8,917

.32$

54

2,068

.42$

62

7,715

.24$

72

8,149

.67$

851,9

35.12

$

Tota

l ass

ets

458,7

14$

52

5,151

$

582,4

15$

608,3

36$

721,2

20$

818,8

12$

792,2

04.46

$ 85

1,619

.79$

92

8,265

.58$

1,0

30,37

4.79

$

1,148

,867.8

9$

1,2

98,22

0.72

$

1,500

,743.1

5$

1,7

37,86

0.56

$

2,015

,918.2

6$

2,3

58,62

4.36

$

Liabi

lities

and

Stoc

khol

ders

' Equ

ity

Curre

nt lia

bilitie

s:Ac

coun

ts pa

yable

25,57

8$

29,56

7$

25

,208

$

30,83

2$

32

,001

$

36,18

7$

Ac

crued

comp

ensa

tion

9,555

12,30

216

,233

18,08

420

,912

25,77

8De

ferre

d rev

enue

11,53

316

,018

22,20

836

,091

Accru

ed ex

pens

es an

d oth

er lia

bilitie

s13

,507

24,41

918

,769

8,838

10,71

310

,437

Inco

me ta

xes p

ayab

le....

......

......

......

......

....

6,153

-

Ot

her t

axes

paya

ble11

,720

9,507

10,92

613

,848

11,52

716

,843

Total

curre

nt lia

bilitie

s66

,513

75,79

582

,669

87,62

097

,361

125,3

3611

2,457

.82$

120,8

92.16

$

131,7

72.46

$

146,2

67.43

$

163,0

88.18

$

184,2

89.64

$

213,0

38.83

$

246,6

98.96

$

286,1

70.80

$

33

4,819

.83$

Defer

red i

ncom

e tax

es5,7

389,9

0413

,297

16,86

620

,472

21,22

1Ot

her l

ong-

term

liabil

ities

6,801

11,16

9To

tal N

on-cu

rrent

Liabil

ities

Tota

l liab

ilities

72,25

185

,699

95,96

610

4,486

124,6

3415

7,726

37,50

4.98

$

(535

.56)

$

(29,1

82.98

)$

(43,7

40.99

)$

(55,3

31.84

)$

(53,7

50.47

)$

(24,4

18.63

)$

9,376

.39$

48

,350.5

9$

106,9

27.91

$

Comm

itmen

ts an

d con

tinge

ncies

-

-

St

ockh

older

s' eq

uity:

Prefe

rred s

tock:

par v

alue $

0.01;

5,00

0,000

shar

es au

thor

ized;

none

issu

ed an

d out

stand

ing-

-

Co

mmon

stoc

k: pa

r valu

e $0.0

1; 18

0,000

,000 s

hare

s aut

horiz

ed;

79,40

5,359

and 7

9,883

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hare

s iss

ued a

nd ou

tstan

ding,

799

794

Comm

on st

ock:

par v

alue $

0.01;

180,0

00,00

0 51

152

2au

thoriz

ed;

79,27

6,086

and 7

8,945

,580 s

hare

s iss

ued a

ndou

tstan

ding,

resp

ectiv

ely78

979

3Ad

dition

al pa

id-in

capit

al72

,063

95,33

198

,897

91,43

010

9,851

89,80

9De

ferre

d stoc

k-bas

ed co

mpen

satio

n(1

6,547

)Re

taine

d ear

nings

321,8

1334

9,994

384,1

1842

9,859

483,4

3756

3,418

657,0

31.48

$ 75

4,487

.36$

85

9,780

.55$

97

6,447

.78$

1,1

06,53

1.73

$

1,254

,303.1

9$

1,4

27,49

3.78

$

1,630

,816.1

7$

1,8

69,89

9.66

$

2,154

,028.4

5$

Ac

cumu

lated

othe

r com

preh

ensiv

e inc

ome

(7,92

4)(6

,395)

2,645

(1,68

5)2,4

997,0

65

Tota

l sto

ckho

lder

s' eq

uity

386,4

6343

9,452

486,4

4950

3,850

596,5

8666

1,086

754,6

99.48

$ 85

2,155

.36$

95

7,448

.55$

1,0

74,11

5.78

$

1,204

,199.7

3$

1,3

51,97

1.19

$

1,525

,161.7

8$

1,7

28,48

4.17

$

1,967

,567.6

6$

2,2

51,69

6.45

$

Tota

l liab

ilities

and

stoc

khol

ders

' equ

ity45

8,714

$

525,1

51$

58

2,415

$ 60

8,336

$ 72

1,220

$ 81

8,812

$ 79

2,204

$

85

1,620

$

928,2

66$

1,0

30,37

5$

1,148

,868

$

1,2

98,22

1$

1,500

,743

$

1,7

37,86

1$

2,015

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$

2,3

58,62

4$

Actu

al Fi

nanc

ial S

tate

men

tsFo

reca

sted

Fina

ncial

Sta

tem

ents

135

Natio

nal I

nstr

umen

ts B

alan

ce S

heet

(Com

mon

Siz

e)20

0220

0320

0420

0520

0620

0720

0820

0920

1020

1120

1220

1320

1420

1520

1620

17

Curr

ent a

sset

s:Ca

sh a

nd ca

sh e

quiva

lents

8.77

%10

.18%

13.0

9%9.

18%

13.9

1%23

.80%

Shor

t-ter

m in

vestm

ents

24.7

7%26

.89%

25.8

2%19

.70%

20.8

2%11

.46%

Acco

unts

rece

ivable

, net

13.7

3%14

.85%

14.9

9%15

.74%

16.2

6%16

.03%

17.4

8%17

.48%

17.4

8%17

.48%

17.4

8%17

.48%

17.4

8%17

.48%

17.4

8%17

.48%

Inve

ntor

ies, n

et8.

56%

7.39

%9.

28%

10.3

3%10

.70%

10.1

0%9.

88%

9.88

%9.

88%

9.88

%9.

88%

9.88

%9.

88%

9.88

%9.

88%

9.88

%Pr

epaid

exp

ense

s and

oth

er cu

rrent

ass

ets

3.00

%1.

86%

1.76

%2.

16%

1.58

%2.

85%

Defe

rred

incom

e ta

xes,

net

1.77

%1.

89%

2.42

%2.

45%

2.89

%2.

35%

Tota

l cur

rent

ass

ets

60.6

0%63

.05%

67.3

6%59

.56%

66.1

5%66

.59%

63.8

8%63

.88%

63.8

8%63

.88%

63.8

8%63

.88%

63.8

8%63

.88%

63.8

8%63

.88%

Prop

erty

and

equ

ipmen

t, ne

t33

.17%

28.8

7%25

.72%

23.7

3%20

.16%

18.5

0%Go

odwi

ll, ne

t2.

29%

8.64

%7.

40%

6.61

%In

tang

ible

asse

ts, n

et6.

24%

8.08

%3.

58%

7.17

%5.

56%

4.93

%Ot

her l

ong-

term

ass

ets

1.06

%0.

91%

0.73

%3.

38%

Tota

l Non

curr

ent A

sset

s39

.40%

36.9

5%32

.64%

40.4

4%33

.85%

33.4

1%36

.12%

36.1

2%36

.12%

36.1

2%36

.12%

36.1

2%36

.12%

36.1

2%36

.12%

36.1

2%

Tota

l Ass

ets

100.

00%

100.

00%

100.

00%

100.

00%

100.

00%

100.

00%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

Liab

ilitie

s and

Sto

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lder

s' Eq

uity

Curre

nt lia

bilitie

s:Ac

coun

ts pa

yable

5.58

%5.

63%

4.33

%5.

07%

4.44

%4.

42%

Accr

ued

com

pens

ation

2.08

%2.

34%

2.79

%2.

97%

2.90

%3.

15%

Defe

rred

reve

nue

1.98

%2.

63%

3.08

%4.

41%

Accr

ued

expe

nses

and

oth

er lia

bilitie

s2.

94%

4.65

%3.

22%

1.45

%1.

49%

1.27

%In

com

e ta

xes p

ayab

le....

......

......

......

......

....

1.34

%Ot

her t

axes

pay

able

2.55

%1.

81%

1.88

%2.

28%

1.60

%2.

06%

Tota

l cur

rent

liabil

ities

14.5

0%14

.43%

14.1

9%14

.40%

13.5

0%15

.31%

14.2

0%14

.20%

14.2

0%14

.20%

14.2

0%14

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14.2

0%14

.20%

14.2

0%14

.20%

Defe

rred

incom

e ta

xes

1.25

%1.

89%

2.28

%2.

77%

2.84

%2.

59%

Othe

r lon

g-te

rm lia

bilitie

s

Tota

l lia

bilit

ies

15.7

5%16

.32%

16.4

8%17

.18%

17.2

8%19

.26%

4.73

%-0

.06%

-3.1

4%-4

.25%

-4.8

2%-4

.14%

-1.6

3%0.

54%

2.40

%4.

53%

Com

mitm

ents

and

cont

ingen

cies

Stoc

khold

ers'

equit

y:Pr

efer

red

stock

: par

valu

e $0

.01;

5,0

00,0

00 sh

ares

aut

horiz

ed;

none

issu

ed a

nd o

utsta

nding

Com

mon

stoc

k: p

ar v

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$0.0

1; 1

80,0

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00 sh

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aut

horiz

ed;

79,4

05,3

59 a

nd 7

9,88

3,83

7 sh

ares

issu

ed a

nd o

utsta

nding

,0.

11%

0.10

%Co

mm

on st

ock:

par

valu

e $0

.01;

180

,000

,000

0.

11%

0.10

%au

thor

ized;

79,2

76,0

86 a

nd 7

8,94

5,58

0 sh

ares

issu

ed a

ndou

tstan

ding,

resp

ectiv

ely0.

14%

0.13

%Ad

dition

al pa

id-in

capit

al15

.71%

18.1

5%16

.98%

15.0

3%15

.23%

10.9

7%De

ferre

d sto

ck-b

ased

com

pens

ation

-2.7

2%Re

taine

d ea

rning

s70

.16%

66.6

5%65

.95%

70.6

6%67

.03%

68.8

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cum

ulate

d ot

her c

ompr

ehen

sive

incom

e-1

.73%

-1.2

2%0.

45%

-0.2

8%0.

35%

0.86

%

Tota

l sto

ckho

lder

s' eq

uity

84.2

5%83

.68%

83.5

2%82

.82%

82.7

2%80

.74%

95.2

7%10

0.06

%10

3.14

%10

4.25

%10

4.82

%10

4.14

%10

1.63

%99

.46%

97.6

0%95

.47%

Tota

l lia

bilit

ies a

nd st

ockh

olde

rs' e

quity

100.

00%

100.

00%

100.

00%

100.

00%

100.

00%

100.

00%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

Actu

al F

inan

cial

Sta

tem

ents

Fore

cast

ed F

inan

cial

Sta

tem

ents

136

Nat

iona

l Ins

trum

ents

Adju

sted

Bal

ance

She

et20

0220

0320

0420

0520

0620

0720

0820

0920

1020

1120

1220

1320

1420

1520

1620

17

Asse

ts

Curr

ent a

sset

s:Ca

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nd c

ash

equi

vale

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40,2

40$

53

,446

$

76

,216

$

55,8

64$

10

0,28

7$

19

4,83

9$

Sh

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stm

ents

113,

638

141,

227

150,

392

119,

846

150,

190

93,8

38Ac

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ts re

ceiva

ble,

net

62,9

8177

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87,3

1295

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117,

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131,

282

138,

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28$

148,

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58$

162,

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19$

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135.

45$

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851.

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226,

961.

66$

262,

367.

68$

303,

821.

78$

352,

433.

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412,

346.

92$

Inve

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net

39,2

4738

,813

54,0

4362

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77,1

3882

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78,2

42.4

2$

84,1

10.6

0$

91,6

80.5

5$

101,

765.

41$

113,

468.

43$

128,

219.

33$

148,

221.

55$

171,

640.

55$

199,

103.

04$

232,

950.

55$

Prep

aid

expe

nses

and

oth

er c

urre

nt a

sset

s13

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9,74

210

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stat

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and

Deve

lopm

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63,9

6456

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67,7

5470

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2De

ferre

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e ta

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8,10

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927

14,0

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20,8

5119

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Tota

l cur

rent

ass

ets

341,

930

387,

842

460,

058

432,

579

567,

570

646,

422

506,

060.

21$

544,

014.

72$

592,

976.

05$

658,

203.

42$

733,

896.

81$

829,

303.

39$

958,

674.

