Jul 27, 2007
TRANSCRIPT SPONSOR
Executives
David G. Hugley - VP, Secretary and General Counsel James J.
Truchard - Co-Founder, Chairman, President and Principal Executive Officer Alexander M. Davern - Sr.
VP of Information Technology and Manufacturing Operations CFO, Principal Accounting Officer and Treasurer John M. Graff - VP of Marketing, Customer Operations and IR
Analysts
Antonio Antezano - Bear Stearns Ajit Pai - Thomas Weisel Partners Robert Mason - Robert W. Baird William Stein - Credit Suisse Mark Moskowitz - JP Morgan John Harmon - Needham & Company
Operator
Good day, everyone, and welcome to the National Instruments Corporation Second Quarter 2007 Conference. Today's call is being recorded.
You may refer to your press packet for the replay dial-in number and passcode. The replay will be available from 7 'o'clock PM Central Time today and will end at Midnight Central Time on August 2nd, 2007.
With us today are Dr. James Truchard, President and Chief Executive Officer; Alex Davern, Chief Financial Officer; and John Graff, Vice President of Marketing.
For opening remarks, I would now like to turn the conference over to Mr. David Hugley, Corporate Counsel.
Please go ahead, sir.
David G. Hugley - Vice President, Secretary and General Counsel
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 our expected revenue growth, non-GAAP operating margin, expected earnings per share, improvement in instrument control product sales, future product announcements, future growth per PXI, growth and investment in industrial and embedded applications, and expanding opportunities for growth.
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 Annual Report on Form 10-K for the year ended December 31, 2006 and our quarterly report on Form 10-Q filed on May 8th, 2007.
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 President and CEO of National Instruments Corporation, Dr.
James Truchard.
James J. Truchard - Co-Founder, Chairman, President and Principal Executive Officer
Thank you, David. Good afternoon and thank you for joining us.
Our key points today for Q2 are solid revenue growth, 22% net income growth, and strong sales of software, data acquisition, PXI and distributed I/O products. We turned in a strong quarter in Q2, delivering solid revenue growth and excellent operating leverage.
Growth was driven by many key product areas including record revenue for USB data acquisition, RF instrumentation and distributed I/O. In our call today, Alex Davern, our CFO will review our financials.
John Graff, our Vice President of Marketing, will discuss our business. And I will close with a few comments before we open up for your questions.
Alex?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Good afternoon. Today we reported quarterly revenue of $179.5 million, a 12% increase over Q2 2006.
Fully diluted earnings per share for Q2 was $0.26 with net income of $21 million, up 22% year-over-year. This compares to our guidance of $0.23 to $0.28 per share.
Non-GAAP net income was $25 million, up 22% from Q2 2006, with non-GAAP fully diluted earnings per share of $0.31 compared to our guidance of $0.28 to $0.33 per share. For Q2 2007 non-GAAP operating margin was 16.4% with non-GAAP net margins of 13.8%.
Our non-GAAP results exclude the impact of stock based compensation and the impact of the amortization of acquisition-related intangibles. A reconciliation of GAAP to non-GAAP results in included as part of our earnings release.
For the first six months we have delivered strong operating leverage, which has allowed us to report a 29% increase in non-GAAP net income for the first half. This performance has increased our non-GAAP operating margin for the first half of the year to 16% in 2007 from 14% in 2006.
Our performance in Q2 builds on the excellent operating performance of the company over the last few years and has positioned us well to achieve our goal of 18% non-GAAP operating margin for the full year. Now looking at revenue in more detail.
Our virtual instrumentation and graphical system design products, which represent the vast majority of our product portfolio, had 15% year-over-year revenue growth in Q2. This represents another quarter of strong year-over-year revenue growth from these products and an increase in their year-over-year growth rate.
Our growth in Q2 is driven by the success of our new products, especially in the areas of software, data acquisition, distributed I/O, modular instrument, RF and PXI. Additionally, we saw a $3.5 million sequential increase in deferred revenue on the strength of good software sales in Q2.
In contrast, sales for instrument control products, while flat sequentially, were down 8% year-over-year in Q2 compared to a 6% year-over-year decline in Q1. The decline in our instrument control products was related to a tough compare in Q2 and the weakness of the Global PMI earlier in the quarter.
With the improvement in Global PMI in June and easier compares, we are cautiously optimistic that we will see an improvement in the year-over-year performance of instrument control in Q3 and Q4. On a regional basis, during Q2 we saw growth in all regions.
Year-over-year revenue growth was 19% in Europe, 14% in Asia, and 7% in the Americas, giving overall growth of 12%. Our growth in Asia was affected by year-over-year decline in our sales in Japan, and this is reflective of a weak Japanese PMI during Q2.
Now looking at the income statement in more detail. Non-GAAP gross margin in Q2 was 76%, up from 75% in Q2 last year.
