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Hittite Microwave Corporation (NASDAQ:HITT)

Q3 2010 Earnings Call

October 21, 2010 5:00 PM ET

Executives

Stephen Daly – Chairman and CEO

Bill Boecke – Vice President and CFO

Analysts

Tore Svanberg – Stifel Nicolaus

Quinn Bolton – Needham & Company

Aalok Shah – D. A. Davidson

Gus Richard – Piper Jaffray

Jiwon Lee – Sidoti & Company

Dale Gose – Analyst

John Haller – HHR Asset Management

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Hittite Microwave Corporation’s Third Quarter 2010 Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions)

This conference is being recorded today, Thursday, October 21, 2010. I would now like to turn the conference over to Stephen Daly, Chairman and CEO. Please go ahead, sir.

Stephen Daly

Thank you. Ladies and gentlemen, good afternoon and welcome to Hittite Microwave Corporation’s third quarter 2010 conference call. With me today is Bill Boecke, our Vice President and Chief Financial Officer.

Before I begin the discussion, 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 and to our quarterly report on Form 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 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 8-K from the SEC’s website at www.sec.gov.

Today’s conference call will be structured as follows. I will begin by summarizing our third quarter results. Following my comments, Bill will review in detail our financial performance. After that, I will provide revenue and earnings guidance for the fourth quarter of 2010. I will then invite listeners to ask questions. Following the question period, I will make some brief closing remarks.

In reviewing the third quarter, our revenue was $64.2 million, an increase of 6.4% over the second quarter of 2010 and 54.7% increase year-over-year. Net income was $20.8 million, an 8.8% sequential increase and a 73.8% increase year-over-year.

Our net income exceeded our guidance to a slightly higher than expected revenues and stronger than expected gross profit margins. Overall, we are very satisfied with our Q3 performance. The first three quarters of the year have been strong, primarily due to the significant improvement in the business environment compared to last year.

On a geographic basis, 44% of our third quarter revenue was from domestic customers and 56% from international customers, which is similar to last quarter’s results. The 2.3% sequential domestic revenue growth is driven by the military market and the 10% sequential international revenue growth is driven by various markets including cellular communication.

In the third quarter, three of our eight markets accounted for approximately 80% of our total revenue, which is slightly less concentration than last quarter. These markets are cellular infrastructure, microwave and millimeterwave communications, and military. The remaining target markets, automotive, broadband, fiber optic, space, and test and measurement accounted for 20% of our revenue.

Six of our eight markets experienced positive sequential growth and two were down. This quarter-to-quarter growth variation is normal and result of timing of orders and revenue. Year-to-date, our total revenues have grown by 50% compared to the first nine months of 2009.

This is exceptionally high growth and we are cautious, and expect the growth levels will moderate in the coming quarters. At a macro level, the increasing demand for additional wireless data bandwidth and network capacity has been driving our growth. Our strategy is to expand our product portfolio to capitalize on this trend and to take market share.

During the quarter, our engineering teams introduced 30 new products for a total of 85 year-to-date, which brings the standard product portfolio to over 880 at the end of Q3. These 30 new non-commodity products will allow us to capture more market share in the cellular infrastructure, fiber optic, microwave and millimeterwave communications and military markets. Our customers will be attracted to these products because of their industry-leading performance, which in turn will give them a competitive advantage. I will briefly review a few specific new product highlights.

During the quarter we introduced eight products targeting the microwave and millimeterwave radio market. Specifically, we introduced five new power amplifiers and three new highly integrated IQ up and down converters.

Our new power amplifier products deliver between 0.5 watt and 4 watts of linear output power and cover poplar microwave bands between 12 and 33 gigahertz. Our new 4-watt linear amplifier represents the highest power of MMIC amplifier we’ve introduced to our standard product portfolio. The amplifiers have been optimized for 3G and 4G high-capacity point-to-point radio system.

Additionally, we introduced three new converters, which include integrated variable gain amplifiers and produce industry-leading figures of merit on sideband rejection, image rejection and noise figure. These feature rich converters target the 5 to 9-gigahertz long-haul microwave radio market. These frequency bands are typically used in rural and remote areas where long distance between links as required.

During Q3, we continue to expand our frequency generation product family, for example our new HMC732 is an ultra small wideband VCO, which covers 6 to 12-gigahertz. The 732 offers best-in-class phase noise in low power consumption of only 285 megawatts. This product family will continue to expand as we innovate and systematically improve our products performance using a wide range of design techniques in semiconductor and packaged technologies. The showcase of our designed capability is our MicroSynth product, which is the industries most compact high-performance wideband synthesizer product.

