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Xyratex, Ltd. (NASDAQ:XRTX)

F1Q10 Earnings Call

March 31, 2010 5:00 pm ET

Executives

Brad Driver – Vice President Investor Relations

Steve Barber – Chief Executive Officer & Director

Richard Pearce – Chief Financial Officer & Director

Analysts

Keith Bachman – BMO Capital Markets

Ananda Baruah – Brean, Murray, Carret & Co.

[Nicolas Suchi] – Real Securities

Richard Kugele – Needham & Co.

[John Flack – Citigroup]

Nehal Chokshi – Technology Insights Research

Operator

Welcome to the Q1 2010 Xyratex earnings conference call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Brad Driver, Vice President of Investor Relations.

Brad Driver

I’d like to welcome investors, research analysts and others listening today to Xyratex’s fiscal first quarter 2010 results conference call. On our call today are Steve Barber, Chief Executive Officer and Richard Pearce, Chief Financial Officer. Today’s call is being recorded and will be available for replay on Xyratex’s investor relations homepage at www.Xyratex.com.

I’d like to remind everyone that today’s comments including the question and answer session will include forward-looking statements including but not limited to a forecast of future revenue and earnings and other financial and business activities. These statements are subject to risks and uncertainties that may cause actual results and events to differ materially. These risks and uncertainties are detailed in Xyratex’s filings with the Securities & Exchange Commission including the company’s 20F dated February 23, 2010.

Also, please note that in addition to reporting financial results in accordance with general accepted accounting principles or GAAP, Xyratex will report certain non-GAAP financial results. These non-GAAP measures together with corresponding GAAP numbers and reconciliations to GAAP are contained in our earnings press release. We encourage listeners to review these items.

I’d now like to turn the call over to Richard to review the financial details of the quarter.

Richard Pearce

Our press release is available on both PR Newswire and our website. I’d now like to provide you with some commentary about our results for the first quarter. Please note that all numbers are in accordance with GAAP unless stated otherwise. Total revenue was $319 million, up 73.5% as compared to the first quarter of last year and up 31.3% from our prior fiscal quarter. Sales of our network storage solutions products were $271 million or 85% of total revenue. This is an increase of $105.3 million or 63.5% compared to the first quarter of last year and up 33.2% compared with $203.4 million in our prior fiscal quarter.

The increase in revenue primarily reflects strong demand across our customer base and also shipments and backlog from Q4 of approximately $30 million. We worked very closely with our suppliers and customers to enable us to secure additional components to meet both backlog and new incremental demand. Sales of our storage infrastructure products were $48 million or 15% of total revenue, up $29.8 million or 164% compared to the first quarter of last year and up 21.4% over our prior fiscal quarter.

While in line with our expectations, we experienced a material increase in demand during the quarter that will be shipped and recognized as revenue in Q2 and Q3. I’ll provide more details in the outlook portion of my remarks. Gross margin was 18.1% for the quarter compared to 11.4% in the same period a year ago and 15.6% in our prior fiscal quarter. This increase is primarily due to the significant increase in revenues relative to the fix overhead costs.

Gross margin also benefitted from a higher proportion of storage infrastructure revenues as well as favorable product mix within the network storage solutions business. The gross margin for our network storage solutions products was above our expectations at 15.2%. This compares with 11.1% last year and 13.2% last quarter. The better than expected NSS gross margin reflects a number of changes to product mix including slower transition to a next generation product by one of our major customers.

The legacy product has higher margins. However, we do expect that the transition to the new product will accelerate over the next couple of quarters. The gross margin for the storage infrastructure products was 34.7% compared to 15.2% last year and 28.7% last quarter, primarily a result of the increase in revenue in the quarter relative to the fixed overhead costs as well as product mix.

Turning to non-GAAP expenses, our operating expenses totaled $27.9 million compared to $29.6 million last quarter and lower than our original forecasts. This reduction is primarily due to a currency benefit of approximately $3 million partially offset by increased stock costs including a bonus provision for the current year. We continue to expect to increase our operating expenses by approximately 25% over the next quarter in support of the current and future business opportunities. On a non-GAAP basis, net income was $29.4 million or $0.96 per diluted share compared to a net loss of $10.5 million a year ago and net income of $7.9 million in the prior quarter.