R&D expenses were up 11% year-over-year in Q2 and software development expenses capitalized in the quarter amounted to $3.6 million compared to $2.8 million in Q2 last year. Also during the quarter, $2.1 million in previously capitalized software development were amortized to cost of goods sold.
Now turning to the balance sheet. Inventory days increased… excuse me, inventory days decreased to 155 days from 168 days last quarter on increased revenue and a slight reduction of inventory.
As of June 30, 2007, the company had $241 million of cash and short term investments, down $4 million from March 31st. This is net of $39 million which the company used to repurchase 1.3 million shares of the company's common stock at an average $29.69 and is also net of $5.6 million in dividends paid during the quarter.
As we've discussed in the past, the company's priorities for the use of cash are for dividends, opportunistic stock repurchases and acquisitions in that order. Given these priorities and the significant improvement in our operating performance, the Board of Directors has today approved an increase in our quarterly dividends $0.10 per share from $0.07 per share previously.
This $0.10 dividend will be payable on September 4 to shareholders of record on August 13. Additionally, today the company announced that the Board of Directors has also approved a new share repurchase plan, increasing the number of shares that the company is authorized to repurchase to 3 million shares as of today.
We believe that the increase in our quarterly dividend and in our stock repurchase authorization reflect a prudent use of our cash and reflects managements' confidence in returning to our model of 18% non-GAAP operating income. Now, I'd like to read some forward-looking statements concerning our expectations for Q3 and for Q4.
We currently expect revenue for Q3 to follow the seasonal pattern and to be in the range of $179 million to $187 million. Due to the anticipated release of new versions of several key software products during Q3, we expect to see a $2 million sequential decrease in the amount of software development cost capitalized.
We expect this to tie in software development cost capitalized combined with a planned increase in headcount to result in an approximately $3 million sequential increase in R&D expenses in Q3. As a result, we currently expect that GAAP fully diluted earnings per share will be in the range of $0.24 to $0.29 per share for Q3.
Non-GAAP fully diluted earnings per share for Q3 is expected to be in the range of $0.29 to $0.34 per share. For the full year, management expects to report a new annual record for revenue and for both GAAP and non-GAAP net income.
Currently, the Company expects revenue for Q4 to be in the range of $200 million to $212 million. GAAP fully diluted earnings per share for Q4 is expected to be in the range of $0.34 to $0.40 per share with non-GAAP fully diluted earnings per share expected to be in the range of $0.39 to $0.45 per share.
In Q3 and Q4, the Company expects the combined impact of stock-based compensation and the amortization of acquisition-related intangibles to be $0.05 per share per quarter. Now before I leave the topic of future guidance, I would like to review how we believe our seasonal earnings pattern will evolve as we move closer to our non-GAAP operating margin goal.
Over the last four years, we have significantly increased our non-GAAP operating profitability, moving from 9.5% in 2003 to 12% in 2004, 14% in 2005 and 16% in 2006. This has resulted in sequential gains in our third quarter non-GAAP diluted earnings per share that are greater that would be expected if our operating performance was stable at our model.
As we move to our goal of 18% non-GAAP operating margin, we expect our sequential earnings model for Q3 to move back to the seasonal earnings pattern we had seen pre-2001, which is for earnings per share to be relatively flat sequentially from Q2 to Q3 with a significant sequential increase in Q4. These are forward-looking statements.
I must caution you that actual revenues, gross margins and earnings could be negatively affected by numerous factors such as any decline in the global economy, delays in new product releases, expense overruns, manufacturing inefficiencies and foreign exchange fluctuations. In summary, Q2 was a good quarter with good revenue growth and net income growth of 22% year-over-year.
And with that I'll turn it over to John Graff, Vice President of Marketing.
John M. Graff - Vice President of Marketing, Customer Operations and Investor Relations
Thank you, Alex. We turned in a strong performance in Q2 with revenue growth driven by continued strong success of our virtual instrumentation and graphical system design products.
While our instrument control products saw an 8% year-over-year revenue decline in Q2, the rest of our business saw 15% revenue growth, up from 13% in Q1. We believe this is indicative of growing momentum of our business in Q2 as well as the recent uptick in the industrial economy.
These business trends are charted in the slides of Company in this call, which are also available on the Investor Relations section of our website. Instrument control product now represents only 10% of our business.
The decline in instrument control revenue Q2 was much more pronounced in our VXI products, then, our larger high volume GPIB business. VXI has historically sold to a relatively small number of customers, primarily military and aerospace accounts.
While we saw a decline in our VXI controller business in mill aero, which is consistent with the decline of the aero VXI market. We were very pleased to once again see strong growth of PXI in this area of in Q2.
As our PXI business in mill aero grew in the quarter, we not only replaced the VXI controller business, but also captured more of the instrumentation content, thus increasing our share wallets in these accounts. Our investment new product R&D over the last five years played a significant role in our revenue growth in Q2.
With USB data acquisition, RF modular instrumentation and distributed I/O products having record quarters. We're also very pleased with the continued strong growth of large system sales.
