National Instruments' CEO Discusses Q2 2011 Results - Earnings Call Transcript

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 |  Includes: NATI
by: SA Transcripts

National Instruments Corp (NASDAQ:NATI)

Q2 2011 Earnings Call

July 27, 2011 5:00 PM ET

Executives

David Hugely – VP, Corporate Counsel and Secretary

Dr. James Truchard – President, CEO and Co-Founder

Alex Davern – COO

Pete Zogas – SVP, Sales and Marketing

Analysts

William Stein – Credit Suisse

Anthony Luscri – J.P. Morgan

Mark Douglass – Longbow Research

Richard Eastman – Robert W. Baird

Ajit Pai – Stifel Nicolaus

Chuck Murphy – Sidoti & Company

Operator

Good day everyone and welcome to the National Instruments second quarter 2011 earnings conference call. Today’s call is being recorded. You may refer to your press packet for the replay dial in number and pass code. With us today are David Hugely, Vice President, General Counsel and Secretary; Alex Davern, Chief Operating Officer; Dr. James Truchard, President, CEO and Co-Founder; and Pete Zogas, Senior Vice President of Sales and Marketing.

For opening remarks, I would now like to turn the call over to David Hugely, Vice President, Corporate Counsel and Secretary. Please go ahead sir.

David Hugely

Good afternoon. During the course of this conference call, we shall make forward-looking statements regarding the future financial performance of the company, including statements regarding future financial impacts of our recent acquisitions, growth and radio frequency product sales, long term growth prospects, future products and our revenue and earnings per share guidance.

We wish to caution you that such statements are just predictions and that actual events or results may differ materially. We refer you to the documents the company files regularly with the Securities and Exchange Commission including the company’s most recent annual report on Form 10-K filed February 18, 2011, and our most recent quarterly report on Form 10-Q filed April 29, 2011.

These documents contain and identify important factors that could cause our actual results to differ materially from those contained in our forward-looking statements. With that, I will now turn it over to the Chief Executive Officer of National Instruments Corporation, Dr. James Truchard.

Dr. James Truchard

Thank you David. Good afternoon and thank you for joining us. Our chief points today are; record quarterly revenue, record operating profit for a second quarter and continued execution on the 2011 investment plan.

I’m extremely pleased to report continued strong revenue growth and an all-time record revenue in Q2. Our ability to also deliver a record operating profit for a second quarter, while significantly increasing our R&D investment and field sales force, is a validation of the strength of our business model and our ability to execute.

We continue to focus on the long term vision and I believe our strategic investments and innovation and customer adoption are key to our future growth and I continue to be optimistic about our position in the industry.

In our call today, Alex Davern, our Chief Operating Officer will review our results. Pete Zogas, Senior Vice President of Sales and Marketing will discuss our business and I will close with a few comments before e open up for your questions. Alex.

Alex Davern

Good afternoon. Q2 was a very successful quarter and there are some clear positives to take away. First, we had record revenue with strong year over year growth in orders over $20,000. Second, we are successfully executing on our 2011 investment plan, and third, we had record operating and net income for a second quarter.

Revenue for Q2 was $253 million, up 20% year over year. Non-GAAP gross margin in Q2 was up 90 basis points year over year at 78.5%. Our ability to significantly increase our gross margins is attributed to the success we’ve had in driving down component costs, improving manufacturing efficiency and to the high value and differentiation we deliver to our customers.

Non-GAAP operating expenses were up 23% year over year in Q2 as we executed on our planned investments, especially in R&D and field sales. Overall head count was 5,862, up approximately 390 people, or 7% since March and up 15% year over year. This includes approximately 150 personnel from the AWR and Phase Matrix acquisitions.

We believe these investments give us the ability to fully leverage the strategic advances we’ve made in our PXI and CompactRIO platforms and are necessary to drive our long term growth.