Turning our attention to the balance sheet, cash and cash equivalents at the end of the quarter was $53.7 million compared with $51.9 million at the end of Q4. Cash flow from operations was $5 million in the quarter. Inventory increased by $50.1 million in the quarter to $158.9 million. Inventory turns was 6.5 compared to 7.5 for the previous quarter. This reflects our increase in working capital required to support increased revenue in the next quarter.

Accounts receivable increased by $76.8 million in the quarter to $201.6 million. Days sales outstanding were 58 in the quarter compared to 47 in the previous quarter due primarily to high February revenues. Headcount at the end of the February quarter was 1,701 permanent employees, an increase of 3.4% or 56 employees. Half of this increase has been in support of the growth in our global manufacturing and fulfillment capability to meet increased customer demand with the balance being in key technical skill areas needed to support increased investment in our product development activities.

In summary, this was a very good quarter for the company in terms of revenue and EPS and in our response to meeting increased customer requirements. The markets we serve remain highly competitive however, I believe we remain well positioned to take advantage of the growth opportunities in the current markets that we serve as well as potential incremental new markets we are looking to grow in 2010 and beyond.

Now, before I turn it to Steve for his comments, I’d like to provide you with our business outlook for our fiscal second quarter 2010 ending May 31st. Our business outlook is based on current business expectations. It should be noted that there are a series of forward-looking statements in today’s guidance that involve risk and uncertainty. Actual results may differ materially from our statements or projections. In order to clearly understand the risks involved, it its recommended that each investor review the risk factors outlined in our Form 20F filing.

For our second quarter 2010 we are projecting total revenue to be in the range of $400 to $460 million, up 105% to 136% as compared to last year and up 25% to 44% compared to Q1. This is represented by revenue from network storage solutions of $300 to $335 million and from storage infrastructure of $100 to $125 million. Our increased revenues in network storage solutions reflect the transition to new products of a major customer as I described previously. These contain higher density and higher cost disk drives which result in reduced gross margin.

In addition, Xyratex will provide 100% of the volume of this product in its first 12 months. Q2 gross margin is expected to be 17.7% to 19.2%. We are estimating non-GAAP earnings per share to be between $1.10 and $1.63. Non-GAAP earnings per share excludes non-cash [stock] compensation and amortization of intangible assets. The number of shares outstanding at the end of Q2 on a weighted average treasury method is expected to be 31 million. Our cash position at the end of Q2 is expected to be approximately $50 million.

I’ll now hand it over to Steve for his comments.

Steve Barber

I was very pleased with our record performance and good execution for the quarter. Our fiscal first quarter clearly reflected a strong business environment and I continue to be encouraged by the industry dynamics in both businesses. Although we continue to be challenged by a number of component supply constraints and extended lead times through Q1, we successfully managed to improve material supply throughout the quarter while working very closely with our suppliers and in some cases taking joint actions with our customers to increase component allocations from certain suppliers.

Our decision last November/December to order key components beyond our customer demand paid dividends enabling us to secure additional material supply, ship the demand backlog from 4Q 09 and meet new upside demand we saw within the quarter. I feel the strategic and financial investments we made during 2009 have improved our market and financial position. The actions we took enabled us to rapidly ramp production capability to meet the resurgence in customer demand we saw in 4Q 09 and 1Q 10 as well as execute on key next generation technology development.

I believe our team has now set the right foundation for effective execution on our strategic goals as a company. I’ll now review our two businesses separately starting with network storage solutions. Our fiscal first quarter revenue was well above our expectations at $271 million as we experienced strong and increasing demand for most of our major customers through the quarter. Customers such as 3PAR, [Compalence], Dell EqualLogic, EMC Data Domain, IBM XIV and NetApp are providing a range of products and solutions that enable real and demonstrable gains in efficiency to users of their technologies.