72$

1,11

0,14

5.33

$

1,28

7,76

8.58

$

1,50

6,68

9.24

$

Prop

erty

and

equ

ipm

ent,

net

152,

133

151,

612

149,

783

144,

330

145,

425

151,

462

187,

859.

72$

201,

949.

20$

220,

124.

63$

244,

338.

34$

272,

437.

25$

307,

854.

09$

355,

879.

33$

412,

108.

27$

478,

045.

59$

559,

313.

34$

Good

will,

net

13,3

5652

,533

53,3

4354

,111

Rest

ated

Goo

dwill

9,51

410

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42,0

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pita

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g Op

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03,

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05,

320.

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798.

03,

113.

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1148

0348

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1238

0235

9635

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1238

09In

tang

ible

ass

ets,

net

28,6

1542

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20,8

2443

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40,0

6540

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Othe

r lon

g-te

rm a

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s6,

148

5,56

55,

293

27,6

72

Tota

l Non

-Cur

rent

Ass

ets

183,

799

206,

980

178,

079

188,

311

184,

912

211,

781

286,

144.

25$

307,

605.

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335,

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53$

372,

171.

37$

414,

971.

08$

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917.

32$

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42$

627,

715.

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728,

149.

67$

851,

935.

12$

Tota

l ass

ets

525,

729

$ 59

4,82

2$

63

8,13

7$

62

0,89

0$

75

2,48

2$

85

8,20

3$

79

2,20

4.46

$

85

1,61

9.79

$

92

8,26

5.58

$

1,

030,

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1,

148,

867.

89$

1,

298,

220.

72$

1,

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56$

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015,

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26$

2,

358,

624.

36$

Liab

ilitie

s an

d St

ockh

olde

rs' E

quity

Curre

nt li

abilit

ies:

Acco

unts

pay

able

25,5

78$

29

,567

$

25

,208

$

30,8

32$

32

,001

$

36

,187

$

Ac

crue

d co

mpe

nsat

ion

9,55

512

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16,2

3318

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20,9

1225

,778

Defe

rred

reve

nue

11,5

3316

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22,2

0836

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Accr

ued

expe

nses

and

oth

er li

abilit

ies

13,5

0724

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18,7

698,

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10,7

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Inco

me

taxe

s pa

yabl

e....

......

......

......

......

....

6,15

3-

Ot

her t

axes

pay

able

11,7

209,

507

10,9

2613

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11,5

2716

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Tota

l cur

rent

liab

ilitie

s66

,513

75,7

9582

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87,6

2097

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125,

336

176,

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44$

189,

248.

84$

206,

281.

24$

228,

972.

18$

255,

303.

98$

288,

493.

49$

333,

498.

48$

386,

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447,

981.

83$

524,

138.

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Capi

taliz

ing

Oper

atin

g Le

ase

3051

3,44

0.0

3,99

6.0

5,32

0.0

4,79

8.0

3,11

3.0

5411

4803

4803

4212

3802

3596

3547

3622

3712

3809

Othe

r lon

g-te

rm li

abilit

ies

6,80

111

,169

Tota

l lia

bilit

ies

69,5

6479

,235

86,6

6592

,940

108,

960

139,

618

(179

,208

.15)

$

(393

,966

.46)

$

(613

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.13)

$

(839

,895

.84)

$

(1

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,721

.41)

$

(1,3

53,0

05.1

7)$

(1

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.32)

$

(1,9

54,8

00.6

4)$

(2

,329

,230

.95)

$

(2,7

53,8

82.9

8)$

Com

mitm

ents

and

con

tinge

ncie

s-

-

Stoc

khol

ders

' equ

ity:

Pref

erre

d st

ock:

par

val

ue $

0.01

; 5,0

00,0

00 s

hare

s au

thor

ized;

none

issu

ed a

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utst

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ng-

-

Com

mon

sto

ck: p

ar v

alue

$0.

01; 1

80,0

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00 s

hare

s au

thor

ized;

79,4

05,3

59 a

nd 7

9,88

3,83

7 sh

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issu

ed a

nd o

utst

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ng,

799

794

Com

mon

sto

ck: p

ar v

alue

$0.

01; 1

80,0

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00 s

hare

s51

152

2au

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ized;

79,2

76,0

86 a

nd 7

8,94

5,58

0 sh

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ed a

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spec

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ditio

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189

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Defe

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atio

n(1

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tain

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arni

ngs

391,

515

426,

129

449,

141

453,

959

530,

373

620,

917

873,

744.

61$

1,14

2,35

5.68

$

1,43

4,20

8.04

$

1,75

7,95

5.93

$

2,11

8,93

4.83

$

2,52

7,61

7.58

$

3,00

2,42

1.61

$

3,55

5,01

2.38

$

4,19

9,24

7.18

$

4,95

7,40

3.01

$

Accu

mul

ated

oth

er c

ompr

ehen

sive

inco

me

(7,9

24)

(6,3

95)

2,64

5(1

,685

)2,

499

7,06

5

Tota

l sto

ckho

lder

s' e

quity

456,

165

515,

587

551,

472

527,

950

643,

522

718,

585

971,

412.

61$

1,24

5,58

6.25

$

1,54

1,73

3.70

$

1,87

0,27

0.63

$

2,23

6,58

9.30

$

2,65

1,22

5.89

$

3,13

2,66

8.47

$

3,69

2,66

1.20

$

4,34

5,14

9.20

$

5,11

2,50

7.34

$

Tota

l lia

bilit

ies

and

stoc

khol

ders

' equ

ity52

5,72

9$

594,

822

$

638,

137

$

620,

890

$

752,

482

$

858,

203

$

792,

204.

46$

851,

619.

79$

928,

265.

58$

1,03

0,37

4.79

$

1,14

8,86

7.89

$

1,29

8,22

0.72

$

1,50

0,74

3.15

$

1,73

7,86

0.56

$

2,01

5,91

8.26

$

2,35

8,62

4.36

$

Actu

al F

inan

cial

Sta

tem

ents

Fore

cast

ed F

inan

cial

Sta

tem

ents

137

Nat

iona

l Ins

trum

ents

Adju

sted

Bal

ance

She

et (

Com

mon

Siz

e)20

0220

0320

0420

0520

0620

0720

0820

0920

1020

1120

1220

1320

1420

1520

1620

17

Asse

ts

Curr

ent a

sset

s:Ca

sh a

nd c

ash

equi

vale

nts

7.65

%8.

99%

11.9

4%9.

00%

13.3

3%22

.70%

Shor

t-te

rm in

vest

men

ts21

.62%

23.7

4%23

.57%

19.3

0%19

.96%

10.9

3%Ac

coun

ts re

ceiv

able

, net

11.9

8%13

.11%

13.6

8%15

.42%

15.5

8%15

.30%

17%

17%

17%

17%

17%

17%

17%

17%

17%

17%

Inve

ntor

ies,

net

7.47

%6.

53%

8.47

%10

.12%

10.2

5%9.

63%

10%

10%

10%

10%

10%

10%

10%

10%

10%

10%

Prep

aid

expe

nses

and

oth

er c

urre

nt a

sset

s2.

62%

1.64

%1.

61%

2.12

%1.

51%

2.72

%Re

stat

ed R

esea

rch

and

Deve

lopm

ent

12.1

7%9.

54%

10.6

2%11

.32%

12.0

2%11

.79%

Defe

rred

inco

me

taxe

s, n

et1.

54%

1.67

%2.

21%

2.40

%2.

77%

2.24

%

Tota

l cur

rent

ass

ets

65.0

4%65

.20%

72.0

9%69

.67%

75.4

3%75

.32%

64%

64%

64%

64%

64%

64%

64%

64%

64%

64%

Prop

erty

and

equ

ipm

ent,

net

28.9

4%25

.49%

23.4

7%23

.25%

19.3

3%17

.65%

Good

will

, net

0.00

%2.

09%

8.46

%7.

09%

6.31

%Re

stat

ed G

oodw

ill1.

60%

1.67

%6.

77%

5.67

%5.

04%

Capi

taliz

ing

Ope

ratin

g Le

ase

0.58

%0.

58%

0.63

%0.

86%

0.64

%0.

36%

Inta

ngib

le a

sset

s, n

et5.

44%

7.13

%3.

26%

7.02

%5.

32%

4.70

%O

ther

long

-ter

m a

sset

s0.

96%

0.90

%0.

70%

3.22

%

Tota

l Non

-Cur

rent

Ass

ets

34.9

6%34

.80%

27.9

1%30

.33%

24.5

7%24

.68%

36%

36%

36%

36%

36%

36%

36%

36%

36%

36%

Tota

l ass

ets

100.

00%

100.

00%

100.

00%

100.

00%

100.

00%

100.

00%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

Liab

iliti

es a

nd S

tock

hold

ers'

Equ

ity

Curr

ent l

iabi

litie

s:Ac

coun

ts p

ayab

le4.

87%

4.97

%3.

95%

4.97

%4.

25%

4.22

%Ac

crue

d co

mpe

nsat

ion

1.82

%2.

07%

2.54

%2.

91%

2.78

%3.

00%

Defe

rred

reve

nue

1.81

%2.

58%

2.95

%4.

21%

Accr

ued

expe

nses

and

oth

er li

abili

ties

2.57

%4.

11%

2.94

%1.

42%

1.42

%1.

22%

Inco

me

taxe

s pa

yabl

e....

......

......

......

......

....

1.17

%O

ther

taxe

s pa

yabl

e2.

23%

1.60

%1.

71%

2.23

%1.

53%

1.96

%

Tota

l cur

rent

liab

ilitie

s12

.65%

12.7

4%12

.95%

14.1

1%12

.94%

14.6

0%22

%22

%22

%22

%22

%22

%22

%22

%22

%22

%Ca

pita

lizin

g O

pera

ting

Leas

e0.

58%

0.58

%0.

63%

0.86

%0.

64%

0.36

%O

ther

long

-ter

m li

abili

ties

0.90

%1.

30%

Tota

l lia

bilit

ies

13.2

3%13

.32%

13.5

8%14

.97%

14.4

8%16

.27%

-23%

-46%

-66%

-82%

-95%

-104

%-1

09%

-112

%-1

16%

-117

%

Com

mitm

ents

and

con

tinge

ncie

sSt

ockh

olde

rs' e

quity

:Pr

efer

red

stoc

k: p

ar v

alue

$0.

01; 5

,000

,000

sha

res

auth

orize

d;no

ne is

sued

and

out

stan

ding

Com

mon

sto

ck: p

ar v

alue

$0.

01; 1

80,0

00,0

00 s

hare

s au

thor

ized;

79,4

05,3

59 a

nd 7

9,88

3,83

7 sh

ares

issu

ed a

nd o

utst

andi

ng,

0.11

%0.

09%

Com

mon

sto

ck: p

ar v

alue

$0.

01; 1

80,0

00,0

00 s

hare

s0.

10%

0.09

%au

thor

ized;

79,2

76,0

86 a

nd 7

8,94

5,58

0 sh

ares

issu

ed a

ndou

tsta

ndin

g, re

spec

tivel

y0.

12%

0.13

%Ad

ditio

nal p

aid-

in c

apita

l13

.71%

16.0

3%15

.50%

14.7

3%14

.60%

10.4

6%De

ferr

ed s

tock

-bas

ed c

ompe

nsat

ion

-2.6

7%Re

tain

ed e

arni

ngs

74.4

7%71

.64%

70.3

8%73

.11%

70.4

8%72

.35%

110%

134%

155%

171%

184%

195%

200%

205%

208%

210%

Accu

mul

ated

oth

er c

ompr

ehen

sive

inco

me

-1.5

1%-1

.08%

0.41

%-0

.27%

0.33

%0.

82%

Tota

l sto

ckho

lder

s' e

quit

y86

.77%

86.6

8%86

.42%

85.0

3%85

.52%

83.7

3%12

3%14

6%16

6%18

2%19

5%20

4%20

9%21

2%21

6%21

7%

Tota

l lia

bilit

ies

and

stoc

khol

ders

' equ

ity

100.

00%

100.

00%

100.

00%

100.

00%

100.

00%

100.

00%

100%

100%

100%

100%

100%

100%

100%

100%

100%

100%

Actu

al F

inan

cial

Sta

tem

ents

Fore

cast

ed F

inan

cial

Sta

tem

ents

138

Statement of Cash Flows The statement of cash flows can be looked upon as one of the most

informative financial statements due to the fact that it provides an outlay of the

company’s collections from cash. The statement of cash flows is broken down

into three different layers: cash flow from financing, investing, and operations. In

order to get the most precise depiction of cash flows from operating activities,

we concluded that the CFFO/Sales ratio would be the best ratio to utilize. We

took an average of the CFFO/Sales ratio from the past six years and came up

with 15%. We then used this number to forecast into the future by taking (1+

0.15) and multiplying it by the cash flow from operating activities in the prior

year.

