Oct 28, 2009
Executives
David G. Hugley - Vice President, General Counsel, and Secretary Dr.
James Truchard - President, Chief Executive Officer, and Cofounder Alex Davern, CPA - Chief Financial Officer and Senior Vice President, Manufacturing and IT Operations John Graff - Vice President, Marketing and Customer Operations
Analysts
David Yuschak - SMH Capital Mark Douglass - Longbow Research Richard Eastman - Robert W. Baird & Co., Inc.
Ajit Pai - Thomas Weisel Partners Anthony Luscri - JPMorgan
Operator
Good day, everyone and welcome to the National Instruments Third Quarter 2009 Earnings Conference Call. 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 07:00 P.M.
Central Time today and will end at midnight Central Time on November 1, 2009. With us today are David Hukely, Vice President, General Counsel and Secretary; Alex Davern, CFO; Dr.
James Truchard, President, CEO and Co-Founder; and John Graff, Vice President, Marketing and Investor Relations. For opening remarks, I would like to turn the call over to Mr.
David Hugley, Vice President and Corporate Counsel and Secretary. Please go ahead, sir.
David G. Hugley
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 opportunities to grow and gain market share, our strategies, gaining future operating leverage, our revenue and earnings per share guidance and expected tax rates.
We wish to caution you that such statements are just predictions and 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 quarterly report on Form 10-Q filed today and our Annual Report on Form 10-K.
These documents contain and identify important factors. They could cause our actual results to different materially from those contained in our forward-looking statements.
With that, I will now turn it over to the Chief Executive Officer of National Instruments Corporation, Dr. James Truchard.
Dr. James Truchard
Thank you, David. Good afternoon and thank you for joining us.
Our key points for today are: strong sequential revenue growth, strong operating leverage in Q3 and we are guiding for strong sequential growth in Q4. While Q3 continue to be a challenging economic environment, I was pleases with our ability to deliver strong sequential revenue growth with great operating leverage.
Our business model allowed us to continue to make... continue making strategic investments through the recession.
And I believe these investments in innovation and new product development have further differentiated National Instruments from other players in the market research, and will help drive our future growth. 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?
Alex Davern, CPA
Good afternoon. Today, we are pleased to report Q3 revenue of $165 million, which is in the upper-end of our guidance provided on September 9th and is a strong 8% sequential increase over Q2.
The sequential increase in revenue in Q3 is approximately 20 times the average Q3 sequential change that we have seen since the IPO of 1995. Quarters were also strong sequentially and our end of quarter backlog increased by $5 million in Q3.
The Q3 last year representing the highest revenue quarter in the histories of the company made a very tough to compare this quarter and revenue was down 23% from a year-over-year perspective. Then income for Q2 was $10 million with fully diluted earnings per share of $0.13.
Non-GAAP net income was $15.4 million with non-GAAP fully diluted earnings per share of $0.20. In Q3 the GAAP to non GAAP net adjustment was $0.07 per share; $0.02 per share greater than the $0.05 per share we had anticipated in our guidance.
The differences related to impact on our effective tax rate of this significant increase in our profit expectations for the year. I will discuss the impact of this on Q4 in more detail during the guidance session of my comments.
A reconciliation of GAAP and non GAAP results is included in our earnings press release. While Q3 is a very difficult quarter from year-over-year perspective, there are some clear positives to take away.
First the quarterly average of the global PMI has improved from its record of 36 in Q1 and a Q3 our quality average of 52 indicate that the industrial economy expanded sequentially in Q3. Second, while we did not see the full traditional end of quarter surge in large orders, we did see an encouraging improvement in the large orders closing at the end of September.
Third, our expense management efforts continued to pay-off in Q3, allowing us to reduce our non-GAAP expenses by 16% or $20 million year-over-year, which includes a $2 million credit to patent litigation expense. Fourth, strong sequential revenue growth, combined with prudent expense management have allowed us to increase our non-GAAP operating margin from 2% in Q1 to 5% in Q2, and now 10% in Q3.
Our guidance contemplates a further significant sequential revenue increase in Q4 with continued operating leverage. From a revenue point of view, earnings from the control business saw a 28% year-over-year decline in Q3, while the revenue for our virtual instrumentation and graphical system design products declined 23% year-over-year.
After four quarters of sequential decline, we saw a greater than 20% sequential increase in instrument control revenue. Traditionally, NI Instrument control revenues have been highly corrugated to the overall tested measurement industry and the current trends indicate that the industry may have bottomed in Q2 and began a sequential recovery in Q3.
Revenue for all other products continued this sequential increase that has begun in Q2. We saw the impact of the industrial recession across all regions.
During Q3 year-over-year revenue growth in U.S. dollars is minus 30% in Europe, minus 16% in Asia and minus 22 in new markets.
