Hittite Microwave Q3 2009 Earnings Call Transcript

Hittite Microwave Corporation (HITT)

Q3 2009 Earnings Call

October 22, 2009 5:00 pm ET

Executives

Stephen G. Daly - Chairman of the Board, President, Chief Executive Officer, Director

William W. Boecke - Chief Financial Officer, Vice President, Treasurer

Analysts

Romit J. Shah - Barclays Capital

Matthew Robison - Wedbush Securities

Aalok Shah - DA Davidson & Co.

Jiwon Lee - Sidoti & Company

Ryan Brookman - Oppenheimer

Nicole Conway - Thomas Weisel Partners

Presentation

Operator

Good afternoon ladies and gentlemen, thank you for standing by and welcome to the Hittite Microwave Corporations’ third quarter 2009 conference call. During today’s presentation all parties will be in a listen only mode. Following the presentation the conference will be open for questions. (Operator’s instructions) This conference is being recorded today, Thursday, October 22, 2009. At this time I’d like to turn the conference over to Mr. Steven Daly, Chairman, President and Chief Executive Officer, please go ahead, sir.

Stephen G. Daly

Thank you. Ladies and gentlemen, good afternoon and welcome to Hittite Microwave Corporations third quarter 2009 conference call. With me today is Bill Boecke, our Vice President and Chief Financial Officer. Before I begin the discussions I would like to review the Safe Harbor statement.

Please note that statements made in this conference call about Hittite’s future expectations, plans and prospects constitute forward-looking statements for the purposes of the Safe Harbor provisions under the private securities litigation reform act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors. For information about these factors I refer you to the earnings release that we issued earlier today into our report on Form 10-K and 10-Q filed with the Securities and Exchange Commission.

The earnings release along with other financial and statistical data that we may discuss on the call and copies of our SEC reports are available free of charge in the investor relations section of our website at www.hittite.com. You may also obtain copies of our SEC reports and a copy of our press release furnished under Form 10-K and 8-K from the SEC’s website at www.sec.gov.

Today’s conference call will be structured as follows. First I will summarize our third quarter performance. Next then we’ll review in detail our third quarter financial results. When Bill is finished I will provide revenue and earnings guidance for the fourth quarter of 2009 and then invite listeners to ask questions. Following the question period I’ll make some brief closing remarks.

In the third quarter our revenue increased 4.5% compared to the second quarter for 2009. Net income for the quarter increased 13.2% sequentially to $12 million and exceeded our plan primarily due to strong gross margins. The overall business climate has improved relative to Q1 and Q2.

On a geographic basis, 43% of our third quarter revenue was from domestic customers and 57% from international customers. The decreased in the international revenue percentage compared to last quarter is due to lower international sale or infrastructure revenue and higher US military revenue.

Going forward, we expect this ratio to remain close to a 40-60 split as it has been historically.

The Q3 revenue distribution across our target eight markets were slightly less concentrated in comparison to Q2. In the third quarter, three of our eight markets accounted for approximately 78% of our total revenue. These markets are cellular infrastructure, microwave and millimeter wave communications and military. The remaining target markets, automotive, broadband, fiber optic, space and test and measurement accounted for 22% of our revenue.

We experienced sequential revenue growth in six of our eight end markets. This performance marks a continued improvement over Q2 results where only four of our markets grew sequentially. The improvements came from most geographic regions and submarkets. And we believe that this represents improved and demand.

Measured on a percentage basis, the strongest sequential growth came from the test and measurement market, and then in descending order, military, automotive, microwave communications, broadband and space.

As anticipated our cellular infrastructure revenue declined, primarily results of our exceptionally strong Q2 that related to the 3G rollout in China. Our fiber optic revenue also declined primarily due to timing of orders. These decreases are examples of short term variations which are normal for our business and we believe our long term growth prospects in these markets and our other six markets remains excellent.

The underlying favorable trend of increased loading existing infrastructure networks and the need to expand connectivity worldwide represents a significant growth opportunity for Hittite.

We will continue to focus on developing advanced semi-conductor based products using a combination of Hittite R&D and government based funding. Recently we’ve been successful in supplementing our internal research projects with new government contracts to support next generation IC development.

We continue to expand our relationships with government agencies and look for funding on the most advanced and technically challenging projects.

Our recently awarded programs primarily focus on investigating new circuit design techniques around high power applications. And achieving new levels of IC chip densities for microwave frequency applications. These funded research activities will have a direct benefit on our future commercial business.