We continued by forecasting cash flow from investing activities. Over the

past six years, we determined that our investing activities are extremely volatile.

Because of this, we came up with an assumption instead of an average. We used

this assumption of 12%, to forecast the future cash flow from investing activities.

We took (1+.12) and multiplied this by the cash flow from investing activities in

previous years to determine the future cash flows from investing activities.

Although getting an accurate forecasted number for cash flow from

financing activities is not necessary, we were able to forecast the amount of

dividends paid each year. In order to get this number, we used an assumed rate

of 17.5% to begin with for the years of 2008-2009. After the recession, this

growth rate dropped to 11.5% and continued on for the next seven years. This

allowed us to get an idea of the company’s future dividend amounts.

139

Conclusion

Overall, the forecasting of financial statements provides an outlook into

the future and helps to understand the future outcomes of a company. With the

lingering recession, the technology and system software industry as a whole will

suffer, but there is certainty that it will pick back up in the future. There is no

doubt that National Instruments will be able to successfully return to its normal

state after the recessions end. Although sales growth may decline for a few

years, it is forecasted that growth will indeed resume. Because of National

Instruments focus on research and development and emergent products, it can

be concluded that they will continue to be a major player in the technology and

system software industry.

140

Natio

nal Instru

men

tsSt

atem

ent o

f Cas

h Fl

ows

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Cash

flow

from

ope

ratin

g ac

tivitie

s:Ne

t inco

me

31,4

05$

33

,368

$

48,6

10$

61,5

17$

72,7

08$

107,

033

$

Adjus

tmen

ts to

reco

ncile

net

inco

me

to n

et ca

shpr

ovide

d by

ope

ratin

g ac

tivitie

s:De

prec

iation

and

am

ortiz

ation

20,7

4824

,774

25,5

9228

,553

34,1

8136

,605

Impa

irmen

t of c

ost m

etho

d inv

estm

ent

2,50

0St

ock-

base

d co

mpe

nsat

ion1,

545

14,5

0717

,754

Gain

on sa

le of

subs

idiar

y(2

42)

Prov

ision

for (

bene

fit fro

m) d

efer

red

incom

e ta

xes

(207

)2,

329

(825

)3,

219

(1,8

23)

(17,

185)

Tax b

enef

it fro

m st

ock o

ption

plan

s1,

835

3,84

93,

071

675

(4,2

71)

(2,9

64)

Chan

ges i

n op

erat

ing a

sset

s and

liabil

ities:

Acco

unts

rece

ivable

(9,3

57)

(14,

989)

(9,3

42)

(4,0

80)

(21,

502)

(14,

047)

Inve

ntor

ies(6

,640

)43

4(1

5,23

0)(4

,572

)(1

4,31

1)(5

,537

)Pr

epaid

exp

ense

s and

oth

er a

sset

s1,

823

4,04

94,

624

(2,1

77)

2,11

6(1

2,09

9)Ac

coun

ts pa

yable

(3,3

80)

3,98

9(4

,359

)4,

647

1,16

94,

186

Defe

rred

reve

nue

1,18

62,

746

3,38

53,

847

6,19

013

,883

Taxe

s and

oth

er lia

bilitie

s11

,720

2,54

77,

848

(5,1

24)

8,92

719

,743

Net c

ash

prov

ided

by o

pera

ting

activ

ities

49,1

3363

,096

65,6

3288

,050

97,8

9114

7,37

216

5,05

718

4,86

320

7,04

723

1,89

325

9,72

029

0,88

632

5,79

336

4,88

840

8,67

445

7,71

5

Cash

flow

from

inve

sting

acti

vities

:Pr

ocee

ds fr

om sa

le of

subs

idiar

y68

0Ac

quisi

tions

, net

of c

ash

rece

ived

(6,3

24)

(63,

891)

Capit

al ex

pend

iture

s(3

0,81

7)(1

7,98

3)(1

2,59

6)(1

5,38

3)(1

8,50

3)(2

4,86

4)Ca

pitali

zatio

n of

inte

rnall

y dev

elope

d so

ftwar

e(5

,757

)(9

,717

)(5

,198

)(1

3,38

0)(7

,370

)(8

,263

)Ad

dition

s to

othe

r int

angib

les(2

,993

)(2

,520

)(2

,859

)(4

,288

)(3

,115

)(6

,447

)Pu

rcha

ses o

f sho

rt-te

rm in

vestm

ents

(114

,921

)(1

16,0

30)

(125

,954

)(1

24,2

27)

(244

,238

)(8

7,58

6)Sa

les a

nd m

atur

ities o

f sho

rt-te

rm in

vestm

ents

86,2

2911

5,84

111

6,78

915

4,77

321

3,89

414

3,93

8Pu

rcha

ses o

f for

eign

curre

ncy o

ption

cont

racts

(2,2

42)

Net c

ash

prov

ided

by (u

sed

in) in

vesti

ng(6

8,25

9)(3

6,73

3)(2

9,13

8)(6

6,39

6)(5

9,33

2)14

,536

16,2

80.3

218

,234

20,4

2222

,873

25,6

1728

,691

32,1

3435

,991

40,3

0945

,147

Cash

flow

from

finan

cing

activ

ities:

Proc

eeds

from

issu

ance

of c

omm

on st

ock

13,4

2419

,430

16,8

2623

,222

37,1

4636

,460

Repu

rcha

se o

f com

mon

stoc

k(1

9,62

3)(1

6,06

4)(4

9,45

2)(1

6,51

9)(7

9,72

8)Di

viden

ds p

aid(5

,187

)(1

4,48

6)(1

5,77

6)(1

9,03

4)(2

7,05

2)(3

1,78

6)(3

7,34

9)(4

1,64

4)(4

6,43

3)(5

1,77

3)(5

7,72

6)(6

4,36

5)(7

1,76

7)(8

0,02

0)(8

9,22

2)Ta

x ben

efit f

rom

stoc

k opt

ion p

lans

4,27

12,

964

Net c

ash

prov

ided

by (u

sed

in) fin

ancin

gac

tivitie

s(6

,199

)14

,243

(13,

724)

(42,

006)

5,86

4(6

7,35

6)

Net c

hang

e in

cash

and

cash

equ

ivalen

ts(2

5,32

5)40

,606

22,7

70(2

0,35

2)44

,423

94,5

52Ca

sh a

nd ca

sh e

quiva

lents

at b

eginn

ing o

f per

iod38

,165

12,8

4053

,446

76,2

1655

,864

100,

287

Cash

and

cash

equ

ivalen

ts at

end

of p

eriod

12,8

40$

53

,446

$

76,2

16$

55,8

64$

100,

287

$

19

4,83

9$

Cash

paid

for i

nter

est a

nd in

com

e ta

xes

Inte

rest

128

$

62

$

31

$

17$

41

$

159

$

In

com

e ta

xes

5,05

2$

10

,899

$

10,6

22$

15,1

17$

9,82

7$

21

,147

$

Actual Fina

ncial Statemen

tsForecasted

Fina

ncial Statemen

ts

141

Nationa

l Instrum

ents

Stat

emen

t of C

ash

Flow

s (C

omm

on S

ize)

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Cas

h flo

w fr

om o

pera

ting

activ

ities

:N

et in

com

e63

.92%

52.88%

74.06%

69.87%

74.27%

72.63%

Adju

stm

ents

to re

conc

ile n

et in

com

e to

net

cas

hpr

ovid

ed b

y op

erat

ing

activ

ities

:D

epre

ciat

ion

and

amor

tizat

ion

42.23%

39.26%

38.99%

32.43%

34.92%

24.84%

Impa

irmen

t of c

ost m

etho

d in

vest

men

t3.81

%St

ock-

base

d co

mpe

nsat

ion

1.75

%14

.82%

12.05%

Gai

n on

sal

e of

sub

sidi

ary

‐0.37%

Prov

isio

n fo

r (be

nefit

from

) def

erre

d in

com

e ta

xes

‐0.42%

3.69

%‐1.26%

3.66

%‐1.86%

‐11.66

%Ta

x be

nefit

from

sto

ck o

ptio

n pl

ans

3.73

%6.10

%4.68

%0.77

%‐4.36%

‐2.01%

Cha

nges

in o

pera

ting

asse

ts a

nd li

abilit

ies:

Acco

unts

rece

ivab

le‐19.04

%‐23.76

%‐14.23

%‐4.63%

‐21.97

%‐9.53%

Inve

ntor

ies

‐13.51

%0.69

%‐23.21

%‐5.19%

‐14.62

%‐3.76%

Prep

aid

expe

nses

and

oth

er a

sset

s3.71

%6.42

%7.05

%‐2.47%

2.16

%‐8.21%

Acco

unts

pay

able

‐6.88%

6.32

%‐6.64%

5.28

%1.19

%2.84

%D

efer

red

reve

nue

2.41

%4.35

%5.16

%4.37

%6.32

%9.42

%Ta

xes

and

othe

r lia

bilit

ies

23.85%

4.04

%11

.96%

‐5.82%

9.12

%13

.40%

Net

cas

h pr

ovid

ed b

y op

erat

ing

activ

ities

100.00

%10

0.00

%10

0.00

%10

0.00

%10

0.00

%10

0.00

%10

0%10

0%10

0%10

0%10

0%10

0%10

0%10

0%10

0%10

0%

Cas

h flo

w fr

om in

vest

ing

activ

ities

:Pr

ocee

ds fr

om s

ale

of s

ubsi

diar

y‐2.33%

Acqu

isiti

ons,

net

of c

ash

rece

ived

17.22%

96.23%

Cap

ital e

xpen

ditu

res

45.15%

48.96%

43.23%

23.17%

31.19%

‐171

.05%

Cap

italiz

atio

n of

inte

rnal

ly d

evel

oped

sof

twar

e8.43

%26

.45%

17.84%

20.15%

12.42%

‐56.85

%Ad

ditio

ns to

oth

er in

tang

ible

s4.38

%6.86

%9.81

%6.46

%5.25

%‐44.35

%Pu

rcha

ses

of s

hort-

term

inve

stm

ents

168.36

%31

5.87

%43

2.27

%18

7.10

%41

1.65

%‐602

.55%

Sale

s an

d m

atur

ities

of s

hort-

term

inve

stm

ents

‐126

.33%

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142

Estimating Cost of Capital

Cost of Equity

Investors require compensation to invest in your company because of the

risk that it involves; this rate is called the cost of equity. The rate with cost of

equity will be much higher than that of cost of debt. Cost of equity can be

calculated many ways but for this valuation we used the CAPM Model or Capital

Asset Pricing Model. This model is calculated as follows: Cost of Equity = Risk

Free Rate + Beta of the Firm (Risk of the Market – Risk Free Rate). The risk free

rate is measured by using the returns from Interest Rates of a Treasury bill or

bond. The Beta is a measure of systematic risk of the firm measured by a

regression run on the firm based on a cumulative dividend and stock return, and

market risk premium. The market risk premium is calculated by the subtracting

the risk free rate, given by the St. Louis Federal Fund Treasury Returns, from the

market return given by the S&P 500. To find the most efficient Beta a series of

regressions was run based specifically on National Instruments. It is a measure

of systematic risk based upon or explained by the unpredictability of the market.

When Beta is equal to 1 the firm is essentially the same as the market. This is

because the Beta of the market is equal to 1. However, when it varies from one,

it shows how the firm will be more or less volatile than the market.

First, to find the cost of capital we must first find the estimated Beta

through a series of statistical regressions. To run these series we found monthly

prices over the past 7 years for National Instruments. This series also required

us to find the monthly return for the S&P 500 as well as variations of the

treasury yield for 3 month, 2 year, 5 Year, 7 Year and 10 year rates. By using

the rates for all of these time periods we are better at estimating the appropriate

Beta over the time periods and were able to measure systematic risk

successfully. Also, by using all of these different rates we can measure risk for

143

certain investment periods. We calculated investment periods of 72, 60, 48, 36,

and 24 months for each of the treasury yields. To find the most appropriate

Beta we analyzed the adjusted R2 from 25 regressions. The adjusted R2 is the

most effective coefficient of determination to use because it “adjusts for the

number of explanatory terms in a model” (Wikipedia.com). The higher this

variable the more explanatory power is related to the Market Risk Premium.

After running all of the regressions we saw a major trend in our 24 month

regressions. The highest of these Beta estimates was in the 3 month yield, 24

month regression in which the Beta equaled 1.427.