Operating income was an all-time second quarter record. GAAP operating income was $33 million, an 8% increase over Q2 2008. Non-GAAP operating income also set a new second quarter record at $41 million, up 14% over Q2 2010. This represents a non-GAAP operating margin of 16%.

I would like to thank all of our employees for the hard work they have contributed to this very strong results. Net income for Q2 was $26.5 million with fully diluted earnings per share of $0.22, which includes a $0.01 per share impact from the transaction costs related to closing the AWR acquisition.

Non-GAAP net income was $32.2 million, with non-GAAP fully diluted earnings per share of $0.27 at the midpoint of our guidance range. A reconciliation of our GAAP to non-GAAP results is included in our earnings press release.

As we look to the second half of 2011, I would like to take a moment to reflect on our execution through the last five years. Despite the worst recession in modern history, National Instruments has delivered strong results during the five years since the first half of 2006, increasing first half revenues by 56%, non-GAAP gross margins by 65% and non-GAAP net income by 81%.

We have also stayed true to our long term strategy over the last five years, increasing our R&D personnel by 64%, our field sales force by 80% and releasing hundreds of new products that have expanded our ability to serve customers in a diversity of new application areas.

Key to enabling this performance has been our expanded gross margins. Over the last five years, we have expanded our first half gross margins by approximately 410 basis points, which has allowed us to deliver great profit growth while making the strategic investments necessary to sustain the long term growth of the company.

Now I’d like to make some forward-looking statements. While the trends of the global PMI continue to be positive in Q2, averaging 53.4% for the quarter, we did see the significant decline between March and June that we had anticipated.

We anticipate continued weakness in Q3 and we will be watching closely to see how the global business environment exits Q3. However, encourage by the scale of the long term opportunity open to us, we plan to continue to execute on our 2011 investment plan, which includes adding approximately 400 incremental personnel in Q3 and approximately 100 in Q4.

Should the global economy see some incremental weakness this year, then these investments will likely have an adverse impact on margins in the short term, but we are confident that they will significantly advance our long term position in the industries we serve.

Now turning to specific guidance for Q3; we currently expect revenues for Q3 to be up year over year and to be in the range of $257 million to $273 million. Due to the impact of the acquisition accounting for the AWR transaction, which required us to write down AWR’s historical deferred revenue to fair value; we are also including guidance for non-GAAP revenue.

The amount of the write down, approximately $7 million would have otherwise been recognized over a period of approximately 12 months. As a result, in Q3, we expect non-GAAP revenue to be in the range of $260 million to $276 million.

Looking out further, we expect a non-GAAP revenue adjustment in Q4 to be approximately $2 million and for the Q1 2012 and Q2 2012 adjustments to be approximately $1 million. Starting in Q3 of 2012, we do not expect to continue to report non-GAAP revenue.

Included in our non-GAAP guidance for Q3 is $9.5 million of revenue and $6.5 million of expenses related to the recent AWR and Phase Matrix acquisitions. As we discussed on our call announcing the acquisitions in May, it will not be until 2013 to 2014 that we expect to realize the full benefit of these strategic acquisitions.

While we expect the acquired entities to be profitable on a non-GAAP basis for the rest of this year, it will be at a level below the corporate average operating margin. In Q3 we expect their impact to be to reduce our average non-GAAP operating margin by 30 to 40 basis points.

Given our aggressive 2011 investment plan and the recent acquisitions, we expect to see a significant increase in non-GAAP operating expenses in Q3 to approximately $170 million plus or minus $2 million. In Q4, we are budgeting for a very modest sequential increase in expense as the 2011 investment plan is closed out.

Looking out to 2012, and assuming a normal economy, we expect to return to a plan of growing revenues faster than expenses. We currently expect the GAAP fully diluted earnings per share will be in the range of $0.16 to $0.24 for Q3 with non-GAAP fully diluted earnings per share expected to be in the range of $0.23 to $0.31.

Please remember that in Q3 the GAAP to non-GAAP adjustments will include an incremental $0.03 per share adjustment related to the acquisitions of AWR and Phase Matrix.