Our engineering and product development teams achieved tremendous results in the quarter. The recent new product introductions illustrate the depth of our engineering talent and our ability to expand our product portfolio using a wide range of technologies.

In the quarter we launched 21 new products and launched two new product lines. Our newest set of products uses gallium arsenide and silicon semi-conductor processes as well as a wide range of package technologies.

Each of our new products targets a primary application and in most cases that same product is usable in adjacent application and markets. We are executing our strategy to expand the breadth of our portfolio with more high performance products. And I am pleased with the uniqueness and the competitive attributes of these latest products. These new products represent best in class performance.

I would like to introduce the two new product lines which increase our portfolio to 22 product lines. Our 21^st product line is a high performance dialector resonator oscillator or DRO product line. This product line will service niche applications in the military, in scientific test and measurement markets. These specialized fixed frequency module products are high priced and will be produced in low volumes and targets the $25-$55 million market. Our DROs are designed with proprietary signal generation ICs and architectures that allow us to meet the most difficult signal generation requirements. We incorporate face shifters, temperature compensation, power amplifiers and regulator inside our DRO modulates.

While our most advance DRO solutions will remain proprietary for our subsystem customers, our standardize products will be extremely attractive to military OEMs and test and measurement customers. The tights product line provides a 20 DV improvement in phase noise over solutions that are available in the market today which is an accomplishment our customers will value.

Our 22^nd product line is a PLL with integrated VCO product line. This product line shall service a wide range of applications across all eight of our end markets. This product line is not a niche product line and targets $100 million plus market. The products in this product line showcase our expertise in advanced VCO and PLL design and our ability to combine these functions into one product. This product line widens the advantage we have over the competition which today still struggles to replicate the performance of our first generation stand along microwave frequency VCO products.

Additionally, our leading PLL plus VCOs make it possible for Hittite to address applications at the RF frequencies where we currently have little or no market share.

Our customers will now be able to consider Hittite PLL And VCO solutions in their next design cycle. We offer our customers industry leading phase noise and spurt performance in a highly integration solution which will simplify their design architecture and shorten their product development cycle.

Our customers will also be able to decrease the part count on their bills of materials which may lead to an overall solution cost savings.

To date, customer feedback on this product line has been positive. This is a complex product area with limited suppliers. The product line will compete with small boutique low frequency hybrid VCO manufacturers and large analog and mix signal IC PLL manufacturers.

In time, we expect to successfully take market share based on our products compelling performance not price.

Our sales and business development teams are working with success to expand our customer base. Today our team services over 3,000 customers worldwide and we expect this figure to grow in 2009 as it did in 2008. Our team has recently attended industry trade shows in Italy and will soon be attending fiber optic and microwave focused trade shows in Japan, India and Israel.

Demand for our produce is increasing in all of our eight markets. Our sales team and business development staff have been focused on addressing a wide range of new applications which will allow us to expand our customer basis. For example our new high speed logic and comparative products are finding traction in digital network, medical and industrial applications. And our new PLL ICs have ubiquitous appeal across all markets including many new applications. These new applications will further broaden our global footprint and expand our customer base.

We are pleased with our success in the fiber optic market which has achieved more than 100% revenue growth year to date. Our future growth in this market will come from our expanded product set that better addresses the 10 gigabit and 40 gigabit Ethernet, sonnet an DWDM transceiver modular market.

In Q3 our top 10 customers represented 34% of our total revenue and no one customer exceeded 10%of our total revenue. Our overall customer concentration remained similar to prior quarters and we expect this trend to continue.

Capital spending in the quarter was approximately $1.8 million for a total of $6.2 million year to date, inline with our budget. Spending was focused on production test and assembly equipment and production mass tooling. I am confident these new investments will enable us to achieve our future goals.

Our manufacturing operation continues to plan and execute well to support our business. We maintain a high focus of constantly improving our internal manufacturing processes, supply chain management and factory efficiencies. One example of factory improvements is our recent deployment of state of the art automated assembly equipment. During 2009 we have more than doubled our automated diatatch and wire bonding assembly capability. This new automation will lower the manufacturing costs for many of our products by improving throughput. Automotive assembly also improves our product quality which has a positive effect on production test yield, part to part variation and long term reliability.