Orders over $20,000 were up sequentially from Q1 and saw a strong year-over-year growth increasing our average order size to an all-time record of $3,330. Key to our system level success was the continued strong growth of PXI-based RF instrumentation and FPGA-based CompactRIO systems sales, which both posted record quarterly revenue in Q2.
Software growth in Q2 was drive in part by strong sales of volume license agreements where customers have chosen to standardized on NI software and making more widely available the engineers within a particular site, division or company. Our focus on growing software on top accounts drove standardization and large contract renewals in accounts ranging from major telecom companies to large government research labs.
Software growth in the quarter was also helped by the extension of the LabVIEW platform and other NI software onto the Microsoft Vista operating system, as well as it relates of the LabVIEW's SignalExpress interactive measurement software in March. LabVIEW's SignalExpress provides the acquisition and analysis power of LabVIEW during interactive environment that does not require programming.
This opens new opportunities for LabVIEW and bench-top measurement applications, including instruments control and data logging and help drive strong unit growth to the LabVIEW platform in Q2. LabVIEW continues to see strong adoption in usage in University classroom and labs around the world.
One example is, it deliver a research groups, which is in the Department of Chemistry at Howard's University. Researchers there recently developed a LabVIEW and PXI-based system to detect specific biomolecule and viruses using nanowire arrays.
The nanowires have potential applications in detecting disease markers of breast and ovarian cancers, as well as pathogens uses in biological welfare. According to the group, the LabVIEW and PXI-based system was less than one-fifth the cost and one-fiftieth the size of our rack-mount instrumentation system.
As I mentioned previously, we continued to see very strong growth in data acquisition, fueled by our expanding line of USB devices in our modular USB-based CompactDAQ system. The release of higher-end USB devices have steadily increased the average selling price of our data acquisition devices over the past year and helped drive record revenue in Q2 for USB data acquisition.
Many of our USB data acquisition devices including CompactDAQ leverage our C-series modules, which integrate connectivity, signal conditioning, and ADB Converters. With over 30 C-series modules now supported on CompactDAQ, we're seeing success in applications ranging from bench-top data acquisition to industrial and embedded systems.
CompactDAQ and all of our USB data acquisition devices continued to successfully sale the first time NI customers, further expanding the reach of virtual instrumentation and ceding future platform opportunities. PXI continued to be a growth driver for our business in Q2.
And we were pleased with our third straight record number of PXI system orders in the quarter. System growth in Q2 benefitted from the success of a new low-cost integrated chassis and controller, which provides a new entry price point for PXI systems.
PXI modular instruments had another strong quarter as well. With growth led by very strong sales of our RF modular instruments in addition to strong PXI switching and digital multimeter sales.
This is the fifth year since our first RF product introduction. And in Q2 our RF products had record revenue and triple digit revenue growth.
RF sales were driven by large orders from design wins and application such as spectromonitoring, as well as success for the merging wireless standards. We are very excited about new PXI opportunities and addressable applications with the introduction of PXI Express, which provides up to 45 times the bandwidth of PXI.
In May, we released the first digitizer and high-speed digital I/O modules for PXI Express, as well as an 18 swap PXI Express chassis. These products compliment our previously released line of PXI Express embedded controllers and data acquisition modules.
And all of these PXI Express products are compatible with over 1,200 existing PXI devices from more them 70 vendors. In addition of the sales successes PXI and PXI Express received very strong interest at the fourth annual automated test summoned held last month.
Over 1,800 attendees participated in the online event which covered the latest trends and technologies and tested measurement and featured key partners including Intel and TecTronics. Industrial and embedded applications were again a growth driver for us in Q2 led by record CompactRIO revenue.
CompactRIO and LabVIEW FPGA continued to see success in applications ranging from embedded data logging to unmanned vehicle control. And in third year, since release, CompactRIO had triple-digit revenue growth in Q2 and continues to support our graphical system design approach in the new areas and new applications.
The oil and gas industry was a significant growth area for our industrial products in Q2. For example, Petrobras, one of South America's leading petroleum companies, designed an HMI/SCADA system for its mud-gas separator using LabVIEW.
Another example is PEMEX Exploration and Production, the leading oil and gas producer in Mexico, they recently implemented LabVIEW for supervisory control of crude oil production and distribution across the country. To continue the momentum of NI graphical system design hardware and software in the oil and gas industry, we recently kicked off the Oil and Gas Industry Symposium.
The series of day-long industry events began in May and will be held in 13 targeted cities around the world. Our FPGA software and hardware products continue to drive us in the new applications in Q2 and have been key to some very large system successes, including custom digital protocol testing for mill aero as well as the deterministic control of high-end machines.
We also have continued to see success with our FPGA-based devices replacing or even eliminating the need for custom hardware. One example is NASA's use of LabVIEW FPGA software and hardware to test the James Webb Space Telescope, which NASA is planning to launch in 2013 to succeed the Hubble Telescope.
