Jan 29, 2009
Executives
James Truchard - President, CEO, and Co-Founder Alex Davern - SVP, CFO David Hugley - VP and General Counsel, Secretary John Graff - VP Marketing
Analysts
Antonio Antezano - Macquarie Capital Mark Moskowitz - JPMorgan William Stein - Credit Suisse Ajit Pai - Thomas Weisel Partners David Yuschak - SMH Capital
Operator
Good day everyone and welcome to the National Instruments fourth quarter 2008 earnings conference call. Today's call is being recorded.
You may refer to your press packet for the replay dial-in number and pass code. The replay will be available from 7 PM Central Time today and will end at midnight Central Time on February 3, 2009.
With us today are; Mr. David Hugley, VP, Corporate Counsel; Mr.
James Truchard, Chief Executive Officer, and Mr. Alex Davern, Chief Financial Officer.
For opening remarks, I would now like to turn the call over to Mr. David Hugley, Vice President, Corporate Counsel.
Please go ahead, sir.
David 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 the following: Our expected expenses for the first quarter and for 2009, improving revenue and profit in the second quarter compared to the first quarter, revenue and profit following a normal seasonal pattern, a decline in inventories, effective tax rate, and gaining market share.
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 Annual Report on Form 10-K for the year ended December 31, 2007, and our Quarterly Report on Form 10-Q filed in November 7, 2008.
These documents contain and identify important factors that could cause our actual results to differ materially from those contained in our forward-looking statements. With that, I will now turn it over to the President and CEO of National Instruments Corporation, Dr.
James Truchard.
James Truchard
Thank you, David. Good afternoon and thank you for joining us.
Our key points today are 11% year-over-year revenue growth in 2008, record annual revenue in key product areas including software, data acquisition, PXI and modular instrumentation, and distributed I/O, and continued validation of the advantages of our software based approach in the tough economic environment. Despite the 1% revenue decline in Q4, we turned in a relatively strong performance when you considered the historic weakness in the economy that triggered a severe contraction in the test and measurement market.
The strength of our operating business model was tested and validated in one of the most challenging periods in the history of the company. The diversity and adaptability of our products and channel enabled us to find new business opportunity and growth areas in Q4.
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
Good afternoon. Today we reported quarterly revenue of $202 million, a 1% year-over-year decline.
For the full year, the company reported record annual revenue of $821 million, an 11% increase over 2007. This represents the sixth consecutive annual revenue record for the company.
Given that the US economy was in recession throughout 2008, and that the Global PMI averaged approximately 46 during the year, indicating a global industrial recession. National Instruments 11% year-over-year revenue growth was a very good relative performance.
Net income for Q4 was $19.3 million with fully diluted earnings per share of $0.25. Non-GAAP net income was $24.2 million with non-GAAP fully diluted earnings per share of $0.31.
For comparing our results with our GAAP and non-GAAP fully diluted EPS in Q4 2007, please remember that in Q4, 2007, NI recognized an $18.3 million tax credit, which had the impact of increasing our GAAP and non-GAAP EPS by $0.23 in Q4, 2007. GAAP operating income for 2008 was $96 million, down from $102 million in 2007.
Non-GAAP operating income for 2008 was $120 million, down 3% from 2007. Cash flow from operating activities was $122 million in 2008.
Now, looking at revenue in more detail. From a product point of view, our instrument control revenues saw a 29% year-over-year decline in Q4, with the rest of our products being up 2% year-over-year.
Our instrument control products are the most economically sensitive portion of revenue, and we expect the revenue trend in instrument control to continue to deteriorate in Q1. Q4 represented the lowest quarterly revenue total for our instrument control products since 1994 and this data plus the very negative news announced in the industry since October suggests a very severe contraction in the test and measurement industry during Q4, especially in the semiconductor ATE segment.
The very modest growth of the rest of the business during Q4 was enabled by growth in the areas of modular instruments, PXI, software, and CompactRIO which performed very well in light of the industry contraction. Within the modular instruments, our RF test products were a standout performer with revenues up approximately 50% year-over-year for Q4.
For the full year, our instrument control revenues were down 11% as a result of the contraction in the test market during 2008. Our virtual instrumentation and graphical system design products grew 13% for the year.
We saw the impact of the industrial recession on all regions. During Q4, year-over-year revenue growth was minus 2% in Europe, minus 8% in Asia, and up 4% in the Americas, giving overall growth of minus 1%.