Our successful digitally controlled variable gain amplifier product line continues to expand with the addition of the new HMC926. This product expands the frequency coverage of the product line to cover 3G and 4G applications. We also expect this product to serve other broadband market, such as wireless meter reader applications. This product is typical for a Hittite high-performance product, because it utilizes gas and silicon semiconductor process technologies to optimize product performance and provide several key features such as high gain, low noise figure and an ultra small form factor.

And last, a notable research technical highlight is the delivery of our first high-speed analog-to-digital converters or ADC products to select strategic customers that has very high-end applications. Our ADC products used proprietary design techniques and achieve multi-bit resolutions and multi-gigabit sampling speeds.

Over the past four years, we have launched many new product lines and these product lines are ramping-up in revenues. Our product portfolio has and will broaden our overall addressable market and allow us to expand our customer base and thereby drive revenue growth.

Revenues from our silicon-based products continue to grow in Q3. Growth came from market share gains on our high-speed logic, interface, data converter, down converter, power detector and PLL VCO product lines. Going forward we expect continued growth from these new product lines.

In addition to releasing a wide range of standard products, our engineering teams supported other long-term development projects and they continue to work with the variety of government agencies on advanced technology development projects.

In Q3, our operating expenses increased by 1.6%, R&D spending increased approximately 500 K, due to expansion activities and this trend will continue throughout 2011. This year our goal is to both expand and broaden our engineering disciplines and product lines. We have been adding business development staff and scientists that are expert in a variety of new end-market and product areas. I’m very pleased with the effectiveness of our R&D spending. We continue to manage and we will continue to manage our R&D spending to ensure it is in line with other strategic and financial goals.

Our sales, marketing and business development teams continue to effectively expand our customer base, through customer visits and the publication of selection guides, news, letters and print and web-based advertising, we are accessing more customers than ever before. Our new product lines are also allowing us to enter new sub-markets and allow us to compete the new areas. The customer interest in our technology and products continues to grow.

In Q3, our top-10 customers represented 41.6% of our total revenue. We have a very active and diverse top 20-customer list and typically these customers represent industry leaders in the markets we serve. Feedback from our customers remains positive and during 2010 our sales, engineering and operational employees has taken pride in receiving a variety of supplier awards from our customers.

Capital spending for the quarter was $2.1 million for a total of $6.6 million year-to-date. Capital spending was focused on facility, test equipment and software for engineering, and production masks and other production assets. We expect capital spending to increase to approximately $5 million in Q4 as we complete the expansion of our new Chelmsford, Massachusetts engineering facility.

Our manufacturing operation continues to plan and execute well to support the business. Inventory increased by approximately 350 K or 2% compared to last quarter, in line with our plan. Our inventory is considered low-risk and high-quality and it supports long-term contracts and growing high-turns IC component business. Our inventory increase in the quarter was driven primarily by the commercial IC product lines.

At the beginning of 2010, we started a long-term project to, one, update our ERP software platforms and two, update our transactional business processes to enhance our operational efficiencies. Our operations, finance and information technology organizations have provided tremendous leadership and are almost complete with the first phase of the project. I congratulate the entire team for making excellent progress on this long-term project.

In summary, in Q3 we achieved $64.2 million of revenue and net income of $20.8 million or $0.69 per diluted share. These results represent record revenues and earnings for the company and validates that our growth strategies are effective.

I will now turn the discussions over to Bill Boecke, our Chief Financial Officer.

Bill Boecke

Thank you, Steve, and good afternoon. In the third quarter we continued with strong growth in both revenue and profitability. The key financial highlights in the quarter are revenue growth of 54.7% annually and 6.4% sequentially to $64.2 million.

Gross profit margin of 74.6% and an operating profit margin of 50.2%, a 97 basis point sequential improvement. Net income growth of 73.8% annually and 8.8% sequentially to $20.8 million or $0.69 per diluted share and our return on capital employed of 105% on an annualized basis.

Our business growth continued in the third quarter as Steve stated, a result of improvements in our principal markets, increased market penetration and new product introductions. Revenue for the quarter was $64.2 million, again a 54.7% increase from the prior year. Q3 2009 and a 6.4% increase from the prior sequential quarter Q2 2010. This quarterly revenue set another new record for our company.

Gross profit and margin for the quarter was $47.9 million or 74.6%, respectively, compared with 72.0% in the prior year and 74.8% in the prior sequential quarter. The sequential net change in the gross margin was minimal.

Total operating expenses grew $254,000 or 1.6% representing 24.4% of revenue in the quarter, compared to 27.9% in the prior year and 25.6% in the prior quarter.