Engineers at NASA designed an algorithm in LabVIEW FPGA to control 250,000 onboard microshutters, which control light exposure to the telescope. The algorithm was deployed to an FPGA-based data acquisition device to actuate and test the shutters at 240 cycles per minute.
David Rapchun, lead testing engineer at NASA-Goddard Space Flight Center said, "LabVIEW FPGA and R Series intelligent data acquisition saved hundreds of man-hours and thousands of dollars. The decision to go with commercial off-the-shelf hardware instead of a custom solution provided a more cost-effective method."
In closing, we were pleased with our results in Q2 in both our broad-based high-volume business as well as our system level tests, industrial and embedded business. Our strong investment in new product R&D continued to drive broad adoption of our software platform, very strong growth in USB data acquisition, further growth and penetration of PXI and modular instruments and growth in the new areas with our graphical system design platform for industrial and embedded applications.
With that, I'll turn it over to Dr. T.
James J. Truchard - Co-Founder, Chairman, President and Principal Executive Officer
Thank you, John. I was pleased with solid execution in Q2 across all areas of our business.
Much of our success can be attributed to strong investment in R&D over the past several years, which has produced significant new products such as USB data acquisition, LabVIEW FPGA, CompactRIO and PXI and modular instruments. This aggressive investment strategy allowed us to further disrupt traditional test, control and design markets.
Over the same period, we made significant efficiency improvements in other areas of business, which are allowing us to maintain the strong R&D investment, improving non-GAAP margin towards our long-term goal of 18%. I recently attended the Annual Design Automation Conference as well as NI-hosted Embedded Technology Forum, which bodes attractive machine builders and embedded designers.
At both events, it was evident that our vision for graphical system design is gaining further traction and adoption. Companies that in the past used NI hardware and software to test their designs are now using LabVIEW to design and prototype as well.
Our strong awareness in large customer base for LabVIEW is an asset we will leverage as we grow the LabVIEW platform as a productive tool for customers' designing, prototyping and deploying a broad range of systems and devices. Already, the capabilities of LabVIEW FPGA and CompactRIO have helped us sail into some very demanding applications, including custom digital testing in mill aero and high-end machine control.
I believe that our graphical system design approach is very well positioned to take advantage of new trends and technologies in tests, industrial and embedded applications. In particular, the inherently parallel graphical approach of LabVIEW makes it uniquely suited for execution on multi-core processors and reconfigure those FPGAs.
With this shift toward multi-core processors on the PC and continued adoption of FPGA in embedded designs, LabVIEW allows users to benefit from parallel processing with little to no change in their code. This is not possible with traditional programming tools.
Multicore FPGA and other new technologies will key topics at this year's NIWeek held in often from August 7th to 9th. NIWeek will once again be a key event for new product releases and technology demonstrations in addition to providing an important form for customers, members of the Press, partners and exhibitors to learn and discuss the latest trends in technologies in tests, control and design.
I will kick off the conference with a key note on Tuesday, August the 7th, addressing the State of the Union of graphical system design and including new technology trends and customer successes. Our investor conference will immediately follow.
We look forward to seeing you there. In summary, I am pleased with solid revenue and earnings growth in Q2, and investments in new products resulted in record revenue in key areas, and we are well positioned for a successful second half of the year.
Thank you. We will now take your questions.
Question and Answer
Operator
[Operator Instructions] We will proceed in the order that you signal us, and we will take as many questions as time permits. I request that you please limit questions to one with one follow-up question.
[Operator Instructions] Our first question comes from Antonio Antezano with Bear Stearns.
Antonio Antezano - Bear Stearns
Good afternoon, everyone.
James J. Truchard - Co-Founder, Chairman, President and Principal Executive Officer
Hey Antonio, how are you?
Antonio Antezano - Bear Stearns
Hi, good. I guess, operating margin, your target remains 18% for the full year, so that would assume an improvement in the second half.
And what is going drive or that’s mainly focused in Q4 where you have these significant growth in revenues.
James J. Truchard - Co-Founder, Chairman, President and Principal Executive Officer
Yeah. Historically, Antonio, that is correct.
When we’ve been at 18%, you know, as a more stable model back pre 2001. We typically saw… we generally see a sequential decline in revenue from Q4 to Q1.
And so, we usually see our… in that timeframe we would see our lowest operating margin in the first quarter. And it would jump up a little bit in Q2, as we saw revenue growth increase sequentially that was our historical pattern.
And usually, revenue growth in Q3, revenue would be pretty flat sequentially in Q30. But we often saw an increase in costs as a result of NI week and recruiting for engineering at that point in time.
And then, because of a budgetary buying cycle of our customers, historically, we've seen a significant increase in revenue in Q4. And then, because we have had a fairly significant amount of fixed costs in our expense model, historically, when we were steady at 18, we saw a pretty significant jump in profitability in Q4, with operating margins significantly higher than 18 in the fourth quarter.