These efficiencies coupled with the ongoing growth in data creation, replication and archiving is driving strong end user demand for our customer’s data storage solutions using our technology. Looking at some of the specific drivers to the upside we experienced in the quarter, a number of demand improvements led us to exceeding our expectations. First, we saw resurgence in demand from one of our major customers who revised their 1Q demand upwards mid January after forecasting a softening in end user market demand exiting their Q4. With a combination of some level of finished goods at the end of 4Q and improvements in material supply, we were able to respond to some, although not all, of this upside 1Q demand.

Another major customer took the decision mid quarter to swap out some legacy installed products and replace with Xyratex based products at selected customer sites. Again, through improved material supply we were able to meet much of this upside demand. In addition, we saw continued success and positive momentum in specific segments including video editing, media and entertainment. This sector has seen a recovery in demand specifically for video and film creation after the decline in 2009 largely related to the growth in 3D and high definition video.

Many of the recent high grossing films were created using technologies that included Xyratex’s solutions. Lastly, we continue to see growth being enabled through the delivery of products that target other vertical applications with technology solutions that meet the demanding storage system needs of such applications. Such events and trends have all contributed towards the overall positive demand environment we have been experiencing since late fall 2009.

We shipped 612.71 petabytes of external storage in our fiscal first quarter representing a 40.3% growth over the prior quarter and 111.3% growth over a year ago. Based on recently published data, our total petabytes shipped for the calendar year 2009, we estimate that Xyratex once again maintained its position as the leading player in the market supplying 15.2% of capacity on an annual basis.

Our first quarter 2010 shipped capacity was made up of the following in terms of disk driver interface: in fiber channel 78.12 petabytes; starter 453.03 petabytes; SAS 81 petabytes; and SSDs 570 terabytes. Our relationship with our key customers remains strong as we bring to market next generation technologies that support their demand requirements and improving end user demand environment. As we move forward, we will continue to identify incremental opportunities to expand and extend our product portfolio within these customers.

However, as always, we recognize the potential risk of these customers making decisions to strengthen their internal resources, rationalize their hardware base to provide a common product platform and/or restructure their business models to source in house design products with alternative providers such as contract manufacturers or ODMs. We continue to invest in next generation technologies, innovation and fulfillment capabilities as well as focusing on reducing hardware costs through design and operational process enhancements.

With successful execution against these goals, we believe we will retain our leadership position in this market in 2010. Overall, I’m very pleased with our execution over the last year and specifically in the last quarter. As I mentioned earlier, I believe the structural cost reduction actions taken and strategic investments made over the last 12 months have resulted in our ability to be more efficient and responsive to our customer requirements.

We remain highly focused on securing the required material supplies to meet all our customers’ requirements. Material supply remains a concern for us given the forecast for continued tightness in supply throughout all of 2010 in a number of key commodity areas including semiconductor memory, power devices and disk drives. While we continue to be quoted 16 week plus lead times for certain semiconductor components, I feel confident the actions we have taken in recent months in working with our supply chain to secure material supply will enable us to meet most, if not all, of the demand our customers are forecasting.

Moving on now to our storage infrastructures business, in the first quarter revenues in this business were $48 million a 21.5% growth over the fourth quarter results and in line with our expectations. As anticipated, after a period of significant constraint in capital expenditure within the disk drive industry, our two major customers have no resumed capital investment. During the first quarter we began our shipment ramp to fulfill the increases in cap ex spending by our major customers.

Our anticipated first half revenue, as Richard previously discussed, represents a further increase in spending by our two major customers. We view approximately $50 to $70 million of this increase cap ex spending in the first half of our fiscal year as primarily catch up in investments from the historically low levels of cap ex spending during 2009. The demand forecast for 2010 remains strong and as stated in our previous earnings call, we continue to expect that the second half revenue will be broadly equivalent to first half revenue.

During the quarter, based on changes to original forecasts, we saw clear evidence of the disk drive industry accelerating their investments to increase overall production capacity. In addition, we believe we will benefit in 2Q and 3Q from the disk drive industry’s aggressive investment in technology to maintain the rate of [inaudible] innovation as well as expand the capacity while improving capital productivity.