Inventory increased by approximately 2.1 million or 13.5% compared to last quarter. The gross and inventory was planned and is high quality. Our inventory supports a wide range of long term flow velocity contracts and products as well as a large number of short term high velocity contracts and products. Our competitive advantage of off the shelf product availability leads to strong customers satisfaction, especially during these times when our customers find it difficult to manage inventory needs and requires shorten lead times.

In summary, I am pleased to see increasing growth rates, strong gross profit margins and strong operating profit margins. We stand before a multi billion dollar market and have more capability than ever before to take market share. We continue to execute our long term strategy of launching innovative products which will out perform the competition. Our two newest product lines are great examples of how we address new application, new markets and new customers.

Additionally, I’ll note our newest products are not eroding our financial profile and will provide sustainable and steady business for us in the future. I’ll now turn the discussion over to Bill Boecke, our Chief Financial Officer.

William W. Boecke

Thank you, Steve. And good afternoon. The key highlights in our financial performance for the third quarter are, revenue growth of 4.5% sequentially, gross profit margin of 72%, a 158 basis points improvement from the prior quarter. Operating profit margin of 44.1%, a 326 basis point sequential improvement. A return of capital employed of 80%, and $17.9 million of positive cash flow from operations. As Steve described our business continued to grow in the third quarter as a result of new product introductions, improvement in markets and increased market penetration.

Revenue for the quarter was $41.5 million, an 8.9% decrease from the prior year Q3 2008 and a 4.5% increase from the prior sequential quarter Q2 2009. Gross profit and margin for the quarter was $29.8 million or 72% respectively, compared with 72.5% in the prior year and 70.4% in the prior quarter.

The net sequential change in the gross margin was attributable to a number of factors including price, production cost, and mix. R&D expense for the quarter was $5.6 million or 13.5% of revenue compared with $6.4 million in the prior year and $5.2 million sequentially.

The sequential increase in R&D expenses is attributable primarily to the timing of R&D materials. We expect R&D expenses will continue to increase in Q4 as we continue to introduce new products in line with our plan. Sales and marketing expense in the quarter was $3.8 million or 9.1% of revenue, compared with $4 million in the prior year and $3.7 million sequentially.

The sequential increase in sale and marketing expense is attributable primarily to commissions paid to our third-party representatives. We will continue to manage these sales and marketing expense costs to support our revenue growth, plans, and goals. General and administrative expense in the quarter was $2.2 million, 5.3% of revenue, compared with $2.1 million in the prior year and $2.8 million in the prior quarter.

The sequential decrease in G&A expense is primarily the result of accounts receivable charges incurred in the second quarter and lower third party professional costs in the third quarter. We will manage future G&A spending in line with our financial goals.

The resulting operating income and margin in the third quarter was $18.3 million or 44.1% compared to 45.1% in the prior year and 40.8% sequentially. Operating income for this quarter includes equity compensation expense of approximately $1.6 million or $1.1 million after tax.

Interest and other income is primarily interest income and reflects the continued low effective yields on our short-term investments which are primarily in US government securities. The provision for income tax in the quarter was $6.4 million, an effective rate of 34.7% for the quarter and 35.2% year to date, an increase of four basis points compared with the effective rate in 2008.

Net income in the third quarter was $12 million of $0.40 per diluted share, compared with $13.7 million or $0.44 in the prior year and $10.6 million or $0.35 in the prior quarter. Our actual net earnings exceeded our initial guidance due to the higher revenues, improved gross margins, lower operating expenses, and favorable adjustments to our effective tax rate in the quarter, each worth approximately $0.01 per share. In review of our financial position, total assets at September 30, 2009 were $289 million, a net increase of $16 million from June 30.

The increase in total assets in the quarter was primarily cash. Total asset turns in Q3 was 0.6 times annualized and net operating assets or capital employed turned approximately eight items compared with 2.7 in the second quarter and 2.6 in the first quarter.

In further analysis of our financial positing, total cash and short-term investments at September 30 was $215.2 million. Total cash flow in the quarter as $17.2 million. We manage our cash and short term investments to preserve our financial capital. We currently maintain our investments primarily in highly diversified portfolios of finds of short-term US government paper with shortened average maturities to increase liquidity.

Total accounts receivable declined $2.5 million to $19.5 million which represent approximately 42 day sales outstanding, a result of favorable timing of invoices and collections within the quarter. Net inventory was $17.8 million, an increase of $2.1 million from the prior quarter to $17.8 million. Current inventory turns approximate 2.6 times annually.