In local currency terms revenue was down 20% year-over-year in Europe and 13% in Asia, giving an overall local currency decline of 19%. Now looking at the income statement in more detail.
Non-GAAP gross margin in Q3 was 75.3%, compared to 75.2% in Q3, 2008. Our ability to modestly increase our gross margins year-over-year in Q3 has bought a 23% year-over-year revenue decline is attributed to the variability we have built into our manufacturing cost structure and to the very high level of differentiation at national instruments designed into our products.
Total income was 5,169 as of September 30th, up 3% year-over-year. The primary focus for head count additions this year has been in R&D and field sales, which are up by 49 people this quarter.
Now turning to the balance sheet. Similar to Q1 and Q2, inventory decreased by $7 million during the quarter.
We will continue to monitor our productions schedules and we expect to see inventory start to flatten out in Q4. With the expected increase in revenue in Q4 contemplated in our guidance we expect to see our inventory days returned to a much more normal level in Q4.
This is a forward-looking statement and subject to the risk factors discussed by David. Cash flow from operations continued to be very strong at $90 million for the first nine months of the year.
As of Sept 30, the company had $276 million of cash in short-term investments, up $26 million from June 30th. Good cash balance is net of $9 million in dividends paid during the quarter and $3.3 million used to repurchase, 131,000 shares of NI's common stock at an average price of $25.09 per share.
We also announced today that the Board of Directors approved a quarterly dividend of $0.12 per share payable on November 30th to shareholders of record on November 9th. Now, I would like to make some forward-looking comments, starting our strategy in the current economic environment.
While global industrial production turned positive in Q3 and capacity utilization has started to improve, it is clear that the industrial economy is still down dramatically year-over-year and that there continues to be a lot of excess capacity. Given this situation, at our recent investor conference, we laid out our plans to continue to be disciplined on managing expenses through this recovery.
Our intent is to continue to drive operating leverage until NI's revenues recover to the record levels seen in 2008. We believe that the strong sequential growth in Q3 indicates the beginning of an apparent recovery in our business.
Based on our order flow so far in October and our visibility to current opportunities, our guidance anticipates another quarter of strong sequential growth in Q4, which would well exceed the average Q4 seasonal increase that we have seen since the IPO in 1995. While it appears that the period of the recovery has begun, it is also clear that the test and measurement industry will not just return in the same way as it been before.
This recession has caused many companies to rethink all the competitive advantage comes from. For the test and measurement industry, this means that things will look different after recovery, with a greater acceptance of modern and lower-cost more productive approaches to test.
We believe this will favor NI and will allow us to continue to gain market share and help us achieve our goal of record revenues in future course; a profit which seems much closer than we could have imagined six months ago. Now turning to the specific guidance for Q4, we currently expect revenue for Q4 to be up sequentially, it's been in the range of $190 million to $200 million.
We currently expect the GAAP; fully diluted earnings per share will be in the range of $0.22 to $0.30 for Q4 with non-GAAP fully diluted earnings per share expected to be in the range of $0.30 to $0.38. NI guidance assumes that non-GAAP effective tax rate of approximately 30% for Q4, which is significantly greater than the overall 2009 effective rate.
As the company now expects Q4 profit to be significantly greater than was anticipated earlier in the year. The increase in Q4 profit expectations results in a greater than anticipated concentration of NI's tax charge in the fourth quarter.
For 2010 we are currently anticipating that our non-GAAP effective tax rate will be in the range of 18% to 22%. And we are internally using 20% to model our expected results for 2010.
In Q4 the GAAP to non-GAAP net adjustment is also expected to be elevated due to the high effective tax rate. And the adjustment is estimated at $0.08 per share.
In Q1 2010 we anticipate that the GAAP to non-GAAP adjustment will return to a more normal level of approximately $0.06 per share. During the forward-looking statements, I must caution you that actual revenues and earnings could be negatively affected by numerous factors such as any further weakness in the global economy, delays in new product releases, rescheduling of customer orders, expense overruns, manufacturing and efficiencies, effective tax rates and foreign exchange fluctuations.
Given the improvement we have seen in our visibility, we will not be holding a business update call during Q4. On December 2nd, Dr.
Truchard will be presenting at the Credit Suisse Annual Technology Conference in Arizona, and I will be presenting at the NASDAQ-OMX Investor Conference in London. We hope to see you there.
So in summary, we are pleased that how our business progressed in Q3 and from a broader perspective we are pleased that the industrial economy starting to show meaningful and sequential improvement. With that said, we remain cognizant that the industrial economy remains well below prior levels.
And then I will continue to focus on gaining market share and driving profit recovery. With that, I'll turn it over to John Graff, Vice President of Marketing.