We believe that our performance in the US was helped by the fact that it had lower growth than the other regions in Q4, 2007, as the US economy weakened first with a PMI averaging below 50 in Q4 of 2007. On another note, in the earnings release today, we have separately disclosed our software maintenance revenue for the first time.
We have added this disclosure due to the increasing percentage of our revenues coming from the software maintenance and the interest of shareholders’ invisibility into this revenue stream. All future earnings releases and regulatory filings will include this expanded revenue disclosure.
As part of this expanded disclosure, some technical support costs previously included in sales and marketing expenses are now accounted for as part of cost of goods sold. All prior year amounts have been reclassified to conform with this presentation.
This change will have the impact of reducing our gross margins by approximately 40 basis points with a corresponding reduction in sales and marketing expenses as a percentage of sales. Looking at this break down for Q4, product revenue was $187 million, down 4% from Q4, 2007, and software maintenance revenue was $15 million, up 42% year-over-year.
For the full year, product revenue was $765 million and software maintenance revenue was $55 million, representing 9% and 42% year-over-year revenue growth respectively. Now, looking at the non-GAAP income statement in more detail.
Non-GAAP gross margin in Q4 was 75.8% compared to 75.7% in Q4, 2007. Both these data points have been adjusted for the software maintenance reclassification discussed earlier.
R&D expenses were up 7% year-over-year in Q4. Software development expenses capitalized in the quarter amounted to $800,000, down from $1.1 million in Q3, and also during the quarter, $2.5 million in previously capitalized software development costs were amortized to cost of goods sold.
Now, turning to the balance sheet. Inventory increased by 8% during the quarter.
The increase is a result of demand in Q4 falling short of our original expectations. We have adjusted our production schedules and we expect to see inventories decline in Q1.
Accounts receivable days outstanding were flat with Q4, 2007. As of December 31, the company had $236 million in cash and short-term investments.
This cash balance is net of $9 million in dividends paid during the quarter and $45 million used to repurchase 1,989,000 shares of NI's common stock at an average price of $22.86 per share. For the full year, the company paid $35 million in dividends and used $104 million to repurchase 4.1 million shares, or 5% of its common stock at an average price of $25.23 per share.
In January, the Board of Directors increased the company's stock repurchase authorization to 3 million shares of NI's common stock. We also announced today that the Board of Directors approved an increase in the company's quarterly dividend from $0.11 per share to $0.12 per share payable on March 2, to shareholders of record on February 9.
Now, looking forward into 2009. Business conditions which had deteriorated significantly in December have continued to be challenging in January.
The current economic uncertainty coupled with extended holiday shutdowns at many of our customers, and a shift of the Chinese New Year into January of this year from February last year has limited our visibility for Q1. As a result, we have decided to delay giving revenue and earnings per share guidance for the first quarter until our business update call scheduled for Thursday, March 5, when we expect to have a clearer picture of Q1.
Historically, NI's revenues have declined sequentially in Q1 and Q1 has been the lowest revenue and profit quarter for the year. We expect these patterns to continue this year.
Looking out to Q2 and beyond, we expect our normal seasonal pattern to start to reemerge and to see revenue and profit improve sequentially in Q2 from the base level in Q1. On the expense side, we will continue to be very prudent in managing our expenses.
We will continue to increase investments in R&D and field sales, plus significantly limiting expense growth elsewhere. Since the update call on January 2, the company has reduced its spending plans for the full year of 2009 by a further $30 million in order to better position the company to deal with the extended economic uncertainty.
As a result, for the full year of 2009, we are now budgeting for a 3% year-over-year reduction in non-GAAP operating expenses compared to a 14% increase in 2008. For Q1, we are currently budgeting for a year-over-year increase of approximately 1% in total non-GAAP operating expenses.
In other items, we expect non-GAAP gross margins adjusted for the software maintenance change discussed earlier to be between 74.8% and 75.3% for Q1, and we are guiding to a 15% non-GAAP effective tax rate for the full year of 2009. As these are forward-looking statements, I must caution you that actual revenues, expenses, and earnings could be negatively affected by numerous factors such as any further decline in the global economy, delays in new product releases, rescheduling customer orders, expense overruns, manufacturing inefficiencies, the effective tax rates, and foreign exchange fluctuations.