These are forward-looking statements. I must caution you that actual revenues and earnings could be negatively affected by numerous factors such as any further weakness in the global economy, rescheduling of customer orders, expense overruns, manufacturing inefficiencies, effective tax rates and foreign exchange fluctuations.

In summary, we are very pleased with our record second quarter revenue and profit. Our goals for 2011 remain to invest aggressively and to continue to drive towards our 18% non-GAAP annual operating income target.

Now I’ll turn it over to Pete Zogas, Senior Vice President of Sales and Marketing.

Pete Zogas

Thank you Alex. We are very pleased with our strong year over year growth and record quarterly revenue. We believe our performance is a testament to the strength of our business model and validates the investments we have made in key product areas like CompactRIO and RF Modular instrumentation, both of which outpaced the overall company growth rate.

Through Q2, we successfully executed on our 2011 hiring plans with an emphasis on growing our field sales and R&D head count. We believe these investments will allow us to continue to deliver world class products as well as give us the expertise in the field to penetrate large accounts.

In Q2 our orders over $20,000 grew 39% year over year and our average order size reached a second quarter record of approximately $4,440, which is up 17% year over year. It was the expansion into new application areas, which was demonstrated by our strong growth in orders over $20,000, which allowed us to overcome the impact of the weakening PMI on our more traditional business.

We believe this success reflects the enhancements we have made in our product and service offerings, the excellence of our network of integrators and the performance of our outstanding sales teams.

As we continue to expand our software offering, we see a significant opportunity as more engineers are turning towards more software based test systems because their products and systems are evolving faster than ever.

LabVIEW, a tool that has delivered value to engineers and scientists for more than 25 years, led our software business to year over year revenue growth this quarter. Our continued investments in LabVIEW have delivered significant productivity gains by allowing our customers to build their applications in a matter of days or weeks instead of months or years.

In Q2, we experienced record sales to academic institutions, which continue to be a focus area for NI. During the quarter, we introduced two new software products geared toward K through 12 students, LabVIEW for Lego Mind storms and LabVIEW for education.

We believe these tailored versions of LabVIEW will help increase the interest in science and engineering for tens of thousands of students each year, inspiring the future generations of engineers to take their experience of exploration and innovation from the classroom into industry.

Our data acquisition products experienced year over year order growth led by our USB Ethernet and C Series based devices. In addition, we continue to see strong growth from our plug in PCI Express and PXI Express data acquisition boards, which is a testament to the value we offer customers by leveraging off the shelf industry standard technology such as the PCI Express Plus.

Our distributed I/O products saw strong year over year growth, achieving record quarterly revenue. This growth was led by our innovative CompacRIO platform, which is built around LabVIEW and FPGA technology. This quarter, NI introduced two CompactRIO products that when combined with LabVIEW software allows our customers to prototype and deploy custom embedded systems faster, at a lower cost, and without the need for large engineering design teams.

The new integrated controllers extend the price performance options of the CompactRIO platform and are suitable for higher unit volume deployment in industries such as energy, biomedical and robotics that require a short time to market, advanced control algorithms and high performance I/O.

Our PXI modular instruments products also saw record sales and helped drive growth for the company. With more than PXI products and 14 years invested in supporting the modular approach to automated design validation and production tests, National Instruments is the leader in PXI modular instrumentation.

Many customer applications show there is a significant need for including real world measurements from design to validation to production test because of the time to market and the time in market constraints they face.

For nearly a decade, we have invested in expanding our product portfolio to meet the needs of our customers and our strategic focus on our products has led to growth in that area that outpaces the overall company growth, validating our continued investment in our RF hardware and software.

To continue our investment in expanding our RF portfolio, this quarter we announced the acquisition of Phase Matrix and AWR. We believe these acquisitions enhance our ability to serve customers throughout the RF product development cycle and will accelerate the deployment of our RF and wireless technologies to significantly improve customer productivity through increased connectivity between design, validation and production test functions.