John Graff
Thank you, Alex. We are pleased with the strong sequential growth we saw in Q3 as we continued to execute on our long-term strategy of expanding our revenue coming from large application areas that are new to NI and which heavily leverage our technology and competitive position.
While, we did not see our full traditional, end of quarter surge in large orders, we did see encouraging improvement in large orders closing at the end of September. And our Q3 average orders size increased 4% sequentially to about $3,480.
At our annul NIWeek user conference in August, we announced the host of new products deliverer over 200 technical sessions and set a new attendance record, a testament to the value our customers see not only in the event, but also on our product platform. We were particularly excited to announce the release of LabVIEW 2009.
LabVIEW 2009 harnesses key technologies such as multicore processors, FPGAs, wireless platforms and real time map to empower innovation in key opportunity areas such as infrastructure, environmental monitoring and biomedical devices. We are pleased with the positive early response we have received for LabVIEW 2009, including several industry awards.
Continuing the trend of the past few quarters, we saw strong performance in our sales to academic institutions in Q3. There has been increasing interest from the academic community to grow the relationship with NI in order to introduce students to the latest technologies and better prepare them for industry.
For all NI products are used across the myriad of different applications and academia, robotics applications have been a recent focus for the academic team. We also held a robotic summit during NIWeek that was attended by some of the most influential figures in both academia and the industry.
One of the most influential voices in the field of mobile robotics was a speaker at the summit and also gave the NIWeek closing keynote address. Dr.
David Barrett from Olin College described robotics as a fundamentally disruptive technology with applications and growth potential in numerous industries. And he outlined the primary needs for the industry to evolve.
One such need is a richly supported software development system. He highlighted LabVIEW support for a multitude of sensors, the ability to execute complex control algorithms and an architecture that enables application level focus as characteristics that make LabVIEW well suited to robotics applications.
We are seeing many robotic success stories as universities begin to realize the benefits of the NI robotics platform. For example, using LabVIEW and NI data acquisition hardware, the university believes it is developing a safe and reliable robotic rehabilitation system to aid people recovering from a stroke to regain our mobility.
The marginal nature of LabVIEW was ideally suited for prototyping and developing the system. Our industrial embedded products also had a strong quarter in Q3, with record quarterly revenue from our FPGA based CompactRIO products, which continued to see success in prototyping applications as well as higher unit volume deployments.
The combination of LabVIEW and CompactRIO helps engineers quickly try out and modify new designs using the graphical system design approach and achieve it faster time to market. One news case that demonstrated this benefit was that -- a startup company where they quickly prototype and deployed in embedded diagnostic imagining system for small animal veterinary practices.
According to -- using LabVIEW and CompactRIO products save them about three main years of development times and $300,000 in labor costs compared to a custom design approach. The adoption of wireless technology for remote monitoring application is growing.
Yet, engineers and scientists have struggled to find an integrated solution that can provide the required measurement quality, power management and reliable hardware for long-term remote deployments. We are excited this quarter to release the NI wireless sensor network platform which provides the ability to quickly and easily configure and deploy wireless sensors in a wide range of applications.
Our data acquisition products saw sequential growth this quarter with help from our USB and C Series based products. At NIWeek, we released 19 new data acquisition boards for the PCI Express and PXI Express buses.
These new boards leverage the latest semiconductor technology and implement a new ASIC designed to lower manufacturing costs, increase reliability and improved performance. Another closely watched technology in our data acquisition business is the release of Windows 7.
When Microsoft released Windows Vista in 2006, it did not see the wide adoption of previous Windows updates. However, with Windows XP starting to show its age and the economy affecting PC purchases, there appears to be pent-up demand for improvements.
Windows 7 promises increases in performance, security and data throughput, which may entice engineers and scientists on older operating systems to make the switch. We have been testing and running Windows 7 for months prior to its recent release to ensure our products are supported and we believe it will have a positive impact on our hardware and software business in 2010.
We also saw sequential growth in our PXI and modular instrumentation products. We were pleased this past quarter to announce a joint development project with Techtronics to release the industry's fastest PXI digitizer, combining industry leading signal acquisition technology with National Instruments' expertise in modular instrumentation and software.
While NI and Techtronics have collaborated on various projects for more than 20 years, this digitizer represents the first joint hardware development project between the two companies. At NIWeek, we also highlighted a significant semiconductor test success at Analog Devices for one of the new high volume MEMs microphones.
ADI choose to use LabVIEW and PXI as their test platform because of its low-cost, small size and flexible configuration. According to ADI, their PXI-based system is less than one-tenth cost and it uses a fraction of the power and floor space compared to their previous traditional ATE solution.