So in closing, despite the global industrial recession, we successfully grew our business to 11% in 2008, effectively maintained our operating profit, and generated $122 million in cash flow from operations. I believe we have been both strategic and prudent in our business planning and our reaction and execution in this downturn has once again demonstrated that our business model is solid.
And with that, I will turn it over to John Graff, Vice President of Marketing.
John Graff
Thank you, Alex. The historically low Global PMI rating in December of 33.2 suggests that Q4, 2008, was the most challenging global economic environment in the 32-year history of National Instruments.
The instrument control portion of our business was down 29% in the quarter, suggesting a significant contraction of the test and measurement industry in Q4. While we are ultimately unable to sustain growth in Q4 in the phase of these downward forces, we believe that we have weathered this economic storm better than our peers and continued to drive market share gains throughout 2008.
For the full year, we delivered record revenue, up 11%, our 31st year of revenue growth in our 32-year history. Our operating model proved its strength and resilience as strong margins helped fund strategic investments in R&D and field sales in 2008.
The diversity of our business has proven again to be a powerful asset in this harsh environment. Since the last downturn, we have transformed from a transaction focused PC peripheral company to a platform based business that closes the large system sales to high-end test, industrial, and embedded applications.
Sales of distributed I/O products including CompactRIO more than tripled since the end of 2003 and sales of PXI modular instrumentation increased more than 6X in that same five-year period. The success of these system level platforms has led to a shift in our business and sales model, as evidenced by our average order size increasing to $3,700 at the end of 2008, a 35% increase compared to the end of 2003.
Additionally, orders over $20,000 were 38% of our business in 2008 compared to only 25% of our business in 2003. While the success of PXI and NI CompactRIO signal our further penetration in new application areas, National Instruments remains highly diversified across industries and applications with no one industry accounting for more than 10% of revenues and no one customer accounting for more than 3%.
As it did throughout 2008, software growth again outpaced the company average in Q4 leading the record quarterly revenue. Growth was driven by strong sales of Developer Suite, a configurable bundle which packages LabVIEW with other NI software.
We saw continued strength during the quarter in sales of volume license agreements for LabVIEW, which is a strong indicator that companies continued to see the value of investing in and standardizing on LabVIEW across the department or throughout the organization. Continued growth of our LabVIEW user base has contributed to an up tick in paid customer training in 2008.
In Q4, we saw a surge in customers attending our online training offerings, where customers attend a live internet session rather than traveling to a regional training site; making customers more proficient with LabVIEW has been and will continue to be a key focus area for the company as it often leads to further adoption of other NI hardware and software. Our new family of Wi-Fi data acquisition devices released at NIWeek was a bright spot in Q4.
Despite the challenges in the quarter, the Wi-Fi devices exceeded the sales targets that we set earlier in the year. The Wi-Fi capability has allowed us to win applications where cabling would be difficult or impossible, and we've had successes in application areas as diverse as agriculture, mining, and facility monitoring.
While we did see a slowdown in the growth rate of PXI and modular instrument products in Q4 after five consecutive quarters of record revenue, these products had year-over-year sales growth in Q4 well ahead of the company average. Success of the new PXI Express 6.6 gigahertz RF modular instruments helped drive record RF product sales in Q4.
The new modules which were announced at NIWeek last year extend the capabilities of PXI into new applications such as WiMAX and MIMO testing that we were previously unable to address. In addition to the new application areas, internal and customer benchmarks have shown improvements in measurement speed of up to 10X compared to traditional RF instrumentation.
This offers both significant reductions in testing time, as well as reduced number of test systems required for a given volume of production units, which makes our PXI RF solutions especially attractive during periods of tightening capital spending. In addition to wins in production tests, we also continued to see success of PXI Express in validation tests.
One example during the quarter was a prominent LCD manufacturer who adapted PXI Express due to its high bandwidth data streaming capabilities. Their new system executes a complete video test profile in hours and replace the manual process of testing each input source individually that took weeks to complete.
In Q4, CompactRIO saw continued growth and record revenue. Our new NI Single- Board RIO products had another successful quarter, as our FPGA based board-level systems won out against custom designs in OEM applications such as medical devices and green energy.
In addition, starting January 3, approximately 50,000 high school students and 3,000 engineering mentors in the first robotics competition began using CompactRIO. Students in the competition have only six weeks to design, prototype, and deploy their complex robotic devices.