R&D expense for the quarter was $8.3 million or 12.9% of revenue, compared with $5.6 million in the prior year and $7.8 million in the prior quarter. The sequential increase in R&D spending was primarily attributable to R&D supplies and materials and amortization of capitalized cost of acquired technology. We expect R&D expenses will increase in the future as we continue to expand and invest in the development of new products.

Sales and marketing expense in the quarter was $4.5 million, 7.1% of revenue, compared with $3.8 million in the prior year and $4.9 million in the prior quarter. The sequential decrease in sales and marketing expense is attributable primarily to lower third-party representative commissions and the timing of certain product marketing and promotion expenses. We will continue to manage the sales and marketing costs to support the expansion of our sales channel and customer base in our new and existing markets and geographic territories.

General and administrative expense in the quarter was $2.8 million or 4.4% of revenue, compared with $2.2 million in the prior year and $2.7 million in the prior quarter. The sequential increase in G&A expense in the quarter was primarily attributable to personnel costs and third-party professional fees. The resulting operating income and margin in the quarter increased to $32.2 million or 50.2%, compared to 44.1% in the prior year and 49.2% sequentially.

Operating income for this quarter includes equity compensation expense of approximately $2.2 million or $1.4 million after-tax. The provision for income taxes in the quarter was $11.3 million, an effective rate of 35.2% for the quarter and 35.4% year-to-date, an increase of 102 basis points over the effective rate in 2009.

Net income in the quarter was $20.8 million or $0.69 per diluted share, an increase of 73.8% compared with $12 million, $0.40 in the prior year and 8.8% increase compared to $19.2 million or $0.64 in the prior quarter. Our earnings in the quarter exceeded our guidance of $0.65 due to the favorable gross margins and slightly lower operating expenses due to the timing for certain expenditures.

In review of our financial position at September 30, 2010, our total assets were $372 million, a net increase of $36 million from June 30, 2010. The increase in total assets in the quarter was primarily cash and to a lesser degree additional working capital associated with our revenue growth. Total asset churns in Q3 was 0.7 times on an annualized basis and net operating assets or capital employed, turned approximately 3.3 times annualized compared with 3.5 times in the prior quarter.

In further analyzes of our financial position, total cash and short-term investment at September 30 was $273 million, an increase of $31.2 million. The increase in cash is comprised primarily of $23.6 million of free cash flow and $7.7 million from equity compensation plan.

Total accounts receivable were $27.5 million, which represent approximately 39-day sales outstanding. Net inventory was $23.1 million, an increase of $357,000 from the prior quarter. Net inventory turns for the quarter was 2.8 times on an annualized basis, compared to 2.7 times in the prior quarter.

The increase in inventory is primarily in support of the growth and customer demand for our products, as well as the introduction of our new product. From the perspective of financial returns, our return on assets this quarter was 23% and our return on equity is 25% comparable with the prior quarter. Our return on capital employed was 105%.

I’d like to highlight that our Q3 financial results was one of our best. We achieved new records in revenue, operating profit, margins and net income. Furthermore, we are satisfied with our progress in a number of key strategic activities in the quarter.

I’ll now return the discussion back to Steve.

Stephen Daly

Thank you, Bill. Hittite Microwave Corporation expects net revenue in the fourth quarter ending December 31, 2010 to be in the range of $64.5 to $66.5 million and net income to be between $20.2 million and $21 million or $0.67 to $0.69 per diluted share. Our Q4 revenue guidance at the high-end of the range represents a 52% year-over-year revenue increase and 3.6% sequential increase.

Our Q4 forecasted net income is based on a few reporting factors. First, an estimated gross profit margin of approximately 73.5%, the Q3 gross profits were exceptionally high due to product mix and other conditions and they are not expected to be repeated in Q4.

Second, in Q4 we expect operating expenses to increase sequentially by approximately 4% to 5%, primarily due to expansion activities.

And third, a tax rate of approximately 35.4%.

As we look ahead to Q4, we expect the following areas of strength and weakness, four markets are expected to be strong, broadband, cellular infrastructure, fiber optic, and test and measurement. Three markets are expected to be neutral microwave communications, space and military, and one market is expected to be weak automotive. Our goal is to achieve 50% annual revenue growth in 2010.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from line of Tore Svanberg with Stifel Nicolaus. Please go ahead.

Tore Svanberg – Stifel Nicolaus

Yeah. Thank you and congratulations on exceeding 50% operating margin. I had few questions, first of all, could you talk a little bit more about your silicon products, you been referring to them as getting a lot of traction, they’re growing. I’m just trying to understand the size of your silicon products at this point, I mean is it approaching 5% of revenue or is it less than that?