With a strong track record of designing and manufacturing RF and microwave tests, and measurement technology and a highly talented employee base, Phase Matrix has the ability to speed NI’s development and release of high performance RF and wireless products to our production test and R&D customers.

AWR, a leader in design software for RF systems, brings a strong team and RF system design product portfolio that is highly complementary to NI’s hardware and software. We are very excited about the future opportunities that we will be able to address combining our expertise in RF with these two new additions to the NI family.

In summary, we were pleased to see record revenue and strong growth in our strategic investment areas of the CompactRIO and PXI modular instruments. Our ability to drive organic growth through the expansion of R&D and our field sales force, speaks to the strengths of our business model.

We are excited about NI week next week, which has seen 25% year over year growth in registrations to date. Some of the highlights from this year’s NI week include innovative customer solutions, an interactive demo that demonstrates the value of NI products in a breadth of application areas, significant new software and hardware products releases, including enhancements to our service offerings and our ability to support our partners.

Our global sales force will be collaborating closely with thousands of engineers attending the event to discuss industry best practices and better understand how NI products can meet their needs. And finally, the NI Alliance partner network will celebrate 20 years of working closely with our field sales organization to provide integration services, turnkey solutions, products and consulting for our customers. We hope we see you next week at NI week.

With that, I’ll turn it over to Dr. T.

Dr. James Truchard

Thank you Pete. I was extremely pleased with our performance in Q2 as we delivered record quarterly revenue. I believe these result demonstrate the strength of our business model and validate our long term strategy, and I’d like to thank our employees for their hard work.

During Q2, we continued to execute on our 2011 hiring plan and I believe that increasing our R&D department by 64% and our field sales force by 80% over the past five years will give us the power to fully leverage the strategic investments we’ve made in our core platforms; LabVIEW, PXI, Data Acquisition and CompactRIO.

For more than 30 years, engineers and scientists around the world have used NI software and hardware to implement their world changing innovations more quickly and efficiently. The key to success for NI and the customers we serve is that we’ve invested thousands of person years and platforms that leverage both internal and generally available technologies to take advantage of Morris law.

To mind with productivity of graphical system design, these software and hardware platforms provide consistent form factors and the flexibility to evolve and we believe this approach will be the future of instrumentation.

We continue to gain scale in our PXI platform, particularly in the area of RF, including new capabilities from our recent acquisitions of Phase Matrix and AWR. One example of cutting edge performance that will enable NI technology to scale is to analog front end technology from Phase Matrix, which provides industry leading performance for oscilloscopes.

Through our strategic investments in RF, we hope to realize our vision of improving integration between design and test for engineers.

In the area of renewable energy, NI is also leading an initiative to accelerate innovation through the NI Green Engineering Grant program, which helps remove technical barriers, providing access to the training and tools needed to bring smart grid and renewable energy solutions to market.

One participating company is Wind Lift, which develops portable wind energy systems for use in reconstruction and disaster relief efforts. With the productivity gain using LabVIEW, Wind Lift was able to progress from concept to prototype in just eight months.

Many of these products and solutions will be on display during our annual NI week user conference next week, where thousands of engineers will hear about the new products and see the exciting demonstrations from our customers as they tackle some of the world’s most significant scientific and engineering challenges.

NI week also attracts some of the world’s leading experts in such areas as energy, big physics, wireless communication, who will headline the sessions, offered in our summits. During my keynote address, I will discuss the evolution of NI platforms over the past 35 years and my view on the future of instrumentation.

We will also be hosting our annual investor conference in conjunction with NI week on Tuesday, August 2nd, where we will discuss our business model, our differentiated software and hardware as well as our financial results and future investments. I hope to see you at NI week and our investor conference, where you will learn more about how NI technologies are being used in these applications.

In conclusion, we have successfully delivered on our investments over the past five years to build strong organic growth and are executing according to our plan in 2011 to recruit top talent and evolve our field sales and R&D teams.