As Steve explained, the increase in inventory is due, in pat, due to the introduction of new products, changes in customer lead-time requirements, as well as timing of materials for certain customer contracts.

From the perspective of financial returns, our return on assets this quarter annualized was 17% and our return on equity was 18% . More importantly, our return on capital employed is improving from a low of 68% in the first quarter to 70% in the second quarter and to 80% in this quarter. We expect our return on capital employed to continue to improve as we progress through this economic cycle. I'll now turn the discussion back to Steve.

Stephen G. Daly

Thank you, Bill. Hittite Microwave Corporation expects net revenue in the fourth quarter ending December 31^st, 2009, to be in the range of $42.5-$43.5 million and net income to be between $11.3 million and $12.3 million or $0.38-$0.41 per diluted share. Our Q4 guidance at the high end of the range represents approximately 5% sequential revenue growth which is an improvement over Q3.

Our Q4 forecasted net income is based on an estimated gross profit margin comparable with recent quarters in a tax rate of 35%. Our backlog position t the beginning of the fourth quarter is stronger than it was at the beginning of the third. Recently, orders from all regions have been steady. We will continue to service our costumers at the highest level, aggressively attack our competition, and enter new product areas and new markets and introduce innovative technologies which will support our future goals.

And last, in October we will initiative a 300,000 share buyback program to offset dilution from equity incentive grants issued in the past 12 months. We expect this repurchase program to be completed in 3-6 months. This program will allow us to maintain our stated objective of holding a share count at approximately 30 million shares.

I would now like to invite our listeners to ask questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, we'll now begin the question-and-answer session. (Operator's Instructions) Our first question is from the line of Romit J. Shah with Barclays Capital.

Romit J. Shah - Barclays Capital

Steve, you mentioned in Q3 that you saw growth in six out of your eight end markets, what's your expectation for Q4?

Stephen G. Daly

Well, I think that when we give our guidance and talk about the next quarter we categorize the markets as strong, neutral, and weak, and from today's perspective that's probably the best way to characterize it. So we would envision military, space, and fiber markets being strong, and microwave communications in broadband markets being neutral, and the cellular and automotive markets being weak.

Romit J. Shah - Barclays Capital

Okay. It seemed as though one trend we've seen over the last couple of quarters is that the breadth of your business has been improving in Q3 versus Q2. What is your expectation that that trend would continue in Q4 and can you comment specifically on what you're seeing in the infrastructure space?

Stephen G. Daly

On the first part of your question, are you referring to the revenue or the product introduction rate?

Romit J. Shah - Barclays Capital

I'm referring to revenue.

Stephen G. Daly

Right. So we generally look at our business as not having a lot of seasonalities so every quarter has a very different chemistry and makeup so it's really a type of business that we have limited medium term and long term visibility because we start each quarter with about 50% of our business in backlog. So each quarter, as we talked about Q2 compared to Q3, were very different and that's just the nature of our business.

In terms of the long-term growth perspectives in infrastructure, we thin there's a lot of good things happening there and certainly just looking at the activity in India with the release of the 3G license coming up, that should certainly provide the industry with a lot of activity over the next year or so. That's just one example.

Romit J. Shah - Barclays Capital

Okay. Let me just shift gears quickly to your Q4 guidance. You're forecasting revenues to increase about 3.5%-4% at the midpoint and earnings are essentially flat. Should we assume that gross margin comes down a bit in Q4 or should we think about OpEx maybe trending up a little bit more?

Stephen G. Daly

A little bit of both, and I'll let Bill talk to that.

William W. Boecke

Yes. I think you should look at the gross profit margin being comparable to what you've seen in the past two or three quarters which is about 71% give or take, and the OpEx will come up a little bit in the fourth quarter as we talked a little bit about the R&D as well as in sales and marketing.

Romit J. Shah - Barclays Capital

Okay. And is the slight drop in gross margin attributable to mix or pricing in particular?

William W. Boecke

It's hard to say at this point because we are looking forward, but I think the impact will probably be comparable to what we've seen in the past two or three quarters which means I suspect price will have an impact, mix will have an impact, and production cost variances will also have an impact.

Romit J. Shah - Barclays Capital

Okay. Very good quarter, thank you.

Operator

Our next question comes from the line of Matthew Robison with Wedbush Securities.