Stephen Daly

Well, we have a number of different product lines, I think that are essentially silicon-based products. Just as a reminder, we actually have 28 product lines areas where you see a high concentration of silicon products include some of the data converters, comparator, power conditioning type products, all of our high-speed logic type products, a lot of our lower frequency PLLs, power detectors and some of our synthesizer products. So, over the years we’ve actually increased the -- or change the complexion of our product line from 100% gas to now a very strong blend of gas and silicon.

In terms of the revenue contribution from our silicon products and the answer to that, in total meaning silicon and gas because some of our products have both, those numbers are starting to approach 10% of our total revenue.

Tore Svanberg – Stifel Nicolaus

Very good. And can you also give us an update on your vertical integration strategy, I know in the past you’ve had a few programs that I assume that now are ramping. So, just looking for an update there?

Stephen Daly

Well, the vertical integration strategy stands on a few different legs, number one, its to go vertical in the performance driven markets which we define as military, test and measurement and space. So we look for opportunities where we can provide customers in those markets with a large part of their system.

So depending on the market and our position within the market we see different levels of success. I think in late 2008, we announced the award of a $35 million contract that specific project is in the military space, that project has been ramping this year, it was a multi year programs, so that certainly a success. And we expect other projects like that to be successful in the years ahead as well.

The second element I’d point out is that we have a growing test instrumentation part of our product portfolio. So, for example, we’re now selling signal generators into the market, we have product that operated up to 8-gigahertz, 20-gigahertz and now 40-gigahertz. And these are standalone pieces of test equipment that we sell and our value proposition is essentially very high performance, very few features but state-of-the-art hard work performance and I would say that that strategy is also working quite well.

Tore Svanberg – Stifel Nicolaus

I appreciate that and Steve, I know you usually don’t comment on bookings or backlog numbers, but could you just give us a sense of how your visibility is so far in the December quarter, please?

Stephen Daly

Yeah. It’s certainly no different than what we’re seeing during the course of 2010 and we typically go into a quarter with about half our business in backlog and I would characterize Q4 is being typical. The general environment for bookings I would say is good but not great.

Tore Svanberg – Stifel Nicolaus

Very good. And question for Bill, you’re CapEx is going to bump up in Q4 to $5 million, will that sort be the only bump up we see and will we sort of go back to the $2 million level after that?

Bill Boecke

Yeah. Primary reason for the step up in Q4 is the new facility that we’re working on that should be completed in the fourth quarter.

Tore Svanberg – Stifel Nicolaus

Great. I did have one last question back to Steve. Steve, I know in the past it’s been difficult to find good engineering talent. Looks like you’re -- a little bit more successful in increasing R&D now. Does that mean that you found some new design centers or you found more people to hire at this point?

Stephen Daly

The short answer is yeah. Certainly finding extremely talented analog mix signal designers whether it be in gas or silicon is always a challenge. This year has been a great year for filling out a lot of the strength within engineering. And you’re exactly right, this year we’re looking at R&D growth of over 35% year-over-year and that’s going to pay huge dividends in the future.

Tore Svanberg – Stifel Nicolaus

Great. Thank you very much and congratulations again on the other results.

Stephen Daly

Thank you.

Operator

Thank you. Our next question comes from the line of Quinn Bolton with Needham & Company. Please go ahead.

Quinn Bolton – Needham & Company

Hi, guys. I’ll echo my congratulations on obtaining the 50% plus operating margin. First question for Steve, Steve can you give us a little bit more detail on the military business and specifically the $35 million contract ramp. It sounds like you’d mentioned military was one of the reasons that domestic sales grew in the third quarter, but it looks like you’re forecasting military business to be flattish, it seem like that business should have been on kind of ramp. So, just wondering if there has been any change in that program or whether we should sort of think of it has been lumpy from quarter-to-quarter?

Stephen Daly

Well, specifically on the $35 million contract that program was initially scheduled to run over three years and it’s actually slightly ahead of schedule in terms of our execution. We had previously stated earlier in the year that we were estimating revenues of about $8 million this year from that contract and it looks right now that will be over $10 million. So, I would, the general report on that program is that it’s ahead of schedule and it’s doing great.

In terms of the other elements of our military business earlier this year there was a strong wave of component sales for Counter-IED type equipment. The complexion of our sales today is shifting a little bit towards more communication system and (inaudible) type platform. So, little bit of a shift in that overall complexion but generally the military sales are strong and we are very bullish on the future.

Quinn Bolton – Needham & Company

So, its sounds like there is a, I guess, a pretty good ramp in that military contract in the third quarter and to the extent it continues to ramp. It may be offset by just other military business but seems like it did hit a pretty meaningful run rate in the third quarter?