The challenges they face are similar to those faced by many of our industry customers, and first represents not only an opportunity to impact the engineers of tomorrow, but also expose the benefits of graphical system design to today’s leaders in the engineering community. One team mentor, who has been C programmer for the past 20 years, described his first experiences with LabVIEW by saying, “you do not really appreciate the depth and breadth of LabVIEW, until you actually work with it.
Now the kids can focus on problem solving. I am very impressed and definitely converted.”
In summary, we believe our continued focus on making our core customer base successful in combination with the disciplined investments we have made in new product R&D and field sales to target new application areas has enabled us to outperform the market even during economic contraction and provides a very strong position to take advantage of the eventual recovery. With that, I'll turn it over to Dr.
T.
James Truchard
Thank you, John. Q4 was indeed the most challenging and turbulent period in the history of the company.
It's during these times that the strength and resilience of our business model truly shows its merit. Our field sales force again proved to be a powerful asset, as their aptitude and adaptability enabled us to outperform the market in Q4.
The breadth of customers in markets we serve enables our field sales engineers to continue to find and capitalize on areas where investment is flowing. Two areas in particular where we see continued focus from our customers are manufacturing cost reduction and R&D innovation.
In manufacturing, customers continued to show significant caution in increasing production capacity, but also have an increased need for efficiency gains and cost reductions. Software based test systems with PXI and modular instrumentation are well suited to meet this need providing much faster bandwidth, faster test times, and greater flexibility than traditional instruments, which result in lower per unit test costs.
In industrial and embedded applications, our ability with CompactRIO to run sophisticated control algorithms on the FPGA enables more efficient motor control, improved energy management, and reduced scrap. In R&D we see the opportunity and efforts to improve efficiency and reduce design times.
For example, the ability to design application specific code in LabVIEW and deployed on re-configurable FPGAs provide significant advantages and efficiency gains and prototyping and design validation of products ranging from advanced engine control units to next generation semi conductors. We are also in a good position to benefit from the increased capital flows into such areas of structural help monitoring, alternative energy research, and science and engineering at the high school and university level.
For example, earlier this month, the National Institute of Standards and Technology announced a $3.4 million grant to fund the five-year research product between the University of Texas, National Instruments, and an Illinois-based engineering firm to develop sensor networks for bridge inspection. Further examples are found in research facilities such as National Renewable Energy Laboratory that are using LabVIEW and National Instruments technology to research and develop solutions for alternative energy including solar, wind, and wave harvesting.
The adoption and the usage of LabVIEW in the high school and university science and engineering classrooms and research labs should benefit NI as thus see additional funding for computers and instrumentation. As these opportunities and others present themselves, the skill and flexibility of our sales force let us quickly respond and capitalize.
Finally, I would like to thank and congratulate our employees for National Instruments being named to Fortune 100 best places to work for a 10th consecutive year. Our employees are the life blood of the company and continue to drive innovative culture that makes National Instruments a great place to work and a leader in the markets we serve.
We will remain dedicated to delivering highly differentiated new products to increase market share in our existing market and drive growth in new application areas. I see the current market condition as not only a challenge, but also as an opportunity as our customers focus on doing more with less, reducing risk, and sharpening design cycle.
We remain financially prudent and committed to tight spending control, but will maintain our strategic investments to find future growth. By striking this balance between long-term strategic priorities and short-term cost management, National Instruments will be well positioned to emerge in a even stronger position in the next up cycle.
This strategy has enabled National Instruments to be a model of consistent growth and profitability throughout our history and we remain committed as ever to the success of our customers, suppliers, employees, and shareholders. Thank you.
We will now take your questions.
Operator
(Operator Instructions). Our first question comes from Antonio Antezano with Macquarie Capital.
Antonio Antezano - Macquarie Capital
Thank you. Good afternoon.
James Truchard
Hi, Antonio, how are you?
Antonio Antezano - Macquarie Capital
Good. I wanted to ask you, back in early January, the preliminary guidance you provided for Q1 was a single digit decline.
So, should we take that or what should we think about that preliminary guidance you provided earlier?
Alex Davern
Well at this point in time, Antonio, we are rescinding that guidance and basically at a point where we're not going to give revenue guidance for the first quarter. The reason for that change in simple terms is that, we had talked about Q4 as we went through the fourth quarter, October and November were slightly positive and then we saw a significant decline in very challenging conditions in December.
January has turned out to be very similar to December at this point in time. It's also been a little bit confused by a significant number of our customers being shutdown during the early part of January and then the shifting of the Chinese New Year into January, instead of February, as it was last year.