Matthew Robison - Wedbush Securities

Hi, congrats on your success. First of all, I heard you mentioned $17.2 million total cash flow, did you also give operating cash flow?

William W. Boecke

Cash flow from operation was 17.9 — total cash flow was 17.2

Matthew Robison - Wedbush Securities

Okay. And this big market you're entering with the phase lock loops and VCOs, is that so large partly because you're going to target the bay station market?

Stephen G. Daly

That market and the requirement for those types of products reaches well beyond the infrastructure market so wire line applications have requirements for PLLs and VCOs. A variety of wireless applications as well, low data rate, high data rate type of applications. So we look at this type of a product line that will service all eight of our markets.

And the nice part about that is there will be many different price point as we enter different markets with different requirements. So we believe this will provide the company a wonderful opportunity for growth over the next few years.

Matthew Robison - Wedbush Securities

And the DRO business, is that going to be mostly defense or will that also be for point to point radios as well?

Stephen G. Daly

It will not be for point to point radios. It will primarily be of defense, scientific measurement, instrumentation, lab equipment, this type of application. And it would not meet the cost requirements of an outdoor radio. And generally those radios use a completely different frequency generation technology.

Matthew Robison - Wedbush Securities

The improvement in test and measurement, I think that was one of the markets you said was somewhat soft in the June quarter. What would you attribute that to?

Stephen G. Daly

We've actually been very pleased with the recovery that this market has been making for Hittite over the year. A lot of that is coming from the adoption of a lot of our high-speed logic products that are going into high data rate type products and new design wins around those products, probably more so than an overall industry recovery.

Matthew Robison - Wedbush Securities

Like the 40 and the 100 GB testers, those types of things?

Stephen G. Daly

Right. We’re not really servicing the 100 GB testers at this point, but we are certainly serving the 10 and the 40. And we're now just introducing a product that is 28 GB, which if deployed properly, could service 100 GB platforms.

Matthew Robison - Wedbush Securities

Okay. And why was R&D down year over year? Is that a function of materials, as you mentioned?

Stephen G. Daly

Well, R&D is down for the year mainly because our revenue is down and we've been managing, very carefully, the spend in that area. And as I look out into the remainder of the year I think our R&D dollars spent will be down about $1.5 million compared to 2008. So a little bit of that is management. We delayed some programs this year and we're now starting to bring those programs back as we see the recovery in our business.

I'll also point out that over the last three years we've had a tremendous investment in R&D. 2008 was over a 30% increase in R&D dollars spent. The year before that over 23% increase. So we'd like to spend those dollars. We want to get back on track where we're investing significantly in R&D and that's why as Bill made comments to OpEx going up, it will start there.

Matthew Robison - Wedbush Securities

Does neutral mean flat sequential? Is that the way we should look at that?

Stephen G. Daly

I think that's a fair way to look at that. Understand that generally when we categorize these markets, for the next quarter it's a very broad characterization of our expectation. It doesn't necessarily mean that market will show growth. In some instances it means it will remain stable or remain flat, but we think this is the best way to characterize what we expect from those markets.

Matthew Robison - Wedbush Securities

And the new products, were they principally in the new product lines or were they across the board?

Stephen G. Daly

They were across the board. I would say that for the new product lines, today there's approximately 8-10 products that appeared inside of the VCO and PLL product area recently. And besides that, the others were spread around, the other product areas.

Matthew Robison - Wedbush Securities

That's all for me. Thank you.

Operator

Our next question comes from the line of Aalok Shah of DA Davidson & Co.

Aalok Shah - DA Davidson & Co.

A couple of quick questions, Steve, I know you mentioned a little bit about the infrastructure business, but could you provide maybe — I don’t know if you have any more color, but if you could maybe talk about the geographical standpoint about where you’re seeing the strength and where you're not seeing the strength right now. And I think you mentioned before in the past that you thought that China infrastructure build out would probably at some point pick back up an I'm curious to see where you think that is right now.

The second question I have is just on the military business. I understand it was a little bit softer in Q2 and it seems like it was quite ab it stronger in Q3, do you think there was just a shift in revenue from Q2 to Q3 that happened there?

Stephen G. Daly

Okay. Regarding on the infrastructure side, the strength and weaknesses from a geographic point of view, we certainly saw that Asia was down. So a lot of our Chinese-based revenue relative to 3G declined. Europe actually surprised us a little bit. We did see revenue that was slightly ahead of our expectation in the quarter. Generally speaking though, we do see a slowdown in a lot of the programs that we're involved in relating GSM and we see a lot of our costumers switching over to new platforms and a lot of their customers adopting 3G. And so that inflection points seems to be happening and we're seeing a little bit of that.