Stephen Daly

Yeah. I mean, I will disagree with that and I would say that that ramp should continue into the future and if we follow our plan we’ll finish that contract ahead of schedule.

Quinn Bolton – Needham & Company

Great. Okay. Good. The second question, I’m just wondering if you could provide some more commentary on the cellular infrastructure and microwave backhaul markets. Some of your peers have sort of commented that Asia and the U.S. appear to be a little bit stronger than Europe and just kind of wondering what trends you’re seeing by geography in that segments from your business?

Stephen Daly

And so, just in terms of the Europe versus Asia versus the U.S. and globally, let me talk for all markets, let me just say that we had a bit of flip-flop in terms of sequential growth, whereas last quarter we had double-digit sequential growth in Europe and single in Asia and this quarter was actually the opposite. And I think that’s normally it’s due to, of course the timing of all the different orders.

Generally speaking, we’re very focused on taking as much market share as we can in 4G platforms and whether those platforms are being deployed here in the U.S or elsewhere and whether that means on the base station side or the backhaul or even the fiber optic link side. Hittite wants to have a position.

So we have been extremely active in all three of those four markets for the rollout of these wireless systems and wireline systems. And one notable is that fiber optic which has for many, many, many years been our smallest market, is now jumped up into seventh place. It’s now our second smallest market and we are actually starting to see some very strong growth this year and we expect that to continue next year.

So, generally speaking we’re bullish on 3G and 4G. We think a lot of money will be spent over the next three to four years on infrastructure and we’re setting up the product line to take advantage of that.

Quinn Bolton – Needham & Company

Great. And just lastly sort of a general comment about lead times, I know number of the other analog companies have talked about seen lead time is beginning to come back to more normal levels. Just wondering if you’d seen any sort of stretching out of lead times and any commentary that you have about your specifically lead times, has that changed over the past several quarters?

Stephen Daly

Now, are you referring to our lead time to customers or manufacturing cycle time?

Quinn Bolton – Needham & Company

Your lead time to customers?

Stephen Daly

I would say that at the beginning of the year where we were experiencing strong double-digit growth, the lead times were one or maybe two weeks longer than they are today.

Quinn Bolton – Needham & Company

Okay. So they did coming back perhaps a week or two, but never really saw much expansion and would you say they are kind of back to more normal levels now?

Stephen Daly

Yeah. And I accredit that to having very strong relations with our supply chain.

Quinn Bolton – Needham & Company

Great. Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Aalok Shah with D. A. Davidson. Please go ahead.

Aalok Shah – D. A. Davidson

Good afternoon and congratulations. Couple of questions, Steve you mentioned the new products and I know you’ve mentioned them every quarter. But is there anyway to kind of gauge how much revenue you are generating from some of these products and for us to measure how you’re doing with some of these new products?

Stephen Daly

So, we’re a data driven organization and we certainly are constantly looking at the successes and the failures of all our products and we do analyze that in detail. For competitive reasons, we don’t disclose that but clearly what we try to do is when we launched new product lines, we try to size what we expect or we estimate what we think the market is for some of these product lines.

And one trend that, that I’d point out is some of the newer product lines over the past two years are targeting very large markets. And I’ll point to the synthesizer of products PLLs with integrated VCOs, a lot of our high-speed logic, certainly some of our power conditioning in DC power management products. These are multi $100 million product families.

So we would expect that those product line would grow faster than our historical meaning 10 years ago, some of the products we are working on back then. But we don’t specifically disclose the run rates by the 28 product lines.

Aalok Shah – D. A. Davidson

Thanks. And question on head count, have you guys been increasing headcounts throughout the year and can you give us the sense where headcount is right now?

Stephen Daly

The answer is yeah. We have and we’re down to less than 10 offices here at the facility. So we’re really looking forward to moving into our new facility. It’s been a great year for hiring, we have brought in some world-class talent into all the different organizations. And we are not really exactly sure where we are going to end the year but it’s certainly going to be around 400.

Aalok Shah – D. A. Davidson

Okay. And couple of quick one. In terms of -- we’ve been hearing from some of our other companies that there is definitely some tightness especially on gas products and are you guys starting to see any of that. I know you have -- your commitments are made on a yearly basis, but you’re starting to hear extending lead times from some of your fab partners and then how do you think that will play out for next year?

Stephen Daly

So, the short answer is no. We keep both tabs with all of our fabs understand we have 10 different foundries and we spread our business across the different foundries. So from a risk profile point of view, you know, supply is generally something that we would argue is on the lower risk side of the continuance. And it all comes down to the relationships and good agreements and a good working relationship. We have a type of business that sort of the steady, [edy] business. We don’t have wild swings up or down in the loading on our fabs and our fabs like that. So they are able to accommodate us quite nicely.