And then, that would revert back to the model, again, the following sequential Q1, you would see that model repeat itself. That was the pattern we had seen when we were steady at 18.
Antonio Antezano - Bear Stearns
But now, that you are giving guidance for Q3 and Q4, your assumption behind that earnings guidance is, that you get a 18% operating margin for the full year?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
We are working towards that goal, yes. And that would assume that we’re going to see greater than 18% operating margin in Q4, if we get our goal.
Antonio Antezano - Bear Stearns
Okay. And then, I guess, in terms of your guidance for Q3, if I take the middle point of your guidance that would imply 11.5% a year-over-year growth that we precise, versus 12% in Q2.
So why would you… or in broader scenario would you see some kind of a slight slowdown, especially in the Global PMI, as you mentioned has recovered in recent months?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
That is certainly a good point. We’re seeing a recovery of the Global PMI in May and June, which we’re glad to see.
We also do believe, as I talked in the call that we should see a more favorable environment for instrument control business in the second half. You know the one thing that gives me some pause, obviously, we saw a slowdown and negative year-over-year growth in our Japanese operation in the second quarter.
And if Japan has grown with same rate in Q2 as it did in Q1, we'd have been at 14% in Q2. So that’s one element that gives me little bit of caution.
I think, our group in NI Japan management has done a outstanding job of execution in lots of tough PMI environment in the Japanese economy. And we want to be a little cautious until we see how things go, and the PMI looks in July and August.
We do believe that the environment is improving as we look out to the second half. And we are looking for revenue growth to accelerate as we move towards Q4.
Antonio Antezano - Bear Stearns
And let me… one final question. As you hit the 18% operating margin, then, I guess, this question was asked before last quarter, but why would be you're study going forward, in terms of SG&A spending.
Would you keep that 18% operating margin and maybe try to boost topline growth with increased SG&A?
James J. Truchard - Co-Founder, Chairman, President and Principal Executive Officer
Yes. I'll put this way.
We would expect to hope to generate leverage in certain areas of business once we get to 18%. We’re not going to stop looking leverage in areas like manufacturing in G&A and other places.
And as we… if we are successful in generating that leverage, we are going to focus on investing that back into the business to try to stimulate topline growth in the areas we believe will provide the greatest topline benefit. We have a very strong product portfolio.
And we certainly see areas where we believe and, for example, fuel sales force deployment et cetera, where if we were spending more, we would get more growth. And so we would like to switch our focus more heavily in 2008 towards the topline, if we’re successful in meeting our 18% operating goal in 2007.
Antonio Antezano - Bear Stearns
Thank you. I’ll go back to the queue.
Thank you.
James J. Truchard - Co-Founder, Chairman, President and Principal Executive Officer
Thank you, Antonio.
Operator
Thank you. We’ll take our next question from Ajit Pai with Thomas Weisel Partners.
Ajit Pai - Thomas Weisel Partners
Yeah. Good evening.
James J. Truchard - Co-Founder, Chairman, President and Principal Executive Officer
Hey Ajit, how are you?
Ajit Pai - Thomas Weisel Partners
Good. The first question is just about growth rates, I think when you had sent us your invitation to your Investor Conference, you had talked about addressing the corporate goals of 18% operating margin and 20% revenue growth, when you discussed the corporate strategy.
And after that I think, you know, at least in today’s conference call as well as when sort of confirmed our attendance there. You haven’t talked about the 20% revenue growth.
So could you walk us through, you know, whether that’s a goal that’s changing now? And you know, how you expect to get there, that’s first question.
And then, the second question is, just very broadly when you’re looking at your end markets, you’ve talked about a weak Japan, you’ve talked about a pretty strong Europe. In North America as well as in Asia, you know, in non-Japan Asia, you’re seeing all the semi-cap equipment vendors and the semiconductor industry disappoint.
So is that something that you think is going to be a significant headwind going into the second half?
James J. Truchard - Co-Founder, Chairman, President and Principal Executive Officer
Well, let me answer the second question first, Ajit, because you had a lot there in one question. So as we look out, you know, we certainly were pleased to see a pickup in growth in Europe in Q2 and a pickup of growth in North America in Q2.
Non-Japan Asia grew very well for us at plus 25%. So we’re very happy with that, obviously, there has been some disappointments as you said are on semiconductor cap equipment in Japan and in Asian general, both from guys like Teradyne and Agmentus [ph], who brought out their results last night.
And we do sell into customers in that space and certainly, we saw that impact in our instrument control business in Japan in Q2. So that will be a little bit of headwind for us.
But we think overwhelmingly, as we look at global PMI, as we move out to Q4 that we should be able to overcome that headwind and see improved revenue growth as we towards the fourth quarter. Probably the point I would like to push on there, now in terms of our strategy and our corporate goals of pushing our growth to 8% to 20% revenue and 18% operating margin.
Those remained corporate goals for driving the business to. Obviously, we've had a very hard and laser like focus on getting back to 18% over the last three or four years.