Regarding your comment about China and when it will come back, we really can't comment on that at this point. Certainly our sales organization and country is keeping us up to date with the best G2 that they can and the best data they can, but I'm probably not the right person to really comment on when the license would be released for the fourth phase.

On the military side, your question about what is it a shift in revenue from Q2 to Q3, I think yes, there was a little bit of that. But also we did see new programs come online, primarily in the counter IED area, programs such as what they call CREW or counter remote controlled electronic warfare programs where we have strong penetration, as well as other general communication and sensor programs.

Aalok Shah - DA Davidson & Co.

Great. And then this last question in terms of competition for the new product you announced, are these more captive designs typically or are these actually available off the shelf by some competitors out there?

Stephen G. Daly

'Well, the products that we lunched are unique to the market and they will be standard products that will address the common frequency bands that are used in the telecom markets. So we're not launching products that replicate competitors. These are really next generation products that have more features and more functionality and raise the bar on critical performance features. So this is a classical Hittite approach where we go to the market with our own style product and we convert customers to use our products based on performance.

Aalok Shah - DA Davidson & Co.

Okay, great. Thank you very much.

Operator

Our next question comes from the line of Jiwon Lee with Sidoti & Company.

Jiwon Lee - Sidoti & Company

Thank you. First of all, was there nonlinearity in the order trend n the third quarter and how is the tracking so far in the fourth quarter?

Stephen G. Daly

Bill, do you want to comment on that?

William W. Boecke

The order trends in Q3 were relatively linear. We did not see anything unusual in the cycles in Q3 and it's probably a little bit too early to comment on what we think will happen in Q4.

Jiwon Lee - Sidoti & Company

Okay. I remember last quarter that you expected the tests and measurement market to be sort of neutral. So did you that trend in the third quarter surprise you and what kind of embedded revenue assumption did you have for the fourth quarter?

Stephen G. Daly

Well you’re right, we did categorize testing measurement as weak, as well as automotive and both of those market surprised us in the quarter. Some of that had to do with the resumption of programs that were in steady-state products. That increased their run rates. As well as new products coming on line.

But, I think the essence of your question speaks to the fact that it's very difficult with 100% accuracy, to pin down the behaviors of these markets, and I think you should recognize that over the long term we're getting deeper and deeper penetration and that quarter to quarter we're going t see variations and some markets will go up and some markets will go down and that's the nature of our business. With such a grand customer base in so many products that we’re selling, we're considering this ranging normal.

Jiwon Lee - Sidoti & Company

Okay. And the foreign sales, remind us what the percentage was last quarter and whether or not your expectations were declining the foreign sales, including China 3G, did it happen to the degree that you expected?

Stephen G. Daly

Q2 we had domestic sales of 36% and in international of 64%. And as we talked about in Q3 it was a 43-57 split so clearly the domestic revenue climbed and the international declined. We were very accurate in forecasting the decline in the slowdown coming out of our China 3G business, so I think we did a nice job with that. We actually, in looking one layer deeper, were surprised with some of the strength we saw coming out of Europe.

Jiwon Lee - Sidoti & Company

Okay. And in terms of your top 10 customers, if I can go a little bit deeper into it, perhaps top five. Could you give us a little more color as to which end markets they were located in and in terms of their geography?

Stephen G. Daly

Certainly. Generally what we see in our top customer base is the major OEM cycling in and cycling out depending on the period and the production runs that they're making. So we constantly have new names as well as existing names appearing in the top 10 as well as the top five and what we actually look at is how many million dollar customers we're generating over the long term.

And what we can see is that we have a type of business that has a very long tail in terms of the size of our customers and what our focus is on is taking companies that might have a half a million or three-quarters of a million dollars of sales with Hittite and moving them wards $1 million and then to $3 million and then $5 million of revenue on an annual basis.

So you should envision that the makeup of this list is very fluid, constantly changing, and that's also, as I pointed out, the nature of our business given the breadth of the business.

Jiwon Lee - Sidoti & Company

Okay. And lastly, in terms of your military business, was there any significant order gaining and how much visibility do you have for 2010?