Aalok Shah – D. A. Davidson

And then last one, Steve. Just, in terms of the macro, it’s been very much the India ban on foreign equipment. Does that have any impact on you and do you think that’s going to help in other business start to use up on that ban?

Stephen Daly

I think it did certainly have an impact on some of the business this year. And certainly we heard from our customers that that we’re working in India that there were delays especially in the back haul site and that had a trickle down effect to us, yeah. The good news is that that impact is built into our prior results and to the extent that all that business moved to the right is potential upside for the future.

Aalok Shah – D. A. Davidson

Great. Thank you very much.

Operator

Thank you. Our next question comes from the line of Gus Richard with Piper Jaffray. Please go ahead.

Gus Richard – Piper Jaffray

Yeah. Thanks for taking my question. On your R&D line, how are we -- what’s the best way to think about that for the out year, if you kind of scale with revenue or are you -- is it really just kind of how quickly you’re going to hire engineers?

Bill Boecke

Just a lot of that depends obviously on how quickly the revenue grows at the pace it grows. But the best way to think of it is that the R&D would be somewhere around 13, 14, maybe as high as 15%, so little bit lower at the moment because we’re seeing revenue up close -- better than 50% growth year-over-year. But in a more normal environment where we have 25% growth, I expect, the R&D would be closer to 14, maybe 15%.

Gus Richard – Piper Jaffray

Okay. And it’s get it on the ability just to find folks?

Bill Boecke

Absolutely. That is probably the hardest part.

Gus Richard – Piper Jaffray

And then just -- this year you had spectacular growth margins significantly over the last couple of years, can you highlight what is driven that and do you expected to aggress back towards the mean of maybe 72%?

Stephen Daly

This is Steve. I’ll also say a few comments and then maybe both can add to it. The gross profit margins are derived out of the results of engineering and allowing us to bring products that are truly unique to the market and to launch those products with very strong price points. And over those past few years, we have done a very nice job diversifying the product set, having products that have higher ASPs, we’ve been able to control our cost. And so -- but I want to point out that you get to these levels with best-in-class type product.

Bill Boecke

I would also add that, a lot of the variable factors that we measure on a quarter-by-quarter basis have all been favorable. And if you look at over a few past years that’s not always been the case and I don’t suspect they will remain continuously favorable as we go forward. So for that reason alone I think the margins will come down slightly.

Gus Richard – Piper Jaffray

Okay. Just wanted to go back to like the early part of the 2000s, margins were in the low 60s, they’ve migrated appeared to the mid, mid-70s and, but your expectation is you’re going to hold that in about 70, 72% range given just aging the products and sort of it mix and what not said that. Am I thinking about that correctly?

Stephen Daly

I think, in terms of -- conceptually yeah, but we want to be careful not to forecast our long-term gross margins. If we have very limited visibility on our future revenue mix in terms of digital products over selling into the different markets, certainly we’re constantly under price pressure from all of our competitors. And most of our competitors are four, five or six times bigger than us.

So there is tremendous pressure on the business in the market. And so we don’t want to discount that. So we really don’t want to give too much clarity on our future margins because there is a high degree of uncertainty there. Now, what we can do is in the near-term meaning one quarter out give guidance that has a reasonable level of confidence and that’s why we are saying for next quarter, really this quarter Q4, 73.5.

But these are great products, they’re unique, they’re innovative and that’s really how we’re getting into the 70% of range. But you can have a lot of variation around the norm with the execution.

Gus Richard – Piper Jaffray

And then, just last question. I think we’ve talked in the past about the large contract that you’re shipping against, the $35 million weapons contract. Is there a possibility that will expand or is that just a one-time five or is there a renewable aspect to that contract ‘12 or ‘13?

Stephen Daly

So we have a single contract to deliver. If we perform well on this contract, we believe that there can be future business.

Gus Richard – Piper Jaffray

Okay. And then to just get a little color on exactly what we’re talking about, is this something that’s reusable or does it blow up?

Stephen Daly

Yeah. I really can’t comment on the details in terms of the application or the customer. What I said is its one of the most sophisticated products that we’ve designed as a company and provide state-of-the-art performance to our customer.

Gus Richard – Piper Jaffray

Okay. All right. Thanks so much.

Stephen Daly

Thank you.

Operator

Thank you. Our next question comes from the line of Jiwon Lee with Sidoti & Company. Please go ahead.