I feel our strong competitive position and innovative products such as LabVIEW, CompactRIO, Data Acquisition and PXI modular instruments will allow us to disrupt the test and measurement industry for years to come.

We will now take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from William Stein with Credit Suisse.

William Stein – Credit Suisse

Great, thanks. First I have just a clarification. I think there were some comments about demand trends for the traditional smaller order flow versus order flow for some of the larger orders. I think $20,000 above was how you separate those out. Can you review or clarify those please?

Alex Davern

Right. So we have a metric that takes our orders, our revenue that’s coming from orders that are $20,000 and above and then the business that comes from orders less than that. We call that transactional business versus system level or larger orders.

So the large order is orders greater than $20,000 and we experienced 39% year over year growth from that order revenue bucket and 10%, a little over 10% from the business that’s coming from the transactional level, orders less than $20,000.

William Stein – Credit Suisse

Is that noteworthy? I mean is that a different trend from what we’ve seen in the past couple quarters with the bigger deals growing faster or it just seems to me that given both the beat and the raise in terms of the revenue guidance, it doesn’t seem so unique or noteworthy.

Alex Davern

Well it certainly indicates what we’re anticipating, what we’re seeing with the business. As we expand our product portfolio with PXI and CompactRIO system level platforms if you will, we’re getting involved with more and more mission critical applications, which are tending to be higher volume, higher, larger orders.

And so we’re fueling that and we’re meeting that need with this increased investment in sales and we’re getting the results by seeing that area of our business growing much faster as a component of the business.

William Stein – Credit Suisse

Appreciate that. I’m wondering if we can also talk about end market strength and where the maybe relative weak points were as well. I think Dr. T you talked about strength in academic, which is a bit of a surprise relative to what’s going on with budgets around the country. Maybe you could talk about generally speaking stronger and weaker end markets in the quarter and any outlook.

Pete Zogas

Yeah, this is Pete Zogas. I’ll take that one. So regarding our vertical, so academic was fairly strong from a standpoint of the quarter. Other strong verticals for us were mobile communications, so anything related to smart devices, smart phones, set top boxes etc. Semiconductor was strong. Energy, big physics, things related to high end research.

And then (inaudible) was a little on the weaker side. It was strong last year at this time, but we did see a little bit of softening; still growth, but not quite as big. And then transportation was not as strong as the strongest either – still growing.

Operator

Next question we have is from Anthony Luscri with J.P. Morgan.

Anthony Luscri – J.P. Morgan

Hi. Thanks for taking the question. It’s a follow up to an earlier question. The academic market you mentioned was fairly strong. Has the sequential order growth slowed there in any way?

Alex Davern

I assume you mean – it’s Alex here. I assume you mean from a year over year point of view?

Anthony Luscri – J.P. Morgan

Well I guess I’m trying to figure out has end demand slowed even though there has been a record quarter for you in terms of revenue, have you seen any softness in the academic market?

Alex Davern

Not noticeable at this point. I mean I would also – our academic business is very, very globally diversified, so it’s one of our strongest business areas in the emerging markets and some of the emerging market countries, it tends to be a bigger percentage of revenue than the developed countries.

So the US budget issues have an impact on the academic business but our investment in academic specific products and our investment in academic specific sales force has really helped us continue to gain market share and I think that’s allowed us to offset some of the maybe overall budget constraints that are prevalent in the United States.

Anthony Luscri – J.P. Morgan

Okay. Thanks. And then as a follow up, you mentioned more mission critical applications and higher volume orders are driving your large order flow. Can you speak to the applications that are driving that? Is it a mix of – what is it skewed toward; production tests or R&D? How should we view that market for you guys?

Alex Davern

We’re seeing as much diversity in the large systems as we do in our base level as they span from heavy industrial applications, controlling frac sites, fracturing of natural gas shale. On the industrial side of things we’re seeing automated test on the consumer electronics and automotive electronics.