And you've seen the execution of the entire Company on that goal has been phenomenonal. And I'm proud of everyone in the organization as we move towards that goal.
We will be talking at NIWeek in Investor Conference, about our strategies to work to accelerate our topline growth. That will be the core focus of the organization and the senior management team as we look forward from here.
And we continue to remain optimistic that we can put in place the strategies that will help us to achieve that goal. I will see in caveating that, you know, we need the industry to grow in the high single-digits for us to have a realistic shot at 20%.
And we've certainly didn't see that kind of performance out of the industry in Q1 or Q2. I believe we're very successfully outgrew the overall T&M space by at least 10 points in the second quarter as we did in the first quarter.
And we'll certainly going to push to keep that separation of very high growth relative to the space overall as we move forward.
Ajit Pai - Thomas Weisel Partners
Got it. And the follow-up would be just the stock based compensation.
Could you give us the breakdown between R&D and G&A, and sales and marketing for that?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
I don't have that in front of me right now. Perhaps, I… we can… we could talk offline or we can do it in the email exchange.
Ajit Pai - Thomas Weisel Partners
Okay.
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
It should be very… it'll be very, very similar to last quarter and previous quarters.
Ajit Pai - Thomas Weisel Partners
Got it. I'll get back in queue.
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Pretty stable. I just don't have it with me, I'm afraid at the moment.
Ajit Pai - Thomas Weisel Partners
Okay. Thanks.
Operator
Thank you. Next, we'll hear from Rob Mason with Robert W.
Baird.
Robert Mason - Robert W. Baird
Yeah. Alex, you noted in the third quarter that headcount would be in incremental in sense like $1 million, presumably that carries forward as well.
Now, what is the current headcount?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Right now, we're at a little under 4,400 people. So 4,369 up about 9.5% I think year-over-year.
Robert Mason - Robert W. Baird
Okay. And the plan…
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Go ahead, Rob.
Robert Mason - Robert W. Baird
I was going to say and the plans for the balance of the year?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Well just… at Q2, Q3 time is a prime hiring time for us for engineering talents.
Robert Mason - Robert W. Baird
Right.
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
For our field sales force and for our engineering group. And we will continue to be… and are very aggressive right now in terms of recruiting talent into the Company.
We feel very optimistic about the portfolio of products we have able to us and as we gear up towards pushing more dollars in to customer facing activities, we will be continuing to bring that talent into the business as we move forward. One of the key points I'm trying to make in the call here is, I want people to understand obviously our cost model is impacted by the timing of the release of the new products for also the software side.
You know, last year we saw a significant increase in R&D cost from Q3 to Q4 related to the release of the software products last year. Obviously, software product release changes timing a little bit here and there.
And so we expect to see that, biggest sequential impact this year from Q2 to Q3, with a smaller increase sequentially in R&D from Q3 to Q4 that we saw last year.
Robert Mason - Robert W. Baird
Okay. Well, should just with respect to headcounts, should we assume the 9% growth rate holds through the year?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
I think that's a good working assumption to work with.
Robert Mason - Robert W. Baird
Okay. And then just quickly, I believe you're consolidating some shipping points in Hungary?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Correct.
Robert Mason - Robert W. Baird
And I was just curious where that stands, what degree of extra cost or inventory might be involved there? And when it might be finished?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Well, we don't anticipate any increase in inventory. Some of you maybe aware from the conversations in the past, we are and have as of July 1st effectively shift our distribution point for shipments into the United States for the NI branded business.
From Austin, Texas too, Debrecen Hungary where we have our European distribution centre and where we do our production. Our team on the both sides we've advantaged… done an outstanding job in last four weeks of pulling them off and shifting the inventory.
And we've been shipping product in to our US customers now, for the last two or three weeks. This is something we had piloted with NI Canada our sales into Canada in January and with sales to our ancillary brands Measurement Computing and I/O, two of the companies we bought a number of years ago.
They've been receiving their shipping into US customers direct from Hungary for almost a year now. So we feel very confident.
Our execution there and team has done a outstanding job. And we're optimistic at this stage that we won't see any hiccups in Q3.
To value this for the Company obviously from the cost point of view is a key element, but also from a value to our customers. By the consolidation of our inventory distribution locations right there at the point of production, we expect to be able to continue to offer best in class delivery to our customers globally.
Robert Mason - Robert W. Baird
Okay. And just if I could squeeze one more in.
Is R&D still expected with respect to the 8%... excuse me 18% operating margin goal, is R&D still expected to be 16% of sales, roughly?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
That is correct.
Robert Mason - Robert W. Baird
That's the target?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Yes.
Robert Mason - Robert W. Baird
You happen to have that number on a non-GAAP basis target?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
I don’t have it right in front of me. We can talk… maybe we can chat about that later.
But the target for 16% non-GAAP in R&D is not something we plan on changing going forward.
Robert Mason - Robert W. Baird
Okay. All right.