With our strong portfolio of products, including the Optimus 2.5 inch back end test product, I believe we are well positioned to benefit from this emerging market dynamic. Our strong track record of innovation and broad technology portfolio has been recognized by the disk drive industry which has resulted in active engineering engagements in back end tests now with the top four disk drive manufacturers.

The introduction of Optimus, our 2.5 inch disk drive dedicated test platform has been favorably viewed by the industry and we’re pleased with the adoption rates we have achieved. The investments we made in technology innovation during 2009 are now being translated in to the revenue growth we’re experiencing. During the quarter, we completed the production introduction of the next major enhancement of the Optimus platform. We have now began volume production shipments of the Optimus USB interface platform which will be a major component of our near term back end test revenue.

In addition, our incumbent back end test platforms are the only commercially available systems capable of testing 3.5 inch disk drive form factors. These systems represent a significant portion of our first quarter back end test revenue. While Sandler continue to predicts strong 2.5 inch Form Factor disk drive volume growth it would appear that 3.5 inch demand remains strong in support of high capacity digital video recorder, external personal storage devices and enterprise archiving applications.

We’ve also successfully launched and shipped a number of new products in addition to the Optimus platform. Titan, our substrate optical inspection platform is in production qualification and is progressing as planned at a major large substrate supplier. Phoenix, our next generation media and [inaudible] platform has shipped and will enter production qualification within this fiscal quarter. Finally, our [inaudible] system development and customer collaboration is progressing as expected.

With regard to improved operational efficiency, during the 2009 fiscal year we focused on adjusting the business model without sacrificing critical long term investments. We’re now seeing the benefits in our storage infrastructure business of successfully executing to these strategies. We are further accelerating our investments within the business during this fiscal year to both bring forward availability of key products as well as expand our product road map to meet emerging customer’s needs.

As a result, we anticipate new products resulting from these strategic technology investments with a little more than 40% of the fiscal year 2010 revenue for the storage infrastructure business. Increased technology investments during the fiscal year within the storage infrastructure business are focused on our incumbent product portfolio within the disk drive assembly and integration segments while simultaneously broadening Xyratex’s capital footprint in the disk drive component segments of disk drive head fabrication and disk drive substrate and media manufacturing.

In summary, I feel very satisfied with our strategic position within the disk drive market and the execution of our technology investment strategy. We are a valued partner with the two leading disk drive manufacturers and are making early, but encouraging progress, with additional leading companies in the disk drive and disk drive component space. I believe our technology and our comprehensive product portfolio will enable us to maintain a leadership position in the areas where we currently provide capital equipment.

Our expanded investments in technology, innovation and product development position us well to expand our footprint within the capital equipment processes of our current customers as well as enabling us to access new customers. I’m confident that our focus, extensive domain experience and execution will allow us to meet the requirements of our customers over the coming years.

I’d once again like to take this opportunity to thank all of our employees worldwide for their contribution towards the company’s performance. The new fiscal year is off to a very strong start requiring considerable focus and execution by the entire organization. I appreciate the efforts of all our employees ensuring that we do our best to meet the strong demand requirements of our customers and execute effectively on our strategic investments.

I believe we are well positioned in both the market sectors we serve to deliver an outstanding year in all areas of our business. That concludes our formal comments. I’d now like to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Keith Bachman – BMO Capital Markets.

Keith Bachman – BMO Capital Markets

I had a couple of things if I could. Number one, on the network storage solution guidance, I just wondered if you could talk a little bit about the contribution from players. In other words are all your various customers contributing equally to that sequential and how much of that sequential growth would you contribute to backlog if any, backlog burn if any?

Richard Pearce

If I can answer your second question first Keith, I think the majority of the backlog that we saw in Q4 we shipped in Q1. There’s a small bit of backlog still from Q1 to go in to Q2 but as Steve said, I think we met most of our customers’ demands through the actions we took with the supply base in Q1 so there’s not a significant amount of backlog. In terms of the distribution among our key customers, again as Steve said, the demand was pretty much spread both in Q1 and as we look in Q2 across that customer base.