After finding the Beta with the most explanatory power we then gathered

the other variables for the cost of equity formula. The most recent 10 year rate

was 4.02 which we used for our rate, we also used 7% as our MRP because we

agreed with the authors of Business Analysis and Valuation that the “returns to

the Standard and Poor’s 500 index have exceeded the rate on intermediate-term

treasury bonds by 6.8 percent…as a result, market risk premium is around 7

percent”. We felt that this estimate was more effective than the 3-4% rate

because those rates are such a small fraction of time and the 7% was more of a

solid average of the return for bearing beta risk. After gathering these terms we

calculated the cost of equity to be 13.96% before the CAPM size adjustment and

15.66% after the adjustment. This analysis we believe is correct because of the

strong explanatory power given by the Beta found in the regressions. Below are

the regression results:

144

3 Month Rate Months Beta Est rf MRP Ke CAPM Size Adj Adj R Square

72 0.80 4.02 7 9.620 11.320 0.05160 1.48 4.02 7 14.380 16.080 0.20448 1.53 4.02 7 14.733 16.433 0.21236 1.40 4.02 7 13.848 15.548 0.24924 1.42 4.02 7 13.957 15.657 0.312

2 Year Rate Months Beta Est rf MRP Ke CAPM Size Adj Adj R Square

72 0.051 4.02 7 4.376 6.076 0.80060 1.481 4.02 7 14.387 16.087 0.20348 1.524 4.02 7 14.686 16.386 0.21136 1.390 4.02 7 13.753 15.453 0.24524 1.406 4.02 7 13.865 15.565 0.308


72 0.799 4.02 7 9.615 11.315 0.05160 1.480 4.02 7 14.382 16.082 0.20348 1.518 4.02 7 14.649 16.349 0.21136 1.381 4.02 7 13.688 15.388 0.24424 1.40 4.02 7 13.805 15.505 0.306


72 0.799 4.02 7 9.615 11.315 0.05160 1.480 4.02 7 14.381 16.081 0.20348 1.517 4.02 7 14.638 16.338 0.21136 1.378 4.02 7 13.665 15.365 0.24324 1.395 4.02 7 13.785 15.485 0.305

145


72 0.821 4.02 7 9.764 11.464 0.050 60 1.517 4.02 7 14.639 16.339 0.202 48 1.553 4.02 7 14.889 16.589 0.209 36 1.405 4.02 7 13.857 15.557 0.241 24 1.427 4.02 7 14.008 15.708 0.304

Based upon 3 Month rate, 24 Months

Upper Bound Cost of Equity 26.93

Lower Bound Cost of Equity 9.57

Back Door Method

After running the regressions National Instruments the Beta was

established to be 1.42. With this data we calculated that CAPM would be 15.66.

Since these numbers may not be right we used an alternative method, the back

door method, to run the same type of regression with different variables to

calculate cost of equity. Using this alternative method the cost of equity was

10.34. Seeing as how our Beta had great explanatory power we decided to use

the CAPM model for cost of equity because it seemed to be more accurate in

describing the risk in investing in our company.

Back Door Cost of Equity ROE P/B-1 Growth Rate P/B Cost of Equity National Instruments 12.9% 1.91 9% 2.91 10.34%

146

Cost of Debt

Cost of debt is the cost of having debt to a company. Basically, when a

company borrows money from an outside source, they must pay interest on the

loan. This interest is a cost to the company and it is useful in analyzing this

number in relation to the cost of equity. In addition, it is also useful to take

these numbers and put them together to find the weighted average cost of

capital. The cost of debt is lower than the cost of equity because the risk is

lower in financing activities with debt rather than equity. For example, if a

company were to go under, the debt would be paid off before the equity.

National Instruments has a very limited liability section on their balance sheet.

In fact, their long-term liabilities account for approximately 21% of the

company’s entire liabilities.

To find the cost of debt, you simply take the interest rate of each liability

and multiply it times the weighted average that each item holds in relation to

total liabilities. Finally, you add each weighted average cost of debt to get the

total cost of debt. The interest rates are normally listed in the company’s 10 K,

however National Instruments does not list the interest rates for its current or

long-term debt. We used the interest rates from the website

(http://research.stlouisfed.org/fred2/categories/22). The 2-month commercial

paper for a non-financial company of 2.11% was used for accounts payable,

accrued compensation and liabilities, and deferred revenue. The 5-year Treasury

bond rate of 2.32% was used for the income tax payable and deferred income

taxes. We used the AA Bond Interest rate from yahoo finance of 6.38 for long

term debt because our Altman Z-Score was approximately 5.5. Our cost of debt

was 2.46%.

147

WACC Weighted cost of capital is used to analyze the capital structure of the

company and the average cost of capital (interest rate) used by the company.

By calculating both the cost of equity and the cost of debt, we were able to

accurately calculate what interest rate is used to finance the firm. We found the

cost of equity to be 15.66% and the cost of debt to be 2.46% before tax and

after tax. The WACC before tax was equal to 13.11% and the WACC after tax

came out to be 13.08%; these numbers are included in the chart below.

Weighted Average Cost of Capital L/Value of Firm Cost of Debt Tax Rate E/Value of Firm Cost of Equity WACC WACC (Before Tax) 19.3% 2.46% 0 80.7% 0.1566 0.131124WACC (After Tax) 19.3% 2.46% 0.06 80.7% 0.1566 0.130839

Weighted Average Cost of Capital (Adjusted) L/Value of Firm Cost of Debt Tax Rate E/Value of Firm Cost of Equity WACC WACC (Before Tax) 17.4% 2.46% 0 82.6% 0.1566 0.133632WACC (After Tax) 17.4% 2.46% 0.06 82.6% 0.1566 0.133375

Total Liabilities

Debt Interest Rate

Weight Weighted Average Cost of Debt

Accounts payable $ 36,187

2.11% 0.229 0.0048

Accrued compensation 25,778 2.11% 0.163 0.0034

Deferred revenue 36,091 2.11% 0.229 0.0048

Accrued expenses and other liabilities

10,437 2.11% 0.066 0.0014

Other taxes payable 16,843 2.32% 0.107 0.0025

Deferred income taxes 21,221 2.32% 0.135 0.0031

Other long-term liabilities 11,169 6.38% 0.071 0.0045

Total Liabilities 157,726 Cost of Debt

0.0246

148

Valuation Analysis

Method of Comparables

The method of comparable ratios is used by analysts to conclude if a firm

is indeed overvalued or undervalued. An analyst can clarify their thoughts on

how the company is truly valued by using this process. The firm’s value is

measured by comparing it to the industry average. There are pros and cons of

using the method of comparables, one benefit being that are fast and effortless

to apply, nevertheless, the figures are determined with little or no room for

explanation and often turn out inconsistent outcomes. These models can be

ambiguous, not representing what really drives a firm. In our analysis, we will

use the method of comparables ratios in order to compare National Instruments’

share price to the industry average in order to find the value of the firm. National

Instruments share price as of the valuation date November 03, 2008 is $25.09.

We allowed 20% plus or minus margin of safety between our calculated share

price and the actual share price.

149

Price to Earnings Trailing

Trailing P/E

Net Income

# of Shares Outstanding

Price P/E NATI PPS

National Instruments 107 78.83 $18.92

National Instruments Restated 324 78.83 $57.34

Agilent 638 350 23.00 13.71

Teradyne 77.71 169.29 5.19 123.72

Synopsys 1212.47 144.09 18.48 14.19

Average 13.95

The price to earnings trailing ratio is calculated using the earnings per

share for previous years and price per share for upcoming years. This ratio is

very trendy and is seen on many stock websites in the main stock summary

section. We divide the price per share by net earnings per share in order to get

the Trailing P/E. We were able to calculate net earnings per share by dividing net

income from the year prior by net shares outstanding. When we calculated the

P/E ratio, the industry average for the technological software industry was 13.95.

We then compute National Instruments P/E trailing according to the industry

average. We do this by setting National Instruments P/E trailing to 13.95 and

earnings per share to 1.35. When we computed our Trailing P/E we computed a

price of 18.92, which is well below our margin of safety which indicates that

National Instruments is overvalued. The restated trailing P/E shows a new price

per share of $57.34. This is because the restated numbers include research and

development as an asset. This new increase in assets causes an increase in net

income which then causes an increase in the National Instruments price per

share.

150

Price to Earnings Forecast

Forecasted P/E Company Forecasted EPS Price P/E NATI PPS National Instruments 1.59 $16.97 National Instruments Restated 3.61 $38.39 Agilent 1.7 23.00 11.02 Teradyne 0.04 N/A N/A Synopsys 1.24 17.45 10.25 Industry Avg - NATI 10.635

The second comparable ratio we implemented was the price to earnings

forecasted ratio. Price to earnings forecasted is similar to the previous

comparable, Price to earnings trailing, apart from the fact that this ratio requires

that we use forecasted earnings per share as a replacement for the previous

year’s earnings per share the other ratio requires. In order to calculate the

forecasted earnings per share of National Instruments, we must divide the

forecasted net income by the number of total shares outstanding. One

advantage of this ratio is that it is using two variables that are current, not any

from years prior. After we calculate this number we then multiply it by the

industry average forecasted P/E to get $16.97 per share. The share price of

$16.97 is well below the price of 25.09 which incurs that National Instruments is

once again overvalued.

151

Price to Book

Price to Book

PPS BPS P/B Industry Average

Comparables

National Instruments 25.09 2.992 5.26 1.52 4.55 National Instruments Restated 25.09 9.115 2.75 1.52 13.85 Agilent 23 8.908 2.77 Teradyne 5.19 7.036 0.8

Synopsys 17.45 10.714 1.72

The price to book value is calculated in order to observe if the firm’s value

is justified by their book value of equity. It is also used to evaluate a stocks

market value counter to its book value. First we must calculate the book value of

equity per share by dividing the book value of equity by the number of shares

outstanding. Price to Book is calculated by dividing price per share by the book

value of equity per share. After calculating the P/B for each firm, we then

calculated the industry average. We then multiplied the industry average by

National Instruments’ book value of equity per share. When we computed the

numbers, they gave us a share price of 4.55 for National Instruments. This is

well below the share price of 25.09 National Instruments currently has which

tells us that National Instruments is once again overvalued. This low share price

is likely due to the fact that National Instruments P/B is well above the industries

average at 1.52 versus National Instruments at 5.26. After computing National

Instruments restated comparable price, we see that it climbed to 13.85. This

occurred due to the fact that National Instruments’ book value of equity grew

after the restated statements. Even with the spike in comparable price, National

Instruments is still overvalued.

152

P.E.G. In order to calculate the P.E.G. ratio, we looked back at our past P/E

trailing ratio. We then took this number and divided the expected earnings

growth for one year out. Upon gaining a reasonable estimate of the industry

average, making certain to throw out Teradyne, the outlier, we multiplied it by

the National Instruments growth rate to gain the price per share of National

Instruments.

P.E.G

Comparable

Company PE EGR t+5 P.E.G. Industry Avg. NATI PPS National Instruments 18.92 1.22 $23.08National Instruments Restated 39 1.22 $47.58 Agilent 13.71 14.5 0.946 Teradyne 123.72 15 8.248 (Throw Out) Synopsys 14.19 9.5 1.494 Industry Avg - NATI 13.95 13 1.22

As seen above, the National Instruments price per share ended up being

$23.08. This is lower than the share price of $25.09 showing that the company is

overvalued. The restated amount was much higher due to the higher growth rate

we used.

153

Price/EBITDA

Price divided by EBITDA is just one of the many methods of comparables

that we use to help to determine the value of a company. EBITDA stands for

earnings before interest, taxes, depreciation, and amortization. Most of the time,

this number will come out to be the operating income. To determine this

number, we took our operating income and divided it by our outstanding shares.

We then divided our price per share that we derived by our EBITDA to obtain our

price divided by EBITDA. This gave us 19.65. To compare, we found our

industry average for Price divided by EBITDA by taking the values from the

competitors, Agilent, Teradyne and Synopsys, and averaging them together. We

then took the industry average of 7.83 and plugged in the numbers to multiply it

by National Instrument’s EBITDA per share of 1.295 to obtain the PRICE per

EBITDA which gave us 10.14. We can assume our company is overvalued.

Price/EBITDA

Comparable

Company Market Cap (Billions) EBITDA P/EBITDA

Industry Avg. NATI PPS

National Instruments 1.965 1.30 19.65 7.83 $10.14

National Instruments Restated 1.965 4.04 6.14 7.83 $31.63

Agilent 2.29 2.601 8.84

Teradyne 0.64 0.834 6.23

Synopsys 6.59 2.073 8.42

Industry Avg - NATI 7.83

154

Enterprise Value/EBITDA

A ratio that is commonly used among industries, while doing method of

comparables, is the EV/EBITDA. This ratio is formed by the enterprise value

divided by the earnings before interest, taxes, depreciation and amortization.