Thank you.
Operator
Thank you. Moving on we'll hear from Will Stein with Credit Suisse.
William Stein - Credit Suisse
Yeah. Hi, Good afternoon.
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Hey, Will, how are you?
William Stein - Credit Suisse
All right. I was just wondering… I'm not sure if you already spoke about it, but can you spend a little bit of time discussing component pricing and the currently time environment and perhaps your expectations going forward?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Sure. We're very pleased with where we are with pricing at the moment.
Obviously, we've turned in our highest gross margins here of 76% since the third quarter of 2000. And so as we've gained scale and improved our relationships with our key vendors and also we made some sourcing decisions, we've been able to leverage that from the price point of view I think very effectively.
At this point in time, we are not seeing any change in the condition of the market in terms of lead time or pricing on components from what we've seen in the previous six months. So I don't have anything significant in terms of sequential change that we've observed.
William Stein - Credit Suisse
Okay. Great.
Thanks.
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Thank you very much.
Operator
Thank you. Next, we'll go to Mark Moskowitz of JP Morgan.
Mark Moskowitz - JP Morgan
Yes. Very good afternoon.
I was wondering if you could help us in terms of getting back to the crossover to the 18% operating margin range, given that the R&D piece is still core to the D&A of the company and you're going to still stand around 16%. Earlier John made some comments about increase in the traction with new NI customers.
Can you maybe give us a point of reference in terms of how much new or incremental customers that helped drive this crossover to the 18% operating margin in terms of your ability to pull back on SG&A potentially?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Sure. As we look forward, you know, we have been promoting and driving an opportunity into new market areas, around areas like embedded graphical system design, cRIO and areas like RF and other modular instrument aspects of our business.
As we go forward, our long-term model is to reduce G&A. For example, we're currently running above 7%.
Our long-term goal is try to bring that down towards 6% as we go forward. And as we're able to… if we're able to develop leverage in that area and perhaps also in the gross margin area, we will really be wanting to redeploy that available dollars back into those customer-facing aspects that we think can fully leverage the product investments we have made, while keeping our operating margin target at 18.
So while we're under 20% in terms of revenue growth, we're not going to try to exceed the operating margin of 18. We're going to try to keep it at that level and reinvest those dollars back in growth.
And I'll hand it over to Dr. Truchard and John to talk about, you know, our vision for those new markets.
Mark Moskowitz - JP Morgan
Okay.
John M. Graff - Vice President of Marketing, Customer Operations and Investor Relations
This is John. You know, I mentioned first in terms of acquisition and new customers, that's kind of a basic philosophy that we always have baked into our D&A.
As we make decisions on new product R&D, we're looking at a combination of areas where we can get more share of wallet in existing applications or customers we serve. But then we also look for ways to expand in the new applications, new areas.
But you've to make it down to the investor conference. This is where we're going to focus a lot of our discussion about is, you know, how we see opportunity to increase share wallet in our core test and measurement space.
There are success in automated tests like digital and RF that we mentioned in the call. And then we also see lots of new opportunity for us in the industrial and embedded.
And this is where our graphical system design approach, we're really pleased with the early success. And I'll turn it over to Dr.
T to comment on that.
James J. Truchard - Co-Founder, Chairman, President and Principal Executive Officer
Sure. Over the last five years, we've been doing several things.
One, we've been refreshing our product lines and adapting to the US… adoption of USB in the marketplace, but we have also been investing in the strategic initiatives to graphic system design for industrial and embedded applications. We've made great progress on both of those, while simultaneously bringing back our gross… our operating income.
So going forward, we'll be looking to work at the level… percentage levels of R&D we're at, while completing areas we've been working in the graphical system design and working on the new customers, which we've established. Some very nice examples, and we'll be talking about more of those examples at NIV.
Mark Moskowitz - JP Morgan
Okay. I appreciate the three-pronged response to that first question.
Maybe we could shift gears here to the embedded and industrial control piece. Maybe I missed it.
Did you say how much of your total revenues came from that growing segment? And then the second part of the question would be how should we think about that business becoming something… the mid-30s, maybe in 40% of revenues down the road?
John M. Graff - Vice President of Marketing, Customer Operations and Investor Relations
This is John. In past conference calls, we've mentioned that, you know, we have our rough estimate that anywhere from 20% to 30% of our business we could classify is being industrial and embedded.
As we've mentioned in the past, it's hard for us to quantify it exactly, primarily due to fact that our products with hardware and software can be sold in such a breadth of applications, so things like LabVIEW and LabVIEW Real-Time. On the hardware, PXI and CompactRIO are sold in the research, in the manufacturing tests as well as industrial.
We survey our customers regularly and frequently, and we get an idea from the them in terms of how many of them tell us their application is in what we might classify as industrial and embedded. So those are the similar factors we use to kind of estimate a 20% to 30%.
We do see a significant and large opportunity in that space. Now, we're not at a point to give you guidance in terms of when that might be 30% to 40%.