ADI intends to install more of theses systems around the world as production demand grows and they project million of dollars of savings in capital costs alone. In summary, we are pleased with our ability to continue investing in new product R&D and expanding our field sales force throughout this recession.
Our NIWeek conference this year was a significant success with over 55 new products released, a new attendance record and customers coming together to share and learn how NI solutions are solving big challenges and delivering significant business results. We look forward to seeing these new products and our continued commitment to innovation drive future growth as the economy recovers.
With that, I will turn it over to Dr. T.
Dr. James Truchard
Thank you, John. Although we're still operating in a difficult economic environment, I'm pleased with how the company continues to execute on our long-term strategy.
It is a testament to the strength of our business model as throughout this downturn, we have been able to sustain profitability while continue to invest in the strategic initiatives that keep us at the forefront of innovation. I believe this recession has created an opportunity for National Instruments as we've seen our competitors retrench while we continue to innovate and invest.
I believe that National Instruments is very well positioned to benefit from these dynamics and that our business management through this downturn will allow us to more fully leverage the economic recovery. I have described in the past how our commitment to innovation has allowed us to disrupt (ph) many of the traditional markets we serve and how we are redefining instrumentation with our graphical system design approach.
We are helping our customers solve some of the world's most significant fine tipping and engineering challenges through our ability to leverage the latest technologies like multicore processors and FPGAs. The impact we are having on these challenges was seen at NIWeek, during the Graphical System Design Achievement Awards.
This year we have more than 120 submissions from over 25 countries around the world. The application submissions range from developing a system that teach premature infants how to feed to developing a portable intelligent greenhouse to explosive detection system used at the airport checkpoints, the winning submission came from Ford using LabVIEW, PXI, CompactRIO and that controlled -- fine products fit above in electronic control units for fuel sales system that has the potential to provide a commercially viable and greener option to conventional internal combustible vehicles.
While we continue to invest in new innovative products, we've also taken advantage of the market weakness to acquire key new talent that has traditionally been very hard to hire ensuring future innovation. As we continue to develop products at lower costs, reduced risks, ensuring shortened design cycles, our loyal customer base is growing as more engineers understand the capabilities of our products and recognize our field sales force as trusted consultants.
These deep customer relationships and our focus on enabling cost reduction have helped us uncover new opportunities that will continue to help us in the recovery. In summary, I am pleased with our business management throughout this recession, which has enabled us to continue executing on our long-term strategic vision.
We have remained profitable even as we maintain our strategic investments on new product R&D and expanded our field sales force. I would like to again thank our employees for their commitment to innovation, prudent expense management and unwavering focus on serving our customers.
I believe our continued investment in the innovation throughout this recession has further differentiated National Instruments from other players in the markets we serve and will provide a strong foundation to support future growth and profitability. We will now take your questions.
Operator
And today's question-and-answer session will be conducted electronically. (Operator Instructions).
We'll take our first question from the side of David Yuschak. Your line is now open.
David Yuschak - SMH Capital
Hey, congratulations guys on the quarter as well as very much shaping up for the fourth quarter. Of course, I got for is there anything that mean you have seen all the macro has been improving here quite a bit, is there anything from your micro point of view, as you see things coming in the orders and all that?
That kind of suggest that this is more a sustained type of potential we got for 2010 and that is just kind of an inventory blip so to speak if you want to term it in inventory demand curve improvement here?
Alex Davern, CPA
Well David, it's a good question, its Alex here. First off I'll answer by really our customers don't to very, very large extent they do not inventory our products.
So with very few exceptions, it is a turns business for us and for them. So I don't think we're seeing any real dynamic relation to the inventory of our products at our customers' site.
I don't think there is any impact on it at all. However--
David Yuschak - SMH Capital
I was really putting the idea that others recovery seems to be just more, people getting back to business on inventory than this, you're getting inventory stacked in your customers?
Alex Davern, CPA
I think there's two elements on that, if we look at the broader macro perspective, industrial production globally in the first half of this year was down somewhere around 20% year-over-year, when global GDP was down about 2%. So you have a situation in my opinion where industrial production globally was massively under serving actual end demand.
As so I think you've got two things going on here, you've got probably in the broader global industrial economy, you've got a stopping of the reduction in inventories and factories are moving up to just meet end demand. And I think that's going to lead to, in my opinion, sustained year-over-year growth in industrial production, at least probably through the first half of next year.
In terms of our business, we're really seeing a change in the industry where people are shifting and looking at opportunities to lower our cost. And as we have always said, when it comes to recessions, NI tends to gain market share at a more rapid rate during the recession despite the fact that it's painful.
And so we're looking forward to the goal we have obviously to try and retain that market share in a recovery. And what we've seen so far in October and the opportunities, as I said, in the call that we see going forward gives us a fairly high degree of confidence that we are going to see very strong sequential results in Q4.