The importance of this ratio is that is shows the debt free value of the firm and

divide that by the earnings before interest and the amount of debt.

To formally calculate for this ratio the enterprise value must be solved for.

This value is computed by taking the firm’s market value of equity plus the book

value of equity and subtracting off the cash and investments, both short term

and long term. Once the enterprise is computed then divide that by the ebitda,

which is the expenses without tax, interest, depreciation and amortization all

subtracted from revenues. As previously stated above once the enterprise value

and the ebitda are calculated they can by divided by each other respectfully.

Once the values for National Instruments, enterprise and ebitda, have been

calculated the averages of each competitor’s EV/EBITDA are also calculated. To

solve for the comparables price the competitor’s averages is multiplied by

National Instrument’s calculated ratio. Using this method a value of $37.15 is

calculated showing that National Instruments is undervalued by almost $24. The

reason for the estimated price being so much larger than the observed price of

$25.09, is contributed to the lack of debt linked to the EV/EBITDA calculation.

EV/EBITDA

Company EV EBITDA EV/EBITDA Comparable

National Instruments 9.19 1.30 7.07 37.15

Agilent 26.45 2.60 10.168 Throw Out

Synopsys 12.39 2.07 5.98

Teradyne 3.77 0.83 4.528

Industry Average - - 5.25

155

For this ratio to be more accurate a restated ratio needs to be formed

with exclusion of goodwill. This was done by taking the calculated enterprise

values for each of the competitors, as well as National Instruments, and

subtracting off the goodwill. The goodwill amount can be obtained from each of

the competitors’ 10-k, Agilent, Synopsys, and Teradyne. The purpose of

excluding goodwill from this ratio is to compute a ratio without an asset that

does not contribute value. Using the same math as above, EV/EBITDA, a new

industry average is formed and therefore leads to a new estimated price. The

new estimated price is 12.96 showing National Instruments to be overvalued. We

believe that the dramatic decrease, 37.15 to 8.72, is due to the fact that each

company in the industry has such a significant portion of goodwill.

EV/EBITDA- GOODWILL




Synopsys 4.72 2.07 2.28

Teradyne 3.08 0.83 3.70


156

Price/Free Cash Flow

The price/free cash flow comparable method is a ratio that compares the

firm’s market price to its amount of free cash flows. The free cash flow amount is

calculated by taking the cash flow from operations and adding it to the cash flow

from investing activities. We used the Market Cap to represent the price in the

ratio.


Market Cap

(Bill.) FCF P/FCF Industry Average NATI PPS NATI 1.965 0.16 12.12962963 $14 $35.12 Synopsys 2.29 0.51 4.463937622 Teradyne 0.64076 0.24 2.669833333 Agilent 6.59 0.19 35.05319149

In order to calculate the industry average, the totals of Price over Free

Cash Flows from Synopsys, Teradyne and Agilent were used. To get an accurate

result, National Instruments was left out of the industry average. The National

Instruments Price/Free Cash Flow per share price was calculated to be $35.12.

This was achieved by taking the industry average of $14 and multiplying it by the

market cap, 1.965. This number was then divided by the total number of shares

outstanding. Since the National Instruments price per share equated to $35.12

and the current stock price is $25.09, it is implied that the firm is undervalued.

Dividends/Price

The dividend to price ratio is another tool used in the method of

comparables. Since not every company pays dividends, not every firm can use

this ratio. Since National Instruments does payout dividends we will solve for

this equation. The dividend to price ratio is determined by dividing the firm’s

dividend per share by the firm’s price per share. In this specific industry, National

Instruments is the only firm between their competitors that is paying dividends.

The fact that National Instruments is the only firm in its industry to consistently

157

pay back dividends shows them to be a profitable firm. The purpose of this

model is to take National Instruments DPS and divide it by the industry average

D/P ratio, this would give us the suggested price for the dividend to price model.

National Instruments is the only firm paying dividends therefore this model is not

effective in this industry.

Conclusion

Although these comparables are quick and easy, it is hard to rely on them

for accurate results. These comparable numbers are mostly based on industry

averages and do not allow for the opinion of analysts, which can be seen as a

major downfall. Since these comparable ratios are not based on financial theory,

it is important for extreme ratios, or outliers, to be thrown out. Overall, the ratios

suggest that the company is overvalued. The only ratios that seems to deem

otherwise is the Price/Free Cash Flow and EV/EBITDA. Since these two ratios are

the only ratio that goes against the norm, our final conclusion of the company

being overvalued stands. However, because these ratios are not as imperative or

reliable as the valuation models, it is important to pay more attention to the

valuation models discussed below.

158

Intrinsic Valuation Models

The intrinsic valuation models, unlike the method of comparables, are

based upon our forecasting and theories and can be much more easily

interpreted. These models include the following: discounted dividend,

discounted free cash flows, residual income, abnormal earnings growth, and

long-run residual income. National Instruments can be valued by using these

models by forecasting things such as dividends, free cash flows, and residual

income. Sensitivity analysis will show the change in our estimated price per

share by changing key factors such as growth rates and the cost of equity or

debt. With these models we will be able to more accurately value a firm.

Discounted Dividend Model

The discounted dividend model has the lowest explanatory power out of

all of the models. It is very unreliable and almost impossible to value a company

based on their forecasted out dividends. Since it is difficult to forecast dividends

down the year because we do not know the plans of the company, this model is

extremely unreliable. Most stockholders do not choose to purchase one stock

over another based on dividends because the pay period is simply too long to

matter. Finally, in our assumptions we have forecasted National Instruments as

if it will continue to operate forever, in reality this just is not the case. In any

give year the company could claim bankruptcy therefore making this model very

unreliable.

159

Discounted Dividend Model Growth Rate

Ke 0 0.02 0.04 0.06 0.08 0.1 0.120.0957 10.13 11.62 14.18 19.57 38.46 0.1163 8.07 8.90 10.16 12.33 16.90 32.90 0.1367 6.60 7.08 7.77 8.81 10.58 14.26 26.610.1566 5.59 5.92 6.31 6.93 7.82 9.36 12.560.1943 4.32 4.47 4.66 4.90 5.22 5.68 6.400.2317 3.49 3.56 3.65 3.77 3.91 4.10 4.350.2693 2.93 2.97 3.02 3.08 3.15 3.24 3.35

Overvalued < $20.07 $20.07<Fair Valued>$30.11 Undervalued>$30.11

The chart above shows the sensitivity analysis that was run for the

dividends. By using the Ke found of 15.66 and a growth rate of 0% we found

National Instruments to be overvalued. Because of the sensitivity of a growth

rate on terminal value perpetuity, the dividends are very sensitive to growth

rates. With the results of this model National Instruments is suggested to be an

overvalued company.

Discounted Free Cash Flow

The Discounted Free Cash Flow model is a valuation model that helps to

determine if a company is overvalued or undervalued by using a sensitivity

analysis. To start off making the model, you take the cash flow from investment

activities and subtract it from the cash flow from operations for the next ten

years using the numbers you obtained from forecasting. This gives you the

firm’s free cash flows from its assets. We then find the present value of the free

cash flows of the projected years by multiplying the firm’s free cash flows by its

present value factor using the weighted average cost of capital before tax. You

then find the market value of assets by taking the total present value of free

cash flows of the projected years and add them to the derived free cash flow of

the perpetuity. By subtracting the book value of debt, you are able to formulate

160

the market value of equity. This market value of equity can then be divided by

the number of shares outstanding to find price per share which will then be

compared to the observed price on November 3, 2008 to determine National

Instrument’s value.

Discounted Free Cash Flows Growth Rate

WACC 0 0.02 0.04 0.06 0.08 0.1 0.120.096 7.94 7.94 14.58 22.09 48.38 0.107 6.75 8.21 10.54 14.85 25.54 97.33 0.119 4.84 5.86 7.40 9.98 15.22 31.48 0.130 3.39 4.15 5.24 6.96 10.05 17.27 53.340.141 2.18 2.75 3.54 4.73 6.7 10.59 21.890.153 1.06 1.48 2.06 2.88 4.16 6.4 11.360.164 0.18 0.51 0.94 1.55 2.44 3.99 6.67


We derived the WACC before tax to be 13%. Therefore, we used this in

the sensitivity analysis along with our lower and upper bounds that we obtained

from our regression of .096 and .164 respectively. We also used growth rates

starting a 0 and ending and at .12. By changing these numbers, we are able see

how different cost of capitals and growth rates affect the value of the company.

As we increased our WACC, our value decreased, and it increased as the growth

rates increased. We recorded our stock price on November 3, 2008 as $25.09.

We compare the changes in value to this price to determine if the company is

over or under valued. As you can see, our company was sensitive to the

changes in WACC and growth and shows to be mainly overvalued, especially with

low growth rates and high WACC.

When we performed a sensitivity analysis using our adjustment financial

statements, our results did not vary much from the original. The only

information that changed was the book value of debt. The number increased

161

from $818, 812 to $858,203. The graph below shows the company is overvalued

using the adjusted financial statements.

Adjusted Discounted Free Cash Flows Growth Rate

WACC 0 0.02 0.04 0.06 0.08 0.1 0.12 0.096 8.44 10.52 14.08 21.59 47.88 0.107 6.98 7.71 10.04 14.35 25.04 96.83 0.119 4.34 5.36 6.90 9.48 14.72 30.98 0.130 2.89 3.65 4.7 6.46 9.55 16.77 52.84 0.141 1.68 2.25 3.04 4.23 6.2 10.09 21.39 0.153 0.56 0.98 1.56 2.38 3.66 5.9 10.86 0.164 0.01 0.44 1.05 1.94 3.4 6.17


Residual Income

The residual income model is one of the most impressive and reliable

valuation models that is used by a firm. The main reason for this is the fact that

the residual income model is less sensitive to growth rate changes than other

models are. The focus of the model is based on book value of equity rather than

terminal value like the discounted dividends and free cash flow models. This

allows for a more accurate account of the firm and decreases the risk of errors

over time. The model also has a much higher percent of explanatory power

compared to other valuation models.

We used the book value of equity for the year 2007 stated in the 10-K to

begin our model. We then looked at our income statement to get the amount of

net income we had forecasted. The dividends were achieved by looking at the

forecasted numbers on the statement of cash flows. In order to get the amount

of book value of equity in years 2008-2017, we took the net income minus the

dividends and added this amount to the book value of equity in the previous

year. To get the annual normal income benchmark we took the initial cost of

162

equity and multiplied it by the amount of book value of equity for that year. This

number was then used to calculate the residual income amount.

Taking net income and subtracting it by the income benchmark got the

residual income number. This was forecasted out for each of the 10 years. We

then had to retain a present value factor amount for each year. This was

achieved by taking 1/(1+Ke)^time. In order to get a year by year present value

residual income, we took the present value factor of each year and multiplied it

by the residual income value of that same year. We continued by getting a sum

of all the years year by year preset value residual income to attain a total

amount.

In order to get the terminal value of the perpetuity, we estimated the

residual income of 2018. In order to achieve an accurate estimate we took the

percentage change in residual income year by year to see how the company’s

residual income was changing every year. We determined that a rate of 1.3 gave

us a reasonable estimate of residual income in 2018. 1.3 was multiplied by the

residual income in year 2017 to gain this reasonable estimate. With this number

we were able to get a terminal value of the perpetuity by taking the 2018

residual income estimate and dividing it by Ke minus the perpetuity growth rate.

We had to ensure that the growth rates we utilized were negative in order to

make certain that the residual income values would reach zero over a period of

time.

After the terminal value of the perpetuity was found, it was added to the

book value of equity as well as the total present value of year by year residual

income to get the market value of equity. The market value of equity was then

divided by the number of shares outstanding that National Instruments

possesses to get a model price. In order to get a time consistent price we had to

make sure that the formula reflected the fact that we are using November

numbers: Model Price* (1+Ke)^10/12.

163

With this formula now in place, we could now change the growth rates as

well as the cost of equity to gain time consistent price amounts. We decided that

we would utilize a 20% margin of acceptance, which shows that any price under

$20.07 was undervalued while any price over $30.11 was overvalued. Any

number between $20.07 and $30.11 was fairly valued. The readjusted numbers

were different due to the impairment of goodwill and the reallocation of research

and development as an expense.