So I wouldn’t be able to pinpoint one particular vertical that is driving our large order growth. I think we’re seeing it across the board.

Anthony Luscri – J.P. Morgan

And in terms of that large order mix flows to your revenue line and becomes a larger piece, does your business overall, do you have a greater visibility versus your core transactional business going forward?

Alex Davern

I think maybe a couple of ways to put some color on that, Anthony. It’s Alex here. It that the transactional business under $20,000 tends to be over time a little bit more correlated to the overall PMI. The large order business is naturally a little more lumpy or perhaps a little bit more volatile.

It tends to respond more directly to the investments we’re making and the platform completion and field sales resources, and we’ve certainly seen the benefits in that business from the investments we’ve made over the course of the last five years, and that’s what encourages us to move forward with our investment plan this year.

As that becomes a bigger part of our business and a much larger overall revenue, from an absolute dollar revenue point of view, the revenue coming from orders over $20,000 is much, much bigger than it was five or six year ago.

As that becomes a bigger group, then it starts to become a bit more statistical and so that allows us to have a pretty good view into the overall pipeline so that we can have an assessment of what business looks like as we look out to the next quarter.

Operator

All right. We have a question from Mark Douglass with Longbow Research.

Mark Douglass – Longbow Research

Good afternoon gentlemen.

Alex Davern

Hey Mark. How are you?

Mark Douglass – Longbow Research

Good. How are you?

Alex Davern

Not too bad.

Mark Douglass – Longbow Research

Good. Alex, can you review the acquisitions for us? What were the purchased revenues and profitability or what’s embedded in the 3Q guidance?

Alex Davern

Sure. In the call I gave some specific commentary on this Mark, so in Q3 guidance, embedded to allow you guys to separate out is about $9.5 million in revenue in Q3 and about $6.5 million in expenses in Q3 guidance.

Mark Douglass – Longbow Research

Okay. Maybe I missed the beginning of the call.

Alex Davern

No problem.

Mark Douglass – Longbow Research

And then so going forward, that’s kind of the run rate we’re expecting at this point?

Alex Davern

I think that’s the run rate you could be modeling to be able to separate the impact of organic versus acquisition.

Mark Douglass – Longbow Research

Okay, great. And then can you review the status of RF tests? I’m really looking at like communications providers and what do you see as far as their capital spending on T&M equipment? It seems that comm spending on equipment is on a downtick here, at least for lot of other players. I mean are you going through that or what are you kind of seeing in your markets there?

Alex Davern

Our business is very much diversified and the carriers, the traditional carriers are not a large portion of our business. In fact, they’re a very small portion of our overall business. We tend to jus sell to the companies that are design manufacturers, the device manufacturers and the components that go into those devices for R&D and production tests.

It’s a pretty diversified business. Certainly it’s benefiting from the strength of Smart phones right now, but overall it’s pretty diversified and not really tied to the carriers themselves.

Mark Douglass – Longbow Research

Okay. But the overall market, you’re not seeing a softening there.

Alex Davern

We had a very, very strong quarter for RF. Overall; our (inaudible) business had very strong growth in Q2 so we see continued, very encouraging signs. The RF market, the test market is a very large market. We’re a recent entrant. We have a relatively small market share and so there’s a lot of market out there for us to chase.

Operator

We have a question from Richard Easton with Robert W. Baird.

Richard Eastman – Robert W. Baird

Yes, good afternoon.

Alex Davern

Hi Rick.

Richard Eastman – Robert W. Baird

What was the percentage of revenue from the large orders in the quarter?

Alex Davern

It was I believe 46% which I believe is a new all-time high.

Richard Eastman – Robert W. Baird

Okay.

Alex Davern

And the data on that will be – if you look at the webcast live slides, you’ll be able to see the trends in large orders and year over year growth. There’s a specific slide on that on the webcast.