That's very encouraging for us. If we are at the midpoint or above in Q4, we'll have recovered over two-thirds at revenue drop from our previous record.
And that's certainly a very encouraging sign if we are able to deliver on that.
David Yuschak - SMH Capital
Now as far as we're hearing, and I'm just kind of curious if you're seeing the same thing, how Asia and the Far East has really been one of the real drivers to this recovery, are you seeing and thinking maybe as you look at the next 12 months that international may become more important and particularly the Far East as far as revenue mix is concerned?
Alex Davern, CPA
Sure, Asia has been an important growing part of our business. We have had very good execution from our management and our overall sales team in Asia overtime.
One of the issues I think in this current quarter, we're seeing Asia outperform the rest of the business me in Q3, partially because Asia really got hit with the downturn a quarter ahead of the Western world. So we saw Asia start to see a significant reduction in the rate of revenue growth in Q3 of last year while the Americas and Western Europe continued to have very strong growth in the third quarter last year.
So I do think Asia is likely to lead it as we've come into the recovery as well.
David Yuschak - SMH Capital
Okay, thanks. I'll check back into queue.
Alex Davern, CPA
Thanks David.
Operator
And we'll move next to the side of Mark Douglass. Your line is now open.
Mark Douglass - Longbow Research
Good afternoon.
Alex Davern, CPA
Hi Mark, how are you?
Mark Douglass - Longbow Research
Fine, how are you?
Alex Davern, CPA
Excellent.
Mark Douglass - Longbow Research
Good outlook. Can you go into a little bit of where the sequential strength is coming from, any markets in particular or is it pretty broad based?
John Graff
Yeah, Mark, this is John. To talk about kind of the veridical industries or end industries.
In Q3, areas where we saw some strong growth, again, we mentioned in the call education, our sales to academic institutions continue to be strong as we've seen in the last few quarters. We also saw strong relative growth in biomedical energy in electronics.
A couple of areas that I'll mention where we saw strong sequential growth was actually in semiconductor and communications which I think kind of intuitively makes sense in terms of the dynamics in the macro world. On the flip side, where we saw some weakness year-over-year included the automotive industry and instruments in ATE as well as sales into the computing and process industries.
So, again, diversity across all these industries has been one of the key strengths for National Instruments over the long term, and I think you saw that kind of playing out once again in Q3.
Mark Douglass - Longbow Research
Okay, thanks. Can you break down the sales of large versus small in the quarter?
John Graff
Yeah, relative, they both did about the same in terms of the sequential. So right in line with this 8% number that Alex mentioned that we saw sequentially.
The breakdown is... so the breakdown between the large orders, meaning over $20,000 is still about as same as last quarter; we are in that 35 to 40% range.
Mark Douglass - Longbow Research
Okay.
Alex Davern, CPA
We have this slide on the webcast, Mark; you can see the data there directly.
Mark Douglass - Longbow Research
Oh, okay. Great.
Then what are your expectations for fourth quarter on gross margins, operating margins? Obviously, you are expecting a pretty big uptick.
I'm looking at something like 18% non-GAAP operating margins. Is that about right?
Can you give me a feel for where you're going on gross margins, operating margins?
Alex Davern, CPA
Well, obviously, the operating margin, net margin is susceptible and depend at where we are net revenue curve. So, I brought a market specific, about a specific number they'll be in a range high and low.
In terms of gross margin specifically I feel particularly pleased about the execution across the whole as a company in terms of maintaining gross margin this year. We obviously had a 1% upside between Q2 and Q3, as we see production -- we ramp backup again in our own facilities in Q4 we would expect to see a sequential uptick in gross margin in the fourth quarter.
But the whole company has delivered very, very well on ensuring we maintain our value to the customer from -- obviously designing very innovative products, a very effective sales and marketing force that can sell our differentiation and backing through manufacturing and rest of the operation ensure we drive the lowest possible cost. I think we did an excellent job in this downturn of ensuring we get the best possible pricing.
And we hope to see that give us some sustained benefit as we go into 2010.
Operator
And now we'll move next to the side of Richard Eastman. Your line is now open.
Richard Eastman - Robert W. Baird & Co., Inc.
Alex, could you just comment on Europe, Asia maybe turned down first. I think people feel that Europe turned down last.
I mean how does your local currency decline of 20% there feel relative to the fourth quarter?
Alex Davern, CPA
Well, when we look at what we delivered in this particular quarter obviously, Asia was the best performance in terms of local currency growth. In Europe, we were minus 20% and in the Americas, roughly minus 22.
So, we see kind of the Western world moving somewhat in concert. Asia obviously saw a downturn a little bit early and they're probably farthest out in terms of the supply chain.