Residual Income Growth Rate

Ke -10% -20% -30% -40% -50%0.0957 23.62 21.34 20.21 19.53 19.090.1163 18.57 17.3 16.64 16.23 15.960.1367 14.87 14.2 13.84 13.61 13.460.1566 12.15 11.84 11.66 11.55 11.470.1943 8.58 8.6 8.62 8.63 8.630.2317 6.33 6.47 6.56 6.62 6.660.2693 4.84 5.01 5.12 5.2 5.25

Overvalued < $20.07 $20.07 <Fair Valued> $30.11 Undervalued > $30.11

Residual Income Adjusted

Growth Rate

Ke -10% -20% -30% -40% -50%

0.0957 48.16 42.78 40.12 38.54 37.48

0.1163 37.19 31.13 32.54 31.57 30.91

0.1367 29.21 27.55 26.64 26.08 25.69

0.1566 23.37 22.54 25.09 21.78 21.57

0.1943 15.8 15.76 15.74 15.73 15.72

0.2317 11.11 11.36 11.52 11.63 11.71

0.2693 8.07 8.4 8.62 8.77 8.88


164

We carried out a sensitivity analysis which showed how the value of

National Instruments would change when the growth rate and cost of equity

changed. We used negative growth rates ranging from -10% to -50%. The cost

of equity upper and lower bounds were attained by gathering information from

our regression analysis.

When looking at both the residual income model as well as the adjusted

residual income model, it can be concluded that the charts reflect mostly red

amounts. This means that National Instruments is mostly overvalued.

AEG (Abnormal Earnings Growth)

Abnormal Earnings Growth (AEG) Growth Rates

Ke -0.1 -0.2 -0.3 -0.4 -0.50.0957 38.56 34.82 32.96 31.86 31.120.1163 26.27 24.38 23.4 22.8 22.390.1367 18.88 17.91 17.39 17.06 16.830.1566 14.21 13.72 13.43 13.26 13.130.1943 9.01 8.89 8.83 8.78 8.750.2317 6.23 6.24 6.25 6.25 6.250.2693 4.6 4.64 4.67 4.69 4.69

Overvalued < $20.07 $20.07 <Fair Valued>

$30.11 Undervalued > $30.11

Abnormal Earnings Growth (AEG) Growth Rates

Ke -0.1 -0.2 -0.3 -0.4 -0.50.0957 78.99 71.64 68.01 65.84 64.410.1163 52.24 48.8 47.01 45.91 45.170.1367 36.38 34.8 33.94 33.41 33.040.1566 26.49 25.83 25.46 25.22 25.060.1943 15.7 15.73 15.75 15.76 15.770.2317 10.14 10.34 10.46 10.55 10.610.2693 6.98 7.19 7.33 7.43 7.5

Overvalued < $20.07 $20.07 <Fair Valued>

$30.11 Undervalued > $30.11

165

The abnormal earnings growth model, or AEG, is primarily based on

financial theory. To calculate AEG we first calculated the dividends reinvested

(DRIP). To calculate this we multiply dividends of the previous year by cost of

equity (15.66%). A time lag is included in this calculation because we want to

analyze the effect of the previous year’s dividends being reinvested in the firm.

This reinvestment is based on the assumption that investors will reinvest

dividends and get a return equal to the cost of equity. We then added net

income to the reinvested dividends to find cumulative dividend earnings. Normal

earnings, or benchmark earnings, were found by taking the previous year’s net

income and increasing it each year by one plus cost of equity and growing it

each year. AEG is then found by subtracting normal earnings from cumulative

dividend earnings. To ensure that the AEG model was calculated correctly we

added a residual income check figure, which is simply the difference between

annual residual income one year ahead, subtracted from this year’s annual

residual income. Our models are equal and our check figures have verified our

numbers.

Abnormal Earning Growth (AEG)

(5,255)

(3,129)

(326)

486

3,270

8,917

10,412

12,174

16,807

Residual Income Check Figure

(5,255)

(3,129)

(326)

486

3,270

8,917

10,412

12,174

16,807

For each year forecasted of the abnormal earnings growth, the present

value was calculated for each year and then the sum of all was taken. Next, to

correctly calculate the perpetuity of this model we forecasted out abnormal

growth earnings one more year in the future, 2018, and then divided that by

cost of equity minus growth to get the continuing terminal value. Finally, we

took the present value factor of the terminal value and then discounted it back to

the same year as the sum of present value of abnormal earnings.

At this point we have the core net income, total present value of AEG, and

present value of terminal value. All of these numbers are in one year future

166

dollars. If you add these three figures together you get the average constant

change to earnings one year in the future. To determine the average earnings

per share perpetuity we divide by the number of shares outstanding. Also, for

this model the capitalization rate (perpetuity) is equal to the cost of equity.

Finally, we found intrinsic value per share at (12/31/2008) by diving EPS

Perpetuity by the Capitalization Rate. Finally, to make this per share calculation

consistent with the valuation we must forecast it out a time of ten months from

the year end of December 31, 2007 until the project valuation date of November

3, 2008. At the time of valuation we found a price per share that was less than

the market price at the time of valuation, to be noted this price is sensitive to the

growth rates of the perpetuity and cost of equity.

Long Run Residual Income

Although the long run residual income model is close to the residual

income model, there are some minor differences. Instead of the use of dividends

as in the residual income model, the long run residual income model incorporates

return on earnings. Also, the long run model is more sensitive than the residual

income model, and therefore it is not used as frequently. The following formula

shows the inputs used to calculate the long run residual income model:

Market Cap Estimate= BVE(1+(ROE-Ke/Ke-growth rate))

To perform this model correctly we averaged our return on equity over the next

10 years. We used our forecasted statements to acquire the figures we needed.

The average that was held constant was 18.13%. We used our capital asset

pricing model for this evaluation, we calculated a Ke of 15.66%. We used

growth rate average of 14%. When we gather the ROE and growth rate we key

in this information into the residual income formula. We can determine that our

time consistent share price to be $23.55.

167

Growth Ke 7% 8% 9% 11% 12% 0.13 0.14

0.0957 39.19 58.39 144.96 0.1163 22.1 25.65 31.91 94.91 0.1367 15.57 16.67 18.24 24.92 34.25 71.45 0.1566 12.11 12.46 12.9 14.37 15.69 17.99 23.010.1943 8.73 8.64 8.53 8.25 8.05 7.79 7.440.2317 6.87 6.66 6.43 5.85 5.48 5.03 4.490.2693 5.71 5.47 5.21 4.58 4.2 3.77 3.27

ROE Held Constant at 18.13% Overvalued < $20.07 $20.07 <Fair Valued> $30.11 Undervalued > $30.11

ROE Ke 0.17 0.175 0.18 0.185 0.19

0.0957 0.1163 87.54 94.83 102.13 109.42 116.720.1367 20.97 22.72 24.46 26.21 27.960.1566 12.19 13.21 14.22 15.24 16.250.1943 6.92 7.5 8.07 8.65 9.230.2317 4.92 5.33 5.74 6.15 6.560.2693 3.85 4.17 4.5 4.82 5.14

Growth Rate Held Constant at 11% Overvalued < $20.07 $20.07<Fair Valued>$30.11 Undervalued>$30.11

ROE Growth 0.17 0.175 0.18 0.185 0.19

0.070 10.93 11.48 12.03 12.57 13.120.080 11.12 11.74 12.36 12.98 13.60.090 11.37 12.08 12.79 13.5 14.210.100 11.71 12.54 13.38 14.22 15.050.110 12.19 13.21 14.22 15.24 16.250.120 12.93 14.23 15.52 16.81 18.110.130 14.24 16.02 17.8 19.57 21.350.140 17.11 19.96 22.81 25.66 28.52

Ke Held constant at 15.66% Overvalued < $20.07 $20.07<Fair Valued>$30.11 Undervalued>$30.11

168

It is also significant that we evaluate this valuation model using our

financials that we have restated. This will give us a clear idea of the changes in

earnings and equity value. The valuations were performed the same as the non-

restated ones and consistent with the forecasted financials. One of the reasons

for this restatement could be the allow a good part of goodwill and research &

development to become assets that impairment would be obsolete from then on.

Our Book Value of Equity changed from 661,086 to the restated 718,585, thus

changing our time consistent price to $25.60. Both prices of the stated and

restated residual income models seem reasonable in comparison to each other,

both dollar and percentage amounts.

Below is the restated long run residual income model. Our return on

equity had to be restated because in the forecasted financial statements, net

income changed. When we found our new growth rate, the new constant

changed from 18.13% to 25.11%.

Long Run Residual Income Restated Growth

Ke 7% 8% 9% 11% 12% 0.13 0.140.0957 63.77 98.63 255.78 0.1163 35.95 43.32 56.3 205.86 0.1367 25.34 28.16 32.19 49.31 73.25 168.66 0.1566 19.8 21.25 22.9 28.67 33.91 43.1 63.360.1943 14.17 14.56 15.02 16.28 17.16 18.31 19.890.2317 11.17 11.25 11.34 11.57 11.71 11.88 12.090.2693 9.3 9.25 9.19 9.06 8.98 8.89 8.79

ROE Held Constant at 25.11% Overvalued < $20.07 $20.07 <Fair Valued> $30.11 Undervalued > $30.11

169

Analyst Recommendation

By carrying out in depth research and extensive analysis, we have

concluded that National Instruments is an overvalued firm. We were able to

come up with this appraisal by analyzing distinct characteristics of the industry as

well as key accounting policies and financial statements. By closely evaluating

current market conditions and examining the past financial statements of

National Instruments, we were able to forecast out specific line items for the

next ten years, 2008-2017. With these forecasts, we were then able to carry out

intrinsic valuation models to come up with an overall stance of the firm. After

looking at the outcomes of the valuation models as well as the performance of

the firm as a whole, we have come to the conclusion that National Instruments is

not meeting the expectations that it should and is worth less then it is trading at

currently. With this said, it would be in the best interest of National Instruments’

current shareholders to sell the stock they hold in National Instruments.

It is important to understand an industry as a whole in order to gain an

understanding of a specific firm competing in that industry. By analyzing the

technical and system software industry, we came up with a group of three major

competitors that National Instruments faces: Agilent, Teradyne, and Synopsys.

By evaluating certain aspects of these companies, we were able to use the

outcomes as a benchmark in order to get an overall sense of National

Instruments performance in this industry. We were able to identify key success

factors that this industry focuses on including: research and development,

superior product quality, enhanced customer service and delivery turn around,

creativity and innovation, and managing global risk. We were able to utilize these

key success factors the remaining parts of our analysis.

170

With key accounting strategies accounted for, we proceeded by getting a

sense of National Instruments’ key accounting policies as well as the disclosure

National Instruments provides in their 10-Ks. We found our key accounting

policies to be: research and development; management and goodwill, operating

and capital leases, warranties, and gains or losses from foreign currency. When

considering these accounting policies, we had to ensure that the managers of the

firm were not making their financial statements look better than they actually

are. In order to do this, we evaluated the accounting policies and determined

which policies partook in aggressive accounting. Then, it was necessary to

identify any potential red flags and undo any accounting distortions in order to

gain the true value of the firm. We determined that National Instruments

provided an inadequate amount of disclosure when it came to goodwill

impairment and research and development. The 10-Ks of National Instruments

claim no impairment of goodwill for the past five years, which proved to be a red

flag. After writing off a significant amount of goodwill, we were able to restate

the past five years as well as come up with a more reliable amount of goodwill

for the next ten years.

Since research and development comprises such a large portion of the

technical and system software industry, we decided that instead of expensing

research and development, as is it currently, we would claim research and

development as an asset. This would provide us with a greater understanding of

the Net Income of the firm and allow us to evaluate the company more clearly.

When looking at the financial analysis and valuation methods, we made certain

to include both unadjusted as well as adjusted amounts.

In order to gain an understanding of the company’s operating

performance, we calculated a series of ratios. These ratios were broken down

into four categories: liquidity, profitability, capital structure, and firm growth.

Once we computed these numbers, we compared the industry averages to that

of National Instruments, which enabled us to see how National Instruments

171

compared to its competitors. We determined that National Instruments was

frequently average or above average and rarely preformed below the industry

average.

To accurately evaluate a company, it is extremely important to come up

with valuation methods/measures. The valuation measures we decided to utilize

included method of comparables and valuation models. While both of these

theories provide us with an overall understanding of whether the firm was over,

under, or fairly valued, it is important to realize what these two models are

based upon. Although the method of comparables is a quick and simple

technique, it is based solely upon industry averages, which may not always prove

to be correct. The valuation models, on the other hand, while more accurate and

reliable then the method of comparables, provide a potential problem mainly

because they are based on estimations of the analysts, which may not always

prove precise.