Richard Eastman – Robert W. Baird

Okay. And then just again, trying to look at the split. I know Pete gave some color on the various pieces of the business, but trying to look at the split a little bit from an industrial embedded and a virtual instrumentation kind of split, and it looks like the key pieces, two of each were strong. So was there any difference in the growth rate on the embedded – industrial embedded side versus the more traditional test side?

Alex Davern

I’ll tell you our traditional test business had a very strong quarter. Industrial embedded piece of our business continues to do very, very well also, but they’re both pretty strong at the moment.

Richard Eastman – Robert W. Baird

And so if you think growth rate total sales growth, it’s the same plus or minus a couple of points?

Alex Davern

There’s not a significant differential.

Richard Eastman – Robert W. Baird

Okay. Okay. And then also, just could you talk a minute or two about the Asia local currency growth rate? It appears to have slowed down and I know at the back half, or the back portion of the first quarter, we were seeing Japan slow quite dramatically. So how did APAC fare in the quarter from a linearity orders perspective?

Alex Davern

The business was pretty linear. I mean the business overall for the whole company was very linear in April, May and June. We saw plus or minus 1% or 1.5% year over year growth in each particular month in April, May and June, so it was very steady.

In Asia, you’re looking at billings growth. This time last year in Asia we had a strong quarter, and in this particular quarter we had some increase in backlog in Asia at the end of the quarter. From a bookings point of view, from an order flow point of view their currency growth was a bit stronger. It was more like 15% or 16%.

Definitely we saw some impact from the tragedy in Japan last quarter. They had certainly a recovery from what we saw at the end of March, but certainly that market remains somewhat challenged and we look at it over the longer term. Asia’s been an outstanding performance for the company and we expect great things from Asia going forward.

Operator

We’ll go next to Ajit Pai with Stifel Nicolaus.

Ajit Pai – Stifel Nicolaus

Yeah, good afternoon.

Alex Davern

Hey Ajit. How are you?

Ajit Pai – Stifel Nicolaus

Good. And you?

Alex Davern

Excellent. We going to see you next week?

Ajit Pai – Stifel Nicolaus

Yes. Looking forward to it. So I had one housekeeping question and then you know one sort of metric that got my eye that I’d like some color on. The first is your head count you said is about 5,800 in your presentation but you have a specific number there at the end of the quarter?

Alex Davern

Yeah. 5,862.

Ajit Pai – Stifel Nicolaus

And 62. The second question is just looking at the expenses during the quarter, the 164.5, going over the past 12 years I see that you never had such a massive sequential uptick in expenses from the first quarter to the second quarter in any of the previous years, and even adjusting for the revenue, even adjusting for your head count, is there something else that’s going on between the first quarter and the second quarter that we should be aware of on the expense line?

Alex Davern

Yeah, certainly one point that you want to add in is the transaction expenses and some modest expenses from the acquisition of Phase Matrix which closed in May. But there’s about $2.5 million to $3 million of expenses in the quarter at the GAAP level that were related to the acquisitions themselves.

Ajit Pai – Stifel Nicolaus

And that’s one time, not recurring?

Alex Davern

Well obviously the transaction expense is one time and then we’ll have in this upcoming quarter, Q3, about $6.5 million in expenses total for both acquisitions, and that will be a onetime jump, and obviously that’s why we’re guiding to such a big sequential increase in expenses between Q2 and Q3.

Now as I talked, we went into the fall of last year and in the spring of this year, particularly in April, our hiring strategy is significantly out of school and hiring time frame for that tends to be staring in the May, June, July time frame.

And as we went through the downturn in ‘09 and ‘10, we backed off college recruiting. We continued to hire experienced talent but we backed up college recruiting somewhat. So when we look at last year, one of the challenges you see is that last year was a great Q3 sequentially from Q2.