Jiwon Lee – Sidoti & Company

Thank you and good afternoon. Just the first question is on some of your end-markets Steve. Last quarter you’ve commented that microwave and millimeterwave were to be flat, now did the quarter play out as you expect this and then you’re expecting the market to be flat I guess. If that is the case, I wonder if you can talk a little bit more about the dynamics that you are seeing there?

Stephen Daly

Yeah. And certainly I think the microwave market did play out according to what we expected. And so that’s the good news, we got that right. In terms of on a go-forward basis, you are right, we had categorized the microwave market has being neutral. That market has being tremendous growth in it, since the beginning of 2009 and so we’re certainly tempering our expectations for 2010.

Jiwon Lee – Sidoti & Company

And similarly Steve, the broadband was down last quarter, I think that was your expectation. But you’re expecting that to move up sequentially. So what trends are specifically favorable for you and then what do you expect a little bit beyond the December quarter?

Stephen Daly

You’ve picked upon something that we’re delighted about it. Broadband has been -- it used to be a close force in terms of market size and its foiled back in the rankings and we’re delighted that our outlook for that market is starting to improve and a lot of that is coming from some of the frequency generation products that are starting to get traction in a variety of different broadband applications. And so there is a very real improvement in that market that we’re seeing in the near-term.

Jiwon Lee – Sidoti & Company

And would that be some of your new products that are sort of generating back traction or is it just generally the market improvement?

Stephen Daly

That’s absolutely product driven. The broadband market itself is quite larger. Our contribution to the market is minimal in the way we are going to win market share is to have the right products. And so some of our PLLs with integrated VCOs, some of our interface products, some of the high speed products are beginning to win design sockets and generate revenue.

Jiwon Lee – Sidoti & Company

That’s helpful. And lastly 50% annual revenue growth, I mean that’s clearly not the normal level that you expect. But with the visibility that you have -- in your opinion and in your mind, what would be a normal sales growth -- what would the normal sales growth looks like in 2011?

Stephen Daly

I’m not sure what -- yeah, that’s great question. And if I just reflect back since 2005 to today, our growth rates have been all over -- they’ve been 30, 60, 20, 15 last year minus 9.5 and this year 50. So normal is difficult to define. I don’t -- it’s very difficult for us to say what next year will be like in terms of growth as we set up our operating mechanisms and our budgets, we start with a baseline of mid to upper 20s, when we think about how we’re going to spend money and where we’re going to spend money. And then as the business comes and the markets develops or not, we adjust our strategy.

Jiwon Lee – Sidoti & Company

Okay. One...

Stephen Daly

I don’t know if that answers your question, but...

Jiwon Lee – Sidoti & Company

No.

Stephen Daly

...but I would say that our general posture is mid to upper 20s is the type of long-term range that we look at is being is the good number to plan again, not necessarily to deliver but to plan again.

Jiwon Lee – Sidoti & Company

That’s very helpful. Thanks. And one last thing, the expansions that you’re undertaking, could you specifically talk about what area that is?

Stephen Daly

Yeah. So, we purchased a building in Q2.

Bill Boecke

Q1.

Stephen Daly

Q1, which is right down the street from our current facility. It will allow us to essentially double our floor space, little bit more than double our floor space. And what we will do is we will move our G&A and engineering and bails out of this building into our main building here which is 75,000 square feet will become a 100% manufacturing. And the other facility will be essentially housing, management, two design centers and sales and marketing.

And so what Bill, referred to in terms of the step up in CapEx of 5 million is essentially the work that we’re doing to facilitize the building with labs and what not.

Jiwon Lee – Sidoti & Company

Terrific. That’s all from me. Thank you.

Stephen Daly

Thank you.

Operator

Thank you. Our next question comes from the line of [Dale Gose] with (inaudible) Capital. Please go ahead.

Dale Gose – Analyst

Hi. Yeah. Congratulations on the quarter. Yeah, my question would be for Steve. How should we really be thinking about that difference between the run rate of $0.25 billion and say $4 billion to $5 billion addressable market? What is the difference in those products? How do you -- what do you need to do to get there?

Stephen Daly

Well, we need to get there is to have a product portfolio that has hundreds of product lines and thousands of products. And today we have 28 product lines and less than a thousand product. So, it requires bringing on more engineers, designing more product lines for it, so that we can win market share.

Dale Gose – Analyst

Right. Right. Interesting. But let me ask you to this, how should we really be thinking about the competitive environment then when you go in for a contract because you’ve got great gross margin. But then it seems like you talk about the competitive nature and how good you competitors are. When you’re going for a contracts what is it that allows you to win it?

Stephen Daly

Generally, it’s we’re bringing some unique technology or solution to the market. Customer select their type product because of their performance not price. And we have a very strong engineering team that has over the years created a very strong knowledge base on a multitude of different semiconductor process technologies. So we use that and leverage that into some of the product that we sell into these market. And our customers see that expertise and want to take advantage of it.