And so it makes sense to me that they would see the impact earliest. And for now we see Europe and U.S.
moving in a local currency point of view moving at relatively similar rates. From a U.S.
dollar point of view Europe's result appear lot worse but obviously we have had a lot of movement in the dollar over the course of last 12 months with the crises. But the dollar against euro is largely back to where it was roughly year ago.
So that local currency negative for Europe is probably not going to be a factor to fourth quarter. And then I think its true performance of the U.S.
-- Americas versus Europe will come more clearly into focus here in Q4.
Richard Eastman - Robert W. Baird & Co., Inc.
Okay. And then just as the follow-up question when I look at the revenue guidance and I try to -- basically what you're saying the 190 to 200 for the fourth quarter.
Trying to support that your backlog was up 5 million at the end of the quarter which is obviously doesn't really support a growth rate like that and also the comment I think both you and John made the comment about did not see the typical surge in orders but did see an improvement in orders, so I'm trying to -- are you making any adjustments on price given the weaker dollar, is there anything in that in your guidance for price?
Alex Davern, CPA
No. So Rich, it's Alex here there's no impact on our guidance from adjustments relative to the weaker dollar.
What I would look is, as we look into this quarter we saw, we are coming up the sequential changes from April, May, June, July, August, September. September was obviously a pretty strong month for us.
We did see, relative to the December quarter of last year, the March quarter of this year larger the close out rate was much better. The push outs were a lot less significant.
And then as we look at opportunities and we look at our order flow through yesterday, and the opportunities that are on table for our sales force at the moment those are the key drivers of our expectations on guidance. So it's not a backlog driven optimism for Q4.
Operator
And now we'll move next to the side of Ajit Pai. Your line is now open.
Ajit Pai - Thomas Weisel Partners
Yeah, good afternoon.
Alex Davern, CPA
Hey, Ajit. How are you doing?
Ajit Pai - Thomas Weisel Partners
Good and you?
Alex Davern, CPA
Excellent.
Ajit Pai - Thomas Weisel Partners
So, just looking at the sort of managing your inventory and also managing your production, you have built backlog again I think sequentially for the second time in a quarter. Is this a backlog built more by design or is it just that the orders were so strong towards the end that you couldn't ship them out in time?
Alex Davern, CPA
It's by design.
Ajit Pai - Thomas Weisel Partners
Right. So then from this point onwards, you actually intend to start maintaining a higher backlog than you have historically primarily to manage the production or like what's the purpose?
Alex Davern, CPA
Well, I mean the purpose is that certainly does help in production to be able to maintain a slightly higher backlog certainly is an improvement in our efficiency. And so that certainly is one of the key reasons.
Ajit Pai - Thomas Weisel Partners
Got it. And then just looking at the headcount, you talked about R&D and field sales being the primary areas of investment even today.
Just given where capacity utilization likely is in manufacturing, it appears that that's not going to be an area where you'd need to be hiring for quite a while. Can you remind us about Malaysia, at what point do you think that the Malaysian operations based on what you see right now are likely to start coming online, like is it a couple of years down the road or further out?
Alex Davern, CPA
So, good question. Obviously, we added about 50 people to our R&D and field sales headcount this quarter, which will seem aggressive probably to many people and certainly will probably be relatively unique in the industry that we've continued this persistent long-term focus.
But as Dr. Truchard mentioned, the talent that's available to us to hire right now is really outstanding and we want to make certain that we take advantage of that to change the rules of the game going forward to help us open up new market and fuel our future growth.
In terms of manufacturing in particular and the expansion to the third production site in Malaysia, our current expectation is we will now initiate production sometime in the latter half of 2012. So roughly a two year delay from our original plan.
Operator
And now we'll move next to the side of Anthony Luscri. Your line is now open.
Anthony Luscri - JPMorgan
Hi, good afternoon. I wanted to follow up on the question that was asked earlier.
You gave detail around the end markets during the third quarter. I was more curious about the guidance for fourth quarter in terms of strengths, weaknesses, what your looking for in terms of this big sequential revenue growth.
John Graff
Yeah, Anthony, this is John. I mean it's really tough for us to do that.
As we've mentioned, the diversity of our business on an annual basis selling the 30,000 different companies and across all these vertical industries. So it's one of strength of our business model, but to kind of project that out is tough.
What we can look at is opportunities driven by our product platform. And you heard us talk about at NIWeek, we are continue to feel really good about the R&D investments we've made and the new product opportunities in areas like RF and communications as well as new opportunities in industrial embedded applications.
So those areas we've been investing and we continue to feel we have some strong opportunities in the future.
Anthony Luscri - JPMorgan
Okay. Maybe could ask a question differently.