If I look at Q1 NetApp, Dell and IBM have very similar proportions of the overall revenue. NetApp around 50%, Dell around 20% and IBM just over 10% and as we project in to Q2 we don’t expect those proportions to differ significantly.

Keith Bachman – BMO Capital Markets

In other words NetApp will remain about 50%?

Richard Pearce

Yes.

Keith Bachman – BMO Capital Markets

Then to follow up, will you anticipate that some of the balance sheet that you built both in terms of AR and inventory will be normalized over the course of the quarter or what will the balance sheet look like at the end of this quarter? Will you recoup some of that in cash?

Richard Pearce

I think in Q2, and obviously I’ve given the projections on cash that we actually don’t increase and probably stay about level in Q2. We really expect to see the cash benefits coming in Q3 and Q4. So there will be a big ramp and obviously significant receivables happening in Q2 flowing through in to Q3 and then in to Q4.

Keith Bachman – BMO Capital Markets

My last question, you mentioned that the drive business you thought second half would equal first half and you had some upside this quarter or I should say upside in the guidance in terms of what I think you previously commented, yet that equation still holds right? So this $48 million revenue that you booked this quarter plus the guidance, you still think that that will roughly reflect the second half?

Richard Pearce

Yes, that’s correct.

Keith Bachman – BMO Capital Markets

Is mix any different?

Richard Pearce

No, mix is very similar in first half to second half.

Operator

Your next question comes from Ananda Baruah – Brean, Murray, Carret & Co.

Ananda Baruah – Brean, Murray, Carret & Co.

Steve, have you given any thoughts I guess given the strength in the NSS business across the board on what to expect from seasonality as we go in to the second half of the year in that business? It sounds like you could see at least typical seasonality in that business?

Steve Barber

Very much so. The overall base of demand is certainly increased as indicated in the discussion. But, yes, we’re expecting very, very similar demand profile through the course of this year as we’ve seen historically.

Ananda Baruah – Brean, Murray, Carret & Co.

Then I guess what would that suggest given the mix of the business, the potential implications on margins in the second half of the year if that were to materialize?

Richard Pearce

In terms of margins, as I said during the call, we have seen some benefits in Q1 which to a degree were unexpected. I’d go back to previous statements I’ve made on margins in the NSS side of the business, but in the medium term we do expect to see margins between 12% and 13% and in fact, that continues to be my expectation in the medium term and expecting actually to revert back to that type of margin profile as of next quarter.

Overall, what we’ve seen is while we’ve seen growth across the board, we have seen our Tier-1 customer growing at a greater rate than our Tier-2 and smaller customers. If that continues towards the back end of the year, we could actually see margins drop further from a percentage basis but obviously overall gross margin on an absolute level increasing so margins could move in to the 11.5% to 12.5% range if the trend continues in terms of the Tier-1 customers.

Ananda Baruah – Brean, Murray, Carret & Co.

Then I guess just going over to SI, your second half of the year comments, can you give us any sense for what the balance of – I guess what the tail of kind of the first half Seagate, Western Digital orders sort of from the capacity increases might be that you’re seeing now relative to sort of what some of the new products that you guys are shipping might be?

Richard Pearce

I think obviously in terms of customers we’re expecting a relatively balanced profile between our two major customers as we go in to the back half of the year. Primarily what I would say is that our legacy products, some of those products we announced more recently and based on the developments that we made last year. Can you repeat some other parts of the question?

Ananda Baruah – Brean, Murray, Carret & Co.

I think I asked the question poorly, I guess I’m wondering if to meet the guidance for the second half of the year in SI, if that’s contingent on you getting some of the newer products to market as the year goes on?

Richard Pearce

To a small extent but not to a large extent no.

Ananda Baruah – Brean, Murray, Carret & Co.

Is there enough leverage left in the business, given it sounds like the mix is going to be similar, that SI margins could potentially be sort of in the mid 30s kind of range through the second half of the year?