Dale Gose – Analyst

So, then once a contract is awarded and you have supplied the product for three or four years, is there a new pricing pressure that comes in or do you have the ability to raise pricing thereafter or is that set?

Stephen Daly

It’s a rarity that we raise prices on the product line and typically over time semiconductor products become commoditize. And part of our strategy is to exit the business as we start to see some of our products come under price pressure. There are certain things we can do during the course of that which would include, maybe shrinking down that dye or focusing on manufacturing cost to allow us to maintain margins, but over the long-term that’s a bit of a losing battle. What you really need to do is innovate and raise the bar on the product that itself. So, yeah, the products come under pressure over the long-term. This is expected.

Dale Gose – Analyst

Thank you. Thank you.

Stephen Daly

Thank you.

Operator

Thank you. Our next question come from the line of John Haller with HHR Asset Management. Please go ahead.

John Haller – HHR Asset Management

Hey, congratulations on a great quarter. Quick clarification, when you referred to a market as neutral that doesn’t necessarily imply zero growth but it just means compared to how it normally grows. Is it neutral or does that mean it’s actually flat?

Stephen Daly

So, strong means that we are seeing some reasonable growth, neutral would mean that the revenue that we’re running is flat. We are only up or down incrementally and weak means the market might actually be sequentially down.

John Haller – HHR Asset Management

Interesting. Okay. And on the military side, Steve you are saying that you were sort of going bullish about the medium or long-term prospects there. And then, on the other hand lot of people seem to worry about military budget. Can you sort of elaborate on what that this bullishness is based on?

Stephen Daly

It’s based on -- I think over the long-term there will be fewer large new platforms airframes or ships, but what there will be as a constant upgrading of the electronics suites on those platforms. And that is -- so what you’ll see money being spent on is essentially on new electronics. And I believe the military wants to take advantage of streaming video on the front line. And if cost wanting to put that hardware in place and it’s typically microwave centric and so -- and certainly that’s one of the example. But generally we think that there will be a lot of money spent in the future on electronics portion of these platforms and also on the platform themselves.

John Haller – HHR Asset Management

And then on the microwave and millimeter area, you’re kind of seeing some panels like a slowdown in growth whatever as you are lap in tremendous growth rates. What is your medium-term outlook on that segment?

Stephen Daly

I’m sorry on the microwave communication segment?

John Haller – HHR Asset Management

Yeah. Yeah.

Stephen Daly

Yeah. I think that’s -- that is certainly one of our core markets and our outlook is strong. We have over the years increased the content for the radio that we can offer. And as I mentioned in my script, we are now really for the first time in years starting to put forward a very competitive power amplifiers that will take market share.

We’ve spent a lot of time with this work and we do not -- we’re not strong across the entire platform. We have weaknesses but one example of why we are bullish is over the next two to three years, we plan are taking significant market share on the power amplifier side of the radio where today we have just a fraction of the market.

John Haller – HHR Asset Management

So would it still be a two statements that similarly to what you said in broadband that in many market you still so tiny, that again over the medium term demand may have inflow, but you have so much room to grow that it’s in the medium term, it doesn’t really matter. How much the end market is growing?

Stephen Daly

I think that’s a reasonable categorization.

John Haller – HHR Asset Management

That’s all I have. Thank you so much.

Stephen Daly

Thank you.

Operator

(Operator Instructions) And our next question is a follow-up question from the line of Tore Svanberg with Stifel Nicolaus. Please go ahead.

Tore Svanberg – Stifel Nicolaus

Yeah. Hi, Bill you know, you’ve escaped those question. But you’re on a $100 million run rate right now as far as free cash flow generation. We’re not yielding a whole lot in a cash, what’s going to be the plan there going forward?

Bill Boecke

Tore, as we’ve said before the primary use of cash will be to fund our growth as well as to take the risk, financial risk out of our business model.

Tore Svanberg – Stifel Nicolaus

All right. Just asking the question. Thank you.

Bill Boecke

Thanks, Tore.

Operator

Thank you ladies and gentlemen. (Operator Instructions) And at this time, I’m showing no further questions. I’d like to turn the call back over to Steve Daly for any closing comments.

Stephen Daly

Thank you. In closing, I would like to congratulate our team for delivering another record quarter as well as setting the stage for additional future successes. Thank you very much.

Operator

Thank you. Ladies and gentlemen, this concludes the Hittite Microwave Corporation Third Quarter 2010 Conference Call. You may now disconnect. Thank you for using ACT Conferencing.

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