Hopefully, [inaudible] to some of the things you'll see in the customer successes we talked about. You'll get an idea that we do see it growing faster than the rest of our business, and we'd expect to continue to add over the next 5 to 10 years.
And as Dr. T mentioned, that's driving a lot of the product R&D decisions.
Mark Moskowitz - JP Morgan
Okay. And just lastly, Alex, is there ever the potential for an argument where National Instruments can may decouple from the Global PMI?
It just seems relative to a lot of other companies out there that your revenue base and your gross margin and profit profiles have been a lot more sturdy than a lot of peers out there.
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Well, Mark, given that I am an Irish guy, there is always a potential for an argument. But no.
I think that that is clearly the strategy that we are looking to pursue. I don't believe we'd ever fully separate ourselves from the PMI, because we sell to such a broad base of customers and have such a diversified user base.
But our goal course is to stand out significantly from the rest of the industry, and I think we fairly done that in the last six months, for the last probably 26 years, but certainly in the last six months. And I think we've had a rate of growth that's been significantly greater, and we would like to continue that.
And our goal should be over time if we're successful in our strategy that we can grow at a higher rate for the same average level of PMI. And that's certainly what we're going to try to execute on as we go forward.
And we will talk more about our strategy for trying to promote growth longer-term at NIWeek, the week after next.
Mark Moskowitz - JP Morgan
Thank you.
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Thanks very much, Mark.
Operator
Next, we have from John Harmon with Needham & Company.
John Harmon - Needham & Company
Hi, good afternoon.
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Hey, John, how are you?
John Harmon - Needham & Company
Good. So my first question that probably contains about two questions so I can get around your guideline…
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
That's the average though, we'd love to go with it.
John Harmon - Needham & Company
Yeah. That will be [inaudible] for the crowd, I met.
I have never seen you give two quarters of guidance before. What's the reason behind that?
And you talk about Q2 to Q3 EPS being certainly flattish historically. Certainly revenues have been flattish.
But, you know, you're going for high-single digit millions of revenue coming up sequentially. Is that from that this mysterious new software product introductions?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Well, the reason I've given two quarters of guidance at this point in time is that the timing around the release of our primary software releases this year has shifted a little bit from last year. And I want people to be able to get visibility into that increase in R&D expenses in the third quarter, now which is something that really occurred in Q4 last year and I have been able to appreciate and separate out that impact.
We're very excited to have these products, which we will be releasing here in the third quarter. I can't get really specific beyond that point.
But the release earlier this year than last year is certainly a positive in our view. And so we want our people to understand that dynamic.
And I also wanted to point out as we look into next year and as we move to hopefully steady state at an 18% operating model that that will cause a slightly different dynamic in terms of the sequential earnings numbers than we've seen perhaps over the last couple of years. And so that's the answer to the first question.
And now, I can't remember what your second question was?
John Harmon - Needham & Company
You haven't heard it yet. The second question is regarding your use of cash.
You said that you prefer dividends over share buybacks, and you doubled your dividend. Is that related to the recent strength in your stock price or from some other philosophy?
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Well, a number of inputs there. Obviously, we increased our dividend from $0.07 a share up to $0.10 a share.
So when we look at that increase, it is certainly significant. We have obviously, as a company, been very successful in very significantly growing our non-GAAP operating income and net income over the last 4 years.
We have increased the dividend steadily over that time, but not at the same rate as our profitability has grown. So we are looking at that a little bit of catch up, and we now feel increasingly confident in our goal of trying to hit 18% this year as we said in the call.
To hit 18% this year, we needed to increase our operating margin by 2 full points for the year, and we've executed on that for the first half of the year. So obviously, we're more confident on that.
Our cash flow generation and our cash capital requirements from capital expenditure point of view are modest, which gives us the ability to generate a lot of cash relative to earnings. And so we see… sorry, dividends as certainly a very a tax efficient way of return that wealth to the shareholders and certainly have had number of inputs from large institutional shareholders that have expressed that view, you know, over the course of last number of years.
On buyback, you know, our strategy is to be opportunistic. We bought back about 2.4 million shares over the first half of the year at an average price, I think, of around $28 a share roughly.
So our strategy is to be opportunistic. We want to certainly have the capacity to buy stock, and certainly the board has supported us in our strategy for the deployment of cash, and we don't anticipate changing those cash priorities in the short term.
John Harmon - Needham & Company
Great. Thank you very much.
Operator
That is all the time we have for questions. I would now like to turn the call back to Mr.
Alex Davern for any additional or closing remark.
Alexander M. Davern - Senior Vice President of Information Technology and Manufacturing Operations Chief Financial Officer, Principal Accounting Officer and Treasurer
Thank you very much for joining us today. We look forward to seeing you at NIWeek on Tuesday, August 7th.
And we’ll have an exciting show. So we hope to see you there.
Thank you.
Operator
This concludes today's call. We thank you for your participation and have a wonderful day.