Richard Pearce

I think so. Historically and more recently we’ve guided to around 30%. I think with the trajectory in terms of overall revenue then I would pitch the margin in kind of the 30% to 35% region and actually at sort of revenue levels that we’re seeing based on the operational cost efficiency that we get potentially up to the higher end of that range.

Operator

Your next question comes from [Nicolas Suchi] – Real Securities.

[Nicolas Suchi] – Real Securities

When the stock goes up there’s been a fade, in other words people have been selling in to it. There are people that feel that the cycle is going to peak in the second half of 2010. Obviously they’ve been wrong. You’ve talked about the cyclicality in your proxy but you also point out IDC’s study that the amount of data being stored is going to increase by 46% a year through 2013. Can you address that dichotomy?

Steve Barber

There doesn’t appear to be any trends or indicators that show a decline in the data growth whether you look at the expansion of central networking sites, consumer content creation is exploding by any measure. I think we feel the analyst expectations on data growth are realistic for everything that we’re seeing and ultimately consumer content ends up generally on enterprise based technology at some point. So that’s the market I think our customers are seeing and I think there’s always the continued speculation in the marketplace as to whether the demand is real.

Certainly some of our suppliers we’re in discussion with are still questioning whether the demand for their components is real or is double booking, or it’s an anomaly. That environment, I think is going to take some time to settle. I think people still are slightly nervous. However, in the discussion we’re having with our customers, they are seeing very strong end user demand in storage. I can’t speak to the wider IT sector but storage appears to be very strong.

[Nicolas Suchi] – Real Securities

The other thing is just this last quarter where you gave quite wide guidance, certainly the guidance is magnificent for this coming quarter, is there any way you can tighten it up a little bit? Also, when are Wall Street analysts going to come around to this fabulous story?

Steve Barber

I can’t answer the second question. The reason for some caution on the range is really about material supply. I think we have made great progress in working very closely with our suppliers, there is still some uncertainty and some risk in material supply which is a fundamental reason why we’ve provided the range that we have.

Operator

Your next question comes from Richard Kugele – Needham & Co.

Richard Kugele – Needham & Co.

Just a few things for me. Obviously paranoia has been in bed and bloom here this spring so any thoughts would be helpful specifically on the SI side, what are your customers saying? How are they viewing the timing of these capacity additions? Is this something that is necessary to achieve 15% to 20% or are they thinking greater than that, or any thoughts around that? Then obviously on the other side of the business from a drive procurement perspective, seasonality should have allowed you to get some more drives. It looks like that was the case but any comments on drive availability today and then in the second half and what you’re seeing from a pricing perspective?

Steve Barber

There’s a few questions there. I think ultimately it’s a slightly strange this year with regard to disk drives. I think you’ve seen it in a number of research coverage on the state. The sector is constrained in terms of units it can produce predominately by [inaudible] or substrate supply. There are significant investments in that space taking place but they only really come on line at the back end of this year or early 2011. Therefore, a range of disk drive volumes this year in that 640 to 670 million units is pretty much the extent the industry can achieve based on everything we can see today.

In that environment, I think we’ll see a situation where overall drive supply remains tight through the course of this year. I would add to it in terms of the enterprise space, bear in mind enterprise drives is a relatively small proportion of total drive shipments, but in a constrained component environment I think the drive companies will remain motivated to utilize components in high value, high margin product. Therefore, I don’t see enterprise being as constrained as other of the disk drive sector. Having said all that, we continue to see relatively flat pricing. Supply I think is there but it’s tight. Pricing remains pretty flat.

Operator

Your next question comes from [John Flack – Citigroup].

[John Flack – Citigroup]

I wonder if you guys could give a little more color around the inventory build? Is it finished goods on the new 2.5 inch platform or is it components? And, specifically what type of components? Drives, controllers, I’d love to hear any color you have there?