The outcome of all but two of our method of comparables were

overvalued. The price per share we calculated for each ratio, other than

Price/Free Cash Flow and EV/EBITDA proved to be significantly under that of the

actual share price of $25.09, proving that the firm is overvalued. The sensitivity

analysis that we carried out in each valuation model showed that the firm was

overvalued as well. While each model provides its own unique insightful

information, we determined that the residual income model was the least

sensitive to changes in growth rates and terminal values. This model illustrated

that at almost every single growth rate and terminal value, the firm is

overvalued. In general, although National Instruments is a profitable company

and has a high likelihood of remaining profitable in the future, it is important to

take into account that the firm is worth less than its current market value.

172

Sales Diagnostics Net Sales/Cash From Sales

National Instruments Agilent Teradyne Synopsys 2003 1.036 0.993 1.042 0.995 2004 1.019 0.992 0.996 0.941 2005 1.015 0.993 1.064 0.969 2006 1.034 1.003 0.949 1.021 2007 1.019 1.008 1.032 1.001

Net Sales/Net Accounts Receivable National Instruments Agilent Teradyne Synopsys 2003 5.462 4.114 5.894 5.856 2004 5.888 6.548 8.310 8.257 2005 5.973 6.222 4.496 9.902 2006 5.633 7.186 8.707 8.937 2007 5.640 7.374 5.817 9.786

Net Sales/Unearned Revenue National Instruments Agilent Teradyne Synopsys 2003 52.270 17.053 53.281 2.951 2004 44.575 22.731 48.071 2.960 2005 35.700 22.854 33.202 2.386 2006 29.737 22.102 30.787 2.459 2007 20.514 21.767 26.290 2.100

Net Sales/Warranty Liabilities National Instruments Agilent Teradyne 2003 595.653 42.962 118.299 2004 630.783 44.483 113.298 2005 624.963 34.704 99.572 2006 761.715 39.157 105.160 2007 987.171 38.440 118.017

Net Sales/Inventory

National Instruments Agilent Teradyne 2003 10.973 4.490 6.294

2004 9.513 6.378 6.562 2005 9.102 6.489 7.323 2006 8.561 7.931 14.613 2007 8.955 8.429 13.725

173

Expense Diagnostics Asset Turnover

National Instruments Agilent Teradyne Synopsys 2003 0.811 0.710 0.758 0.510 2004 0.883 0.722 0.734 0.522 2005 0.940 0.694 0.562 0.463 2006 0.916 0.675 0.788 0.508 2007 0.904 0.718 0.709 0.463

CFFO/OI National Instruments Agilent Teradyne Synopsys 2003 1.564 0.219 (0.223) 2.009 2004 1.047 4.621 1.641 2.956 2005 1.126 4.162 (0.150) (4.498) 2006 1.116 1.366 2.223 6.995 2007 1.444 1.659 3.036 3.672

CFFO/NOA National Instruments Agilent Teradyne Synopsys 2003 0.416 (0.109) 0.063 2.124 2004 0.438 0.533 0.545 1.482 2005 0.610 1.051 0.032 1.582 2006 0.673 0.818 1.276 1.464 2007 0.973 1.210 0.351 3.287

Accruals/Net Sales National Instruments Agilent Teradyne Synopsys

2003 0.070 0.365 0.169 0.205 2004 0.033 0.062 0.064 0.174 2005 0.046 0.122 (0.074) 0.289 2006 0.038 (0.538) 0.185 0.165 2007 0.054 0.061 0.046 0.250

174

Liquidity Ratios Current Ratio

2003 2004 2005 2006 2007 National Instruments 4.369 4.745 4.135 4.900 4.350 Agilent 2.040 2.631 2.297 2.573 2.207 Teradyne 2.739 2.914 2.124 3.425 4.233 Synopsys 1.539 1.232 1.160 1.027 1.288 Industry Average 2.106 2.259 1.860 2.342 2.576 Adjusted 5.117 5.565 4.937 5.830 5.158

Quick Asset Ratio

2003 2004 2005 2006 2007 National Instruments 1.734 1.978 1.730 2.234 2.602 Agilent 1.413 3.058 2.701 1.921 1.540 Teradyne 1.848 1.643 1.799 2.971 3.707 Synopsys 0.901 0.646 0.618 0.520 0.682 Industry Average 1.387 1.782 1.706 1.804 1.976 Adjusted 3.597 3.797 3.098 3.777 3.351

Accounts Receivable

2003 2004 2005 2006 2007 National Instruments 5.462 5.888 5.973 5.633 5.640 Agilent 4.114 6.548 6.222 7.186 7.374 Teradyne 5.894 8.310 4.496 8.707 5.817 Synopsys 5.856 8.257 9.902 8.937 9.786 Indsutry Average 5.288 7.705 6.873 8.277 7.659

Accounts Receivable Days 2003 2004 2005 2006 2007

National Instruments 66.822 61.991 61.105 64.795 64.721

Agilent 88.718 55.740 58.665 50.790 49.497

Teradyne 61.927 43.925 81.187 41.922 62.745

Synopsys 62.332 44.203 36.862 40.840 37.299

Industry Average 70.992 47.956 58.905 44.517 49.847

175

Inventory Turnover

2003 2004 2005 2006 2007


Agilent 3.769 5.016 3.215 3.692 3.812

Teradyne 1.856 3.368 4.555 7.589 7.332


Inventory Turnover Days

2003 2004 2005 2006 2007


Agilent 96.847 72.766 113.542 98.857 95.755

Teradyne 196.669 108.368 80.129 48.095 49.782


Cash to Cash Cycle

2003 2004 2005 2006 2007


Agilent 185.5642137 128.506451 172.2065 149.6477 145.252

Teradyne 258.5957423 152.2923917 161.316 90.01685 112.5276

Synopsys 62.332 44.203 36.862 40.840 37.299



2003 2004 2005 2006 2007


Agilent 2.253 1.785 1.866 2.055 2.699

Teradyne 2.770 2.664 1.804 2.154 1.527

Synopsys 2.710 6.354 7.584 - 4.090


Adjusted 1.365 1.362 1.658 1.404 1.421

176

Profitability Ratios Gross Profit Margin

2003 2004 2005 2006 2007Agilent 16.07% 21.36% 50.46% 53.45% 54.78%Teradyne 70.51% 48.67% 37.80% 48.07% 46.58%Synopsys 79.58% 76.46% 74.33% 79.60% 80.68%Industry Average 55.39% 48.83% 54.20% 60.37% 60.68%Adjusted 73.78% 73.65% 73.89% 74.21% 75.39%National Instruments 73.78% 73.65% 73.89% 74.21% 75.39%


2003 2004 2005 2006 2007

National Instruments 64.31% 61.45% 60.21% 60.93% 61.60%

Agilent 67.84% 53.04% 45.85% 46.55% 44.00%

Teradyne 42.53% 37.94% 45.93% 33.14% 42.75%

Synopsys 58.33% 64.94% 76.57% 74.29% 68.48%

Industry Average 56.23% 51.97% 56.12% 51.33% 51.75%

Adjusted 53.22% 48.79% 49.76% 48.84% 49.39%


2003 2004 2005 2006 2007National Instruments 9.47% 12.20% 13.68% 13.28% 13.79%Agilent -16.23% 7.48% 4.61% 9.33% 10.77%Teradyne -13.04% 13.39% -8.13% 14.93% 3.83%Synopsys 16.56% 8.18% -6.03% 2.69% 9.74%Industry Average -4.24% 9.68% -3.18% 8.98% 8.11%Adjusted 37.20% 41.33% 39.49% 42.49% 43.09%

Net Profit Margin

2003 2004 2005 2006 2007National Instruments 7.83% 9.46% 10.76% 11.01% 14.46%Agilent -46.06% 6.76% 6.98% 66.50% 11.77%Teradyne -14.34% 11.72% 8.67% 14.65% 7.05%Synopsys 12.72% 6.81% -1.73% 2.26% 10.76%Industry Average -15.89% 8.43% 4.64% 27.80% 9.86%Adjusted 35.56% 38.59% 36.57% 40.22% 43.75%

177

Asset Turnover 2003 2004 2005 2006 2007


Agilent 0.545 0.819 0.656 0.737 0.736

Teradyne 0.712 0.790 0.544 0.729 0.640

Synopsys 0.595 0.473 0.474 0.512 0.562


Adjusted 0.810 0.864 0.896 1.064 0.984

Return on Assets

2003 2004 2005 2006 2007


Agilent -25.09% 5.54% 4.58% 48.99% 8.66%

Teradyne -10.21% 9.26% 4.71% 10.69% 4.52%

Synopsys 7.57% 3.22% -0.82% 1.16% 6.05%

Industry Average -9.24% 6.01% 2.82% 20.28% 6.41%

Adjusted 28.81% 33.35% 32.77% 42.78% 43.05%

Return on Equity

2003 2004 2005 2006 2007


Agilent -44.48% 12.36% 9.16% 81.03% 17.49%

Teradyne -20.43% 14.58% 7.29% 14.60% 6.32%

Synopsys 13.45% 5.19% -1.35% 2.03% 11.22%

Industry Average -17.15% 10.71% 5.03% 32.56% 11.68%

Adjusted 33.20% 38.48% 37.92% 50.31% 50.34%

Internal Growth Rate

2003 2004 2005 2006 2007


Agilent -0.251 0.055 0.046 0.490 0.087

Teradyne -0.102 0.093 0.047 0.107 0.045

Synopsys 0.076 0.032 -0.008 0.012 0.060

Industry Average -0.092 0.060 0.028 0.203 0.064

National Instruments Adjusted 0.298 0.358 0.352 0.458 0.466

178

Sustainable Growth Rate 2003 2004 2005 2006 2007


Agilent -0.445 0.124 0.092 0.810 0.175

Teradyne -0.204 0.146 0.073 0.146 0.063

Synopsys 0.134 0.052 -0.014 0.020 0.112

Industry Average -0.172 0.107 0.050 0.326 0.117


Capital Structure Ratios

Debt to Equity 2003 2004 2005 2006 2007National Instruments 0.195 0.197 0.207 0.209 0.239Agilent 1.230 1.002 0.654 1.020 1.336Teradyne 0.880 0.696 0.497 0.264 0.265Synopsys 0.610 0.654 0.757 0.855 0.822Industry Average 0.907 0.784 0.636 0.713 0.808Adjusted 0.154 0.157 0.176 0.169 0.194


2003 2004 2005 2006 2007

National Instruments (650.79) (2,022.45)

Agilent (8.00) (6.72) (6.42)

Teradyne 8.45 (10.07) 5.23 (18.31) (61.26)

Synopsys 4.70 52.80 5.31

Industry Average 6.57 21.37 0.85 (12.52) (33.84)

Adjusted (2,555.61) (6,853.87)

Debt Service Margin

2003 2004 2005 2006 2007


Agilent

Teradyne 25.030 822.026 42.128 1.499

Synopsys

Industry Average

Adjusted

179

Altman Z-Score 2003 2004 2005 2006 2007National Instruments 5.775 5.937 5.831 5.929 5.531Agilent 1.031 2.082 2.125 1.927 1.759Teradyne 2.541 3.354 2.801 4.456 4.350Synopsys 1.954 1.580 1.241 1.279 1.621Industry Average 1.842 2.339 2.056 2.554 2.576Adjusted 6.515 6.805 6.705 6.956 6.526

Cost of Debt

Cost of Debt Debt Interest

Rate Weight Weighted Average Cost of Debt

Accounts payable $ 36,187

2.11% 0.229 0.0048

Accrued compensation 25,778 2.11% 0.163 0.0034Deferred revenue 36,091 2.11% 0.229 0.0048Accrued expenses and other liabilities 10,437 2.11% 0.066 0.0014Other taxes payable 16,843 2.32% 0.107 0.0025Deferred income taxes 21,221 2.32% 0.135 0.0031Other long-term liabilities 11,169 6.38% 0.071 0.0045Total Liabilities 157,726 Cost of

Debt0.0246

180

Weighted Average Cost of Equity 3 Month Rates- National Instruments SUMMARY OUTPUT

Regression Statistics

Multiple R 0.585

R Square 0.342

Adjusted R Square 0.312

Standard Error 0.075

Observations 24

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 0.02 0.02 1.28 0.21 -0.01 0.05