If we could talk about the platform in terms of the fourth quarter sequential growth in terms of instrument control versus embedded industrial versus maybe the rest in terms of relative growth rates within that revenue guidance that you provided.
John Graff
Well, again, I think we want to be careful in giving kind of explicit guidance on products. We don't do that I think Terry and Alex kind of touched on this.
Instrument control, after seeing some very severe sequential declines earlier this year, saw a very strong sequential uptick. We do think that is a sign of some recovery in the traditional test and measurement industry and so that can...
I would expect that to kind of continue into Q4. Meanwhile, the broad base of our products, virtual instrumentation and graphical system design, we started in Q2, we are seeing a sequential uptick.
That's where we are investing new products. That's the area where the investment in field sales is going to pay off.
So those are the areas where we look to control our own destiny and pursue opportunities, find opportunities.
Alex Davern, CPA
And just maybe to add on a point to John's, the current... or the trend we saw certainly in Q3, what's giving us...
or the guidance we have given here for Q4 is very similar to the pattern that we saw very strong sequential revenue growth coming out of last recession in Q3 and Q4 2003. Once the initial invasion of Iraq was over and confidence in business seemed to recover, we saw an outsize relative to the average sequential growth in Q3 of that year and then into Q4 we saw very, very strong sequential growth.
And the pattern we have seen or we are guiding to at this point in time is quite similar to what happened in '03, the second half of '03.
Operator
(Operator Instructions) Our next question will come from the side of David Yuschak. Your line is now open.
David Yuschak - SMH Capital
As far as the... it seems to me, you guys when we talked at a conference call, you've had a lot of pipeline activity out there, none of the stuff really kind of went away or cancelled but there is always a high level of interest, is that kind of what we're seeing now is that high level of interest is starting to come back?
James Truchard
Yeah, David, you're right. We've mentioned, you go back to the start of this downturn Q4 last year Q1, we talked about seeing especially on the large orders some of this business being pushed out.
Now for the last two quarters, well we haven't seen the full return in that kind of end of quarter surge. We have seen it partially return.
And of course, we're very optimistic about that. We don't get feedback from customers that projects are cancelled.
So, our sales force continues to feel good about the opportunities. As you guys know, we talk about this a lot.
We have an opportunity management system that field tails up to the management can use to kind of gauge the health of that pipeline. And we continue to feel really good about the opportunities that we're identifying and working.
So, that's gives us some of the optimism that carries into not only the Q4 guidance but I think some of the optimism you've heard us talk about for 2010.
Alex Davern, CPA
And I think when you look at the investments we've made David, if you look at from two years ago from September of '07 to September of '09 we've increased our field sales headcount by 40%. And so we're in a much, much better position today than we were two years ago to take advantage of opportunities in the market and to work at a much more intimate level with our customers.
And certainly we would expect to get a return on that investment which I think we're starting to see now, in gaining market share and we hope that that plays out as we go into the recovery.
David Yuschak - SMH Capital
And then on the R&D spend in the quarter, sequentially up about I think 6 million or so. Anything in there that as for--
Alex Davern, CPA
Now, that's directly related to software capitalization. In Q2 we had a very large software capitalization number tied to the release of LabVIEW 2009 and as that product gets released then the software capitalization number goes down and expense goes up very similar sequential change that we saw in Q3 of last year.
Operator
And we'll move next to the side of Mark Douglass, or excuse me, we'll move next to the side of Anthony Luscri. Your line is open.
Anthony Luscri - JPMorgan
Hi, thanks for the follow-up. I just wanted to ask about academic percentage of revenues during the quarter was greater in 10?
Alex Davern, CPA
Yeah. I assume I don't have that in front of me, but I would assume it's probably on the same par as the last couple of quarters so in that 10 to 15% range.
James Truchard
Right and obviously academic is very important for us as we see more and more engineers trying with our products and then going into industry and using the products in their new jobs.
Anthony Luscri - JPMorgan
And do you think that there is any impact to the academic strength that you're seeing recently?
James Truchard
It's kind of two sides we're just talking about that earlier. On one side, we are seeing some evidence of stimulus funding while on the others the state batches that typically are funding these universities are being hit pretty hard from balance we hope that it will operate even.
Alex Davern, CPA
I think we might perhaps see more that in the future than we have seen so far and hasn't been overwhelming by any stretch.
James Truchard
Right.
Anthony Luscri - JPMorgan
Fine, thanks. And then is there any better margins there so, any insight will be greatly appreciated.
Alex Davern, CPA
We don't breakout obviously gross margin by end market. But, we do the academic business not only as a very strategic business but also as a profitable business.
Anthony Luscri - JPMorgan
Okay. Thank you.
Operator
And now, we'll move next to the side of Mark Douglass. Your line is now open.