We had strong revenue growth and we hadn’t yet ramped up our expense strategy at the end of third quarter of last year. We had not done a lot of hiring out of school. As we shifted the content for that in the fall of last year, now we’re seeing those recruits come in into May, June, July, August time frame, and that’s why you see this big bulge of recruiting happening with the significant hiring of staff in Q2 and then anticipating 400 additional staff coming on in Q3.

That will then close out as we exit the 2011 investment plan and reduce to about 100 people in Q4. So we have kind of a bulge going through the system at the moment compared to a kind of tough expense compare if you like for Q3 last year. As we go into Q4, we expect the revenue and expense growth to come a lot more in line from a year over year point of view.

Ajit Pai – Stifel Nicolaus

Got it. And then just in terms of the head count that’s being added, the vast majority of the head count that is being added when you talked about the head count growth was going to be folks in either low cost regions or like in out of school, so the average cost should be significantly lower than the average cost of the historical head count. Is that fair?

Alex Davern

I’m not sure I’d quantify it as significant but it definitely will be lower without a doubt.

Ajit Pai – Stifel Nicolaus

Okay.

Operator

Our next question will come from Chuck Murphy with Sidoti & Company.

Alex Davern

Ajit, do you want to come back in? I think you might have got cut off. If you want to come back in again, we’ll take your question when you get back in the queue.

Chuck Murphy – Sidoti & Company

Hi guys. I know you mentioned to Mark with the expected acquisition contribution in the third quarter. Did you say what contributed in the second quarter?

Alex Davern

Chuck, sorry. Could you just repeat the question?

Chuck Murphy – Sidoti & Company

Yeah. You mentioned with the acquisition contribution is expected to be for the third quarter. Did you say what it was for the second quarter?

Alex Davern

For Q2 it was pretty minor. The expense impact was somewhere around $1 million because we just had one of the acquisitions done for a very short period of time, so it was very trivial.

Chuck Murphy – Sidoti & Company

What about the revenue contribution?

Alex Davern

Very immaterial.

Chuck Murphy – Sidoti & Company

And then my other question was Alex, you mentioned some caution regarding the PMI readings we’ve seen. Have you actually seen that show up in your orders recently or is that just kind of you looking at the macro stuff and being aware.

Alex Davern

Well, we’re just watching, like I personally do, what’s going on at the macro side and it seems quite obvious to me that we’ll see continued weakness in the PMI in the third quarter, and I felt that way in April and we saw in Q2. I feel that way again in July and we’ll see what we see in Q3.

Now when you look at our business overall, it tends to be the orders under $20,000 that respond to that. Where we tend to have a bit more influence over the outcome is in the system level business where we have a greater opportunity to gain market share and that side certainly so far, our investments in R&D and the field have really been successful in allowing us to deliver strong growth there.

So we look at all of the factors available to us, including obviously bookings and order growth through this morning in making our guidance decision and so our experience here in July is fully baked into our guidance for Q3.

Chuck Murphy – Sidoti & Company

Got you. Okay, thank you.

Operator

And Mr. Pai, you’re queued back up. Your line is open sir.

Ajit Pai – Stifel Nicolaus

Thank you. I had a question about Penang, which is you are broken down in Penang already and the hiring over there. Is it going to be expensed immediately, the folks that are coming online over there or are you going to be capitalizing some of that and then expensing it only once the plant begins production, and when do you expect that to happen?

Alex Davern

Operating costs of staff, training, etc. will all be expenses as incurred.

Ajit Pai – Stifel Nicolaus

Got it. And when do you expect the plant to start production?

Alex Davern

Right now our current expectation is we’ll begin production July of ‘12. That’s subject obviously to our needing capacity, but our current plan is July of ‘12.

Ajit Pai – Stifel Nicolaus

Got it. Thank you.

Operator

There are no further questions in the queue. I’d like to turn the call back over to Mr. Alex Davern for any closing comments.

Alex Davern

Thank you very much for your time today. We look forward to very exciting NI week next week and thank you for your time.

Operator

Once again, that does conclude the conference call for today. We thank you for your participation.

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