Stephen G. Daly

I wouldn't say that there was any significant major wins that happened during the recent quarter. And in terms of our visibility in the military market, depending on the customer and depending on the program, sometimes we had very good visibility and sometimes we have limited visibility, and especially when we service customers at the component level where we know we have large major OEMs competing for the same platform. What we need to do is get positioned at both customers to make sure that whichever one wins, we ultimately go to production. And so, to the extent that we can forecast and manage that, we do. I would say the military market is one of our markets where we have better visibility compared to a market like broadband which is a very high velocity market where you just don’t get that visibility.

Jiwon Lee - Sidoti & Company

Okay. So some of the orders that you anticipated in the second quarter, the shipment timing of it, has anything been expedited or has pretty much all the big problems as you anticipate since last quarter?

Stephen G. Daly

Well, we constantly have customers expediting us and also pushing out deliveries and that's also a Hittite strength is to work with them to make sure that we’re satisfying their customer schedules. I wouldn't necessarily say that there was anything specific or unique to the third quarter that's notable.

Jiwon Lee - Sidoti & Company

Okay. That's helpful. Thank you very much.

Operator

Thank you. Our next question comes from the line of Rick Schaeffer with Oppenheimer.

Ryan Brookman - Oppenheimer

Hey, guys. This is Ryan Brookman on behalf of Rick. Just had a couple housekeeping items I wanted to run through. You mentioned that there were four variables that contributed to the $0.094 on the EPS number, if you could just run through those again quick?

William W. Boecke

Sure. We had a little bit of increased revenue above what our guidance was. We had expansion on our gross margin, a slight reduction in our operating expenses, and we had some favorable adjustments to our tax rate in the third quarter. And each one of those represented approximately $0.01.

Ryan Brookman - Oppenheimer

And I know you've given the Q4 guidance on the tax rate, could you just repeat that?

William W. Boecke

Approximately 35%.

Ryan Brookman - Oppenheimer

Great. And last question I have is in regards to stock compensation expenses broken out by COGS, SG&A, and R&D?

William W. Boecke

Sure. So the total amount was $1.6 and let me break it out by function. Cost of sales was $353,000, R&D was $544,000, sale sand marketing was $270,000, and G&A was $460,000.

Ryan Brookman - Oppenheimer

Okay. That's it for my questions. Thanks a lot.

Operator

And our next question comes from the line of Nicole Conway of Thomas Weisel Partners.

Nicole Conway - Thomas Weisel Partners

Hi. My question is based on from your vertical integration business, I was curious how that is growing and at what point you would see that contributing materially to revenue?

Stephen G. Daly

We're actually quite pleased with the performance of the strategy, and I'll point at the work we're doing in the test and measurement area. We actually have two standard products today that we sell; what we call a T-2000 and a T-2100. The T-2100 is a 20Ghz signal generator and the T-2000 is an 8Ghz single generator. And the lower frequency one cells for $4,000 and the higher frequency is $8,000.

And these utilitarian products are taking market share because we've found that a vast majority of micro save engineers want a very clean signal that's programable with computer interfaith and that's exactly what these products satisfy. So we've been very successful of the rollout of the product lien. I would say that maybe next year or the year after, we'll start to see material contribution, it's still early. And again, converting our customer base from the major chest and measurement equipment companies over to Hittite and that certainly takes time.

Nicole Conway - Thomas Weisel Partners

Great, thanks. And then finally, in regards to Europe, I was curious what exactly showed the strength that you weren't expecting? And do you see that as being kind of early signs of at turnaround in Europe and that continuing to grow sequentially?

Stephen G. Daly

It was primarily driven from some automotive programs and I would not categorize the strength we saw in Q3 as an indicator of a rebound coming.

Nicole Conway - Thomas Weisel Partners

Okay, great. Thank you.

Operator

And we have no further questions at this time. I'd like to the conference back to Mr. Daly for any closing remarks.

Stephen G. Daly

Thank you. In closing, I would like to acknowledge the hard work of all of our employees during the quarter which made these results possible. I would also like to thank our suppliers and customers for their continued support. Thank you very much.

Operator

Thank you, sir. Ladies and gentlemen, if you'd like to listen to a reply for today's conference, please dial 1-800-406-7325, or international participants can dial 303-590-3030, using the access code of 4160203 followed by the pound key. This does conclude the Hittite Microwave Corporation’s third quarter 2009 conference call. Thank you very much for your participation.

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