X Variable 1 1.42 0.42 3.38 0.00 0.55 2.29

SUMMARY OUTPUT


Multiple R 0.520

R Square 0.271



Observations 36


Intercept 0.02 0.01 1.25 0.22 -0.01 0.04

X Variable 1 1.40 0.40 3.55 0.00 0.60 2.21

SUMMARY OUTPUT


Multiple R 0.479

R Square 0.229



Observations 48


Intercept 0.01 0.01 0.61 0.54 -0.02 0.03

X Variable 1 1.53 0.41 3.70 0.00 0.70 2.36

SUMMARY OUTPUT

181


Multiple R 0.467

R Square 0.218



Observations 60


Intercept 0.01 0.01 0.59 0.55 -0.02 0.03

X Variable 1 1.48 0.37 4.02 0.00 0.74 2.22

SUMMARY OUTPUT


Multiple R 0.255

R Square 0.065



Observations 72


Intercept 0.01 0.01 0.81 0.42 -0.01 0.03

X Variable 1 0.80 0.36 2.20 0.03 0.08 1.53

182

2 Year Rates- National Instruments SUMMARY OUTPUT


Multiple R 0.581

R Square 0.338



Observations 24


Intercept 0.020 0.016 1.276 0.215 -0.013 0.053

X Variable 1 1.406 0.420 3.351 0.003 0.536 2.277

SUMMARY OUTPUT


Multiple R 0.517

R Square 0.267



Observations 36


Intercept 0.016 0.013 1.248 0.221 -0.010 0.042

X Variable 1 1.390 0.395 3.519 0.001 0.587 2.193

SUMMARY OUTPUT


Multiple R 0.477

R Square 0.228



Observations 48


Intercept 0.008 0.013 0.636 0.528 -0.017 0.033

X Variable 1 1.524 0.414 3.683 0.001 0.691 2.356

SUMMARY OUTPUT


Multiple R 0.466

R Square 0.217


183


Observations 60


Intercept 0.007 0.011 0.642 0.524 -0.015 0.029

X Variable 1 1.481 0.370 4.007 0.000 0.741 2.221

SUMMARY OUTPUT


Multiple R 0.253

R Square 0.064



Observations 72


Intercept 0.010 0.012 0.835 0.406 -0.014 0.034

X Variable 1 0.800 0.365 2.193 0.032 0.072 1.528

184



Multiple R 0.580

R Square 0.336



Observations 24


Intercept 0.02 0.02 1.29 0.21 -0.01 0.05

X Variable 1 1.40 0.42 3.34 0.00 0.53 2.27

SUMMARY OUTPUT


Multiple R 0.515

R Square 0.265



Observations 36


Intercept 0.016 0.013 1.259 0.217 -0.010 0.042

X Variable 1 1.381 0.394 3.505 0.001 0.580 2.182

SUMMARY OUTPUT


Multiple R 0.477

R Square 0.227



Observations 48


Intercept 0.008 0.013 0.658 0.514 -0.017 0.034

X Variable 1 1.518 0.413 3.679 0.001 0.688 2.349

SUMMARY OUTPUT


185

Multiple R 0.466

R Square 0.217



Observations 60


Intercept 0.008 0.011 0.690 0.493 -0.014 0.029

X Variable 1 1.480 0.369 4.006 0.000 0.741 2.220

SUMMARY OUTPUT


Multiple R 0.253

R Square 0.064



Observations 72


Intercept 0.010 0.012 0.868 0.388 -0.013 0.034

X Variable 1 0.799 0.365 2.188 0.032 0.071 1.528

186



Multiple R 0.579

R Square 0.336



Observations 24


Intercept 0.021 0.016 1.300 0.207 -0.012 0.053

X Variable 1 1.395 0.419 3.333 0.003 0.527 2.263

SUMMARY OUTPUT


Multiple R 0.515

R Square 0.265



Observations 36


Intercept 0.016 0.013 1.268 0.213 -0.010 0.042

X Variable 1 1.378 0.394 3.501 0.001 0.578 2.178

SUMMARY OUTPUT


Multiple R 0.477

R Square 0.227



Observations 48


Intercept 0.008 0.013 0.671 0.505 -0.017 0.034

X Variable 1 1.517 0.412 3.680 0.001 0.687 2.347

SUMMARY OUTPUT


Multiple R 0.466

187

R Square 0.217



Observations 60


Intercept 0.008 0.011 0.713 0.479 -0.014 0.030

X Variable 1 1.480 0.369 4.008 0.000 0.741 2.219

SUMMARY OUTPUT


Multiple R 0.253

R Square 0.064



Observations 72


Intercept 0.011 0.012 0.883 0.380 -0.013 0.034

X Variable 1 0.799 0.366 2.187 0.032 0.070 1.528

188



Multiple R 0.578

R Square 0.334



Observations 24


Intercept 0.016 0.016 1.012 0.322 -0.017 0.048

X Variable 1 1.427 0.429 3.324 0.003 0.537 2.317

SUMMARY OUTPUT


Multiple R 0.512

R Square 0.263



Observations 36


Intercept 0.011 0.013 0.890 0.380 -0.015 0.037

X Variable 1 1.405 0.404 3.480 0.001 0.585 2.226

SUMMARY OUTPUT


Multiple R 0.476

R Square 0.226



Observations 48


Intercept 0.003 0.013 0.249 0.805 -0.022 0.028

X Variable 1 1.553 0.423 3.668 0.001 0.701 2.405

SUMMARY OUTPUT


Multiple R 0.465

189

R Square 0.216



Observations 60


Intercept 0.003 0.011 0.246 0.807 -0.019 0.025

X Variable 1 1.517 0.380 3.996 0.000 0.757 2.277

SUMMARY OUTPUT


Multiple R 0.252

R Square 0.064



Observations 72


Intercept 0.008 0.012 0.651 0.517 -0.016 0.032

X Variable 1 0.821 0.376 2.180 0.033 0.070 1.571

190

Weighted Average Cost of Capital Weighted Average Cost of Capital

L/Value of Firm

Cost of Debt

Tax Rate

E/Value of Firm

Cost of Equity

WACC

WACC (Before Tax) 19.3% 2.46% 0 80.7% 0.1566 0.131124WACC (After Tax) 19.3% 2.46% 0.06 80.7% 0.1566 0.130839

Weighted Average Cost of Capital (Adjusted) L/Value of

Firm Cost of Debt

Tax Rate

E/Value of Firm

Cost of Equity

WACC

WACC (Before Tax) 17.4% 2.46% 0 82.6% 0.1566 0.133632WACC (After Tax) 17.4% 2.46% 0.06 82.6% 0.1566 0.133375

191

Method of Comparables Trailing P/E

Net

Income # of Shares Outstanding Price P/E NATI PPS

National Instruments 107 78.83 $18.92 National Instruments Restated 324 78.83 $57.34

Agilent 638 350 23.00 13.71 Teradyne 77.71 169.29 5.19 123.72 Synopsys 1212.47 144.09 18.48 14.19

Average 13.95

Forecasted P/E Company Forecasted EPS Price P/E NATI PPS National Instruments 1.59 $16.97 National Instruments Restated 3.61 $38.39

Agilent 1.7 23.00 11.02 Teradyne 0.04 N/A N/A Synopsys 1.24 17.45 10.25 Industry Avg - NATI 10.635

Price to Book

PPS BPS P/B Industry Average Comparables

National Instruments 25.09 2.992 5.26 1.52 4.55 National Instruments Restated 25.09 9.115 2.75 1.52 13.85 Agilent 23 8.908 2.77 Teradyne 5.19 7.036 0.8 Synopsys 17.45 10.714 1.72

P.E.G

ComparableCompany PE EGR t+5 P.E.G. Industry Avg. NATI PPS National Instruments 18.92 1.22 $23.08National Instruments Restated 39 1.22 $47.58 Agilent 13.71 14.5 0.946 Teradyne 123.72 15 8.248 (Throw Out) Synopsys 14.19 9.5 1.494 Industry Avg - NATI 13.95 13 1.22

192

Price/EBITDA Comparable

Company Market Cap (Billions) EBITDA P/EBITDA

Industry Avg. NATI PPS

National Instruments 1.965 1.30 19.65 7.83 $10.14 National Instruments Restated 1.965 4.04 6.14 7.83 $31.63 Agilent 2.29 2.601 8.84 Teradyne 0.64 0.834 6.23 Synopsys 6.59 2.073 8.42 Industry Avg - NATI 7.83

EV/EBITDA




Synopsys 12.39 2.07 5.98

Teradyne 3.77 0.83 4.528


EV/EBITDA- GOODWILL




Synopsys 4.72 2.07 2.28

Teradyne 3.08 0.83 3.70



Market Cap (Bill.) FCF P/FCF

Industry Average NATI PPS

NATI 1.965 0.16 12.12962963 $14 $35.12 Synopsys 2.29 0.51 4.463937622 Teradyne 0.64076 0.24 2.669833333 Agilent 6.59 0.19 35.05319149

193

Discount Dividend Model

Discounted Free Cash Flow

194

Adjusted Discounted Free Cash Flow

Residual Income

195

Residual Income Adjusted

Abnormal Earnings Growth (A.E.G.)

196

Adjusted Abnormal Earnings Growth (A.E.G.)

197

Long-Run Residual Income Perp

ROE Ke 0.17 0.175 0.18 0.185 0.19

0.0957

0.1163 87.54 94.83 102.13 109.42 116.72

0.1367 20.97 22.72 24.46 26.21 27.96

0.1566 12.19 13.21 14.22 15.24 16.25

0.1943 6.92 7.5 8.07 8.65 9.23

0.2317 4.92 5.33 5.74 6.15 6.56

0.2693 3.85 4.17 4.5 4.82 5.14

Growth Rate Held Constant at 11%

Overvalued < $20.07 $20.07<Fair

Valued>$30.11 Undervalued>$30.11

ROE Growth 0.17 0.175 0.18 0.185 0.19

0.070 10.93 11.48 12.03 12.57 13.12 0.080 11.12 11.74 12.36 12.98 13.6 0.090 11.37 12.08 12.79 13.5 14.21 0.100 11.71 12.54 13.38 14.22 15.05 0.110 12.19 13.21 14.22 15.24 16.25 0.120 12.93 14.23 15.52 16.81 18.11 0.130 14.24 16.02 17.8 19.57 21.35 0.140 17.11 19.96 22.81 25.66 28.52

Ke Held constant at 15.66%

Overvalued < $20.07 $20.07<Fair

Valued>$30.11 Undervalued>$30.11

Growth

Ke 7% 8% 9% 11% 12% 0.13 0.14

0.0957 39.19 58.39 144.96

0.1163 22.1 25.65 31.91 94.91

0.1367 15.57 16.67 18.24 24.92 34.25 71.45

0.1566 12.17 12.52 12.98 14.49 15.86 18.26 23.55

0.1943 8.73 8.64 8.53 8.25 8.05 7.79 7.44

0.2317 6.87 6.66 6.43 5.85 5.48 5.03 4.49

0.2693 5.71 5.47 5.21 4.58 4.2 3.77 3.27

ROE Held Constant at 18.13%


Book Value Equity (Millions)

661,086

Ke 0.1566

ROE 0..1813

G 0..07

MVE 12/31/07 4,424,497

divide by shares 78830

Model Price on 12/31/07 10.78

time consistent Price 12.17

Observed Share Price (11/3/2008) $25.09

Initial Cost of Equity (You Derive) 0.1566

198

Adjusted Long-Run Residual Income Perpetuity

Book Value Equity (Millions)

661,086

Ke 0.1566

ROE 0.2511

G 0.0700

MVE 12/31/07 1,382,479

divide by shares 78830

Model Price on 12/31/87 17.54

time consistent Price 19.80

Observed Share Price (11/3/2008) $25.09

Initial Cost of Equity (You Derive) 0.157

Long Run Residual Income Restated

Growth Ke 7% 8% 9% 11% 12% 0.13 0.14

0.0957 63.77 98.63 255.78

0.1163 35.95 43.32 56.3 205.86

0.1367 25.34 28.16 32.19 49.31 73.25 168.66

0.1566 19.8 21.25 22.9 28.67 33.91 43.1 63.36

0.1943 14.17 14.56 15.02 16.28 17.16 18.31 19.89

0.2317 11.17 11.25 11.34 11.57 11.71 11.88 12.09

0.2693 9.3 9.25 9.19 9.06 8.98 8.89 8.79

ROE Held Constant at 25.11%


199

References

• Business Analysis & Valuation: Using Financial Statements; Palepu & Healy

• Wikipedia.com

• National Instruments 10-K

• Synopsys 10-K

• http://cpaclass.com/gaap/sfas/gaap-sfas-5.htm

• Teradyne (10-K)

• Agilent (10-K)

• www.wsj.com- “Instruments Recognizes Global Achievements in

Engineering a Science, ‘About National Instruments’ ”

• www.wsj.com- “National Instruments Introduces NI-Single Board RIO

Platform for Embedded System Development”

• www.wsj.com- “Agilent’s Net Falls 8.6%”

• www.wsj.com- “Sun Gives Away Virtualization”

• www.wsj.com- “The Tech Sector Gets Kind of Good Spending News”

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