Richard Pearce

It’s across sectors in all honesty. Obviously if you look at the guidance for the next quarter over this quarter we’re nearly 50% up and therefore inventory has gone 50% up. Obviously, as we looked in to Q1 we were talking about a number of supply constraints so some of the areas that we’ve been proactive in does mean that we hold a bit more inventory today than obviously we did at the end of the year but one, it’s needed for the revenues that we see in Q2 and at least that gives us a little bit level of comfort in terms of the customer’s upside which comes in through the quarter. The increase in inventory does not concern me.

Operator

Your next question comes from Nehal Chokshi – Technology Insights Research.

Nehal Chokshi – Technology Insights Research

The breakdown by interface type, that is helpful and it seems like the NAS is what’s the significant growth on a sequential basis. Is that correct?

Steve Barber

That’s fair which I guess is supported by industry research coverage that NAS continues to be a big growth sector.

Nehal Chokshi – Technology Insights Research

As far as for Xyratex goes, is there a difference for margin profile for the different interfaces?

Richard Pearce

Not significantly. What we see is the fiber channel areas have lower density and they’re a similar price to the higher density ATA drives so overall it doesn’t make a big difference to us.

Nehal Chokshi – Technology Insights Research

I note that you called out the SSD which is a very small portion so I’m particularly curious as whether or not that is a different margin profile for you guys?

Richard Pearce

They’re clearly very expensive components relatively but because they’re relatively small quantity it doesn’t really move the needle on margin.

Operator

Your next question comes from Ananda Baruah – Brean, Murray, Carret & Co.

Ananda Baruah – Brean, Murray, Carret & Co.

Steve, if the industry to see some loosening of pricing on components as we move through the year are your contracts right now set up as such that you would potentially get a bit of that as a tailwind at any point?

Steve Barber

Potentially, yes. I would say right now the environment is all about allocation and not price reductions on components. I would like to be in that position. I think semiconductors continues to be very tight in supply when you look at the major fab houses like TSMC, pretty much sold out for the year. I think overall supply is going to be the priority focus. We’ll continue to address component costs but I’m not expecting to see significant movement in that area. If it does, great but I’m not planning on that in this current quarter.

Richard Pearce

I guess we’re paranoid about protecting for increased costs.

Ananda Baruah – Brean, Murray, Carret & Co.

Then just to your comment on op ex about 25%, going up 25% in the May quarter, that’s a sequential comment is that correct?

Richard Pearce

That’s correct, yes.

Ananda Baruah – Brean, Murray, Carret & Co.

SG&A was actually down Q-over-Q in the Feb quarter so can you give us any sense kind of like the increase in R&D versus increases in SG&A in May over Feb, how that will break out?

Richard Pearce

We’ll see relatively consistent increases as a proportion of our expectations on both sides. In both areas I think if I look back to the expectations and the projections and the consensus while we were under in Q4 we were also significantly under the consensus and I guess the guidance that we provided within our estimates. A lot of that is down to us in the first quarter not being able to hire some of the key skills that we wanted to hire as quickly as possible. We have seen some momentum in that in Q1 so a proportion of that is for new hires coming on.

What we also did last year was froze salaries and actually took some people’s salaries and benefits down with an agreement with our employee that when the results reached a certain level that we would put back those salary reductions as well as the benefit reductions. So we did that in the first quarter but we will see the effect of that coming through our expense in the second quarter.

In addition, because the second quarter is likely to be the biggest quarter for us of the year, then the most significant bonus accrual for the year will be in the second quarter. All of those elements are contributing to what is a significant expense increase. I think just in terms of obviously the business allowing us and the opportunities that we see, we are taking the opportunity to invest in R&D projects that we see obviously for 2011 and ’12 and going out and feel as though we’re in a position now to invest in those.

Operator

You have no other questions at this time.

Brad Driver

Thank you. Once again, thank you for joining us this afternoon. We look forward to speaking with you again on our Q2 earnings call which will be scheduled for late June. The exact details will be posted on our website and we’ll put out a release probably in near mid June. Also in June we’ll be presenting at the UBS and RBC conferences in New York so look for that on our calendar. As always, you’re welcome to call me if you have any additional questions over the course of the quarter. In the meantime have a nice Easter weekend and we’ll speak to you soon.

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect.

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