Mark Douglass - Longbow Research
Thanks for follow-up. The litigation, accrual reduction, I assume that's a one-time event at this point?
Alex Davern, CPA
Yeah.
Mark Douglass - Longbow Research
Okay. What's the after tax affect of that?
Alex Davern, CPA
It's a few cents a share a little bit less perhaps rounds up to $0.02 a share I think Anthony, but it is little bit less than 2.
Mark Douglass - Longbow Research
Okay, less then 2. Okay.
And Alex you referenced the sequential uptick you saw in 4Q '03 last downturn, what do you thinking in the first quarter 2010, you think it will return to typical kind of seasonality, because back then there is actually a sequential uptick?
Alex Davern, CPA
Not really in the position to give guidance at this point for Q1 and Q2. As we look at the business, we're very pleased with -- just assumes as we hit Q4 guidance.
So, obviously we're guiding to at this point in time, but if we're in the midpoint or above on Q4, we will be very pleased at that point in time in terms of the rate of... the rapidity of the recovery of our business.
And I think that will indicate strongly the value customers place on our solutions. We know we're getting into application areas that we weren't in the past.
So if we see a good recovery year-over-year in industrial production, that would be some cause for optimism as we go into the first half. But it's too early at this stage to comment specifically on revenue for Q4.
I will say that, as we talked in the call, we feel like that the timeframe for returning to record revenue is a lot sooner than we would have imagined six months ago.
Operator
And our next question will come from the side of David Yuschak. Your line is now open.
David Yuschak - SMH Capital
Just a real quick housekeeping one. On your tax rate for the first quarter...
I was offline when you commented about it, Alex. What do you expect it to be to true it up for the whole year?
Alex Davern, CPA
Yeah, it's going to be... we guess it's about 30% non-GAAP effective tax rate for Q4, David.
Now that's obviously much higher than the effective rate for the whole year, and that's coming down to the fact that frankly the profit for the year now is expected to be a lot higher than we had anticipated back in June and July. And so that significant increase in our expectations for profit in the second half pushes a lot of tax charge into the third and fourth quarters, particularly in the fourth quarter.
Now that obviously is something that is having a negative effect on the guidance we're getting. So that is factored into our guidance and it has had an affect obviously of bringing guidance down a little bit from it otherwise would be.
The other impact obviously in Q4 from a GAAP point of view is that we'll have an impact also on our reconciliation between GAAP and non-GAAP. The GAAP...
the difference between those two numbers, this expectation for Q4 is about $0.08 per share, which again is much higher than normal. But as we revert to Q1, we're anticipating for next year a rate on the effective tax rate for non-GAAP purposes between 18 and 22.
And then we anticipate the differential between GAAP and non-GAAP earnings will drop back to a more normal $0.06. It's all detailed in the press release, by the way; if anybody else on the line has questions about that, they can read the specifics in the press release.
Operator
And we'll go next to the side of Ajit Pai. Your line is open.
Ajit Pai - Thomas Weisel Partners
Yeah, when you're looking at the channel right now, you've hired more folks on the direct sales side. But can you give us some color as to the Internet as a channel, whether that's been growing, whether that's been sort of more mature and isn't growing anymore at the same pace as the company or whether it's still growing much more rapidly?
John Graff
Ajit, this is John. We continue to see success with the web channel, especially for the broad-based and transactional or smaller orders.
It's just a very efficient means to reach thousands and thousands of engineers and scientists. So that as a channel actually performs better than our overall results.
The efficiency we get by leveraging that is then part of what lets us turn around and make this investment in the field sales force, the 12% growth this past year and 40% over the last two years that Alex mentioned.
Ajit Pai - Thomas Weisel Partners
Your expectation is that should continue to grow as... faster than the overall company or is that sort of coming close to sort of large numbers or high percentage that you are not going to see that grow much faster?
John Graff
No, there continues to be opportunities. There is a lot of variety and different trends by geography.
The adoption rate of the web obviously varies around the world and then even specifically for e-commerce. So here, I'll give you one highlight.
Just this past summer, we turned on credit card ordering in Europe for the first time. And that just provides some new efficiencies again for that channel, so we expect that to have some positive impact.
And again, that helps us be more efficient in our sales efforts in Europe.
James Truchard
One point is most of our customers now are using the web to evaluate our products and look at applications and examples and in various communities. So it's serving a very important role for creating efficiency in our marketing process, and then of course we get the direct orders as well.
Operator
And it appears that we have no further questions at this time. I'd like to turn the call back over to David Hugley for any closing remarks.
David Hugley
John?
John Graff
Thank you for joining us. We look forward to seeing you at upcoming conferences.
Thank you for your time.
Operator
This does conclude today's teleconference. You may disconnect at anytime.
Thank you for your participation and have a great day.