Those elements have confused the picture a little bit, made it more difficult. I also think that the flood of kind of bad negative news that's come out from many companies over the course of last two weeks has probably made it likely that many of our customers themselves are going through a re-budgeting process and it's quite likely they themselves at this point don't know exactly what their spending plans are going to be.
I think, given that, it's most likely that the biggest variable influencing the outcome if you want for NI will be the broader based economy in the next couple of months and given that that's not a factor that we control, I think the sensible thing for us to do at this point is wait till the picture is a little clearer, and hence, we're going to do a business update call early March. And I think at that point we'll have a very clear idea of how things are going to play out.
Antonio Antezano - Macquarie Capital
And a follow-up. The 3%, I guess, decline in operating and spending, if you could expand?
What actions are you taking to get to that and what should we expect on a quarterly basis during the year?
Alex Davern
Let me answer the second part first. It's going to obviously take a little bit of time to put fully into place.
So, while we are budgeting for minus 3% for the full year, we are budgeting for plus 1% in Q1. And then the change for the remaining three quarters will be largely consistent.
So, the changes we're making we expect to largely be in place for fully for Q2. In terms of the changes we've made, I'm really proud of the organization and the business management around the world and the way that NI has reacted to this downturn.
We've always been very focused on maintaining a strong and stable financial performance as you see over the last 20 years. As we saw strong growth in the first nine months of the year, we were spending aggressively and investing aggressively.
We had increased our operating expenses on a non-GAAP basis, about 18% in the first nine months, in line with our revenue growth in the second and third quarters. And then we adjusted rapidly, bringing our operating expense growth down to less than 6% in Q4.
We're now guiding to 1% in Q1 and then minus 3% for all of '09. So, the company has done an extremely good job of reacting to this downturn, while at the same time we are going to increase our investment in terms of hiring and headcount in R&D and into field sales.
So, we will be continuing to expand our headcount in those two domains. In terms of the main changes that have happened, primarily they relate around to obviously variable compensation which we have adjusted.
Also a significant reduction in hiring expectations, so we're now expecting to only hire about 100 people next year, or this year, in 2009. That's a significant reduction from our original expectation.
We're also using this as an opportunity from a renegotiating point of view. We feel like the steady business that NI has provided our vendors over many years gives us a very good bargaining position and we have launched an initiative to reduce our costs from our suppliers by renegotiating pricing which is paying some early dividends and we're confident we'll see some benefits on that front.
And so it's been a combination of areas. I said at the beginning, related to compensation, related to hiring, and related to vendor pricing contracts.
Antonio Antezano - Macquarie Capital
Thank you. I'll go back to the queue.
Alex Davern
Thank you.
Operator
And next we will go to Mark Moskowitz with JPMorgan.
Mark Moskowitz - JPMorgan
Thank you, good afternoon. A couple of questions here.
Alex, could you talk a little more about the revenue profile in the fourth quarter in terms of the commentary around the healthy dose of new customers, in terms of revenues, are benefiting from investments are still flowing? Just want to get a sense, how much of your revenues came from those new customers, and is that what also was leading to some of the uncertainty around your outlook for the first quarter, in terms of “hey, they popped up in the fourth quarter, great, but we don't really know how sustainable the revenues are”?
John Graff
Mark, this is John.
Mark Moskowitz - JPMorgan
Hi, John.
John Graff
Maybe I will start and then Alex will fill in. In terms of the new areas, we actually were continued to be extremely pleased with the results and the growth and success of our new products.
As you recall back at NIWeek, we had some very significant product introductions, from the latest version of LabVIEW, to new RF instruments, to new versions of our RIO FPGA platform new Wi-Fi data acquisition products. All these areas and more have seen very strong growth through the second half of the year and that trend continued.
So, this is one of the reasons why we continued to be optimistic in the payoff of this investment in R&D. With that, I will turn it over to Alex.
Alex Davern
Yeah, I do not think there was a particular shift in the customer profile in Q4. So, maybe I need to correct that if we led to that misperception.
It's really, as John said, around the new products selling largely to existing customers some new customers and new application areas, but it's not that there was one or two big new customers that came in the fourth quarter that we are concerned about. I guess, looking at some of the caution on the expectations for Q1, Mark, the way I would kind of push it is, as it appears, and certainly seems to be, clear from what we are seeing that there is a general if you maybe back up and look at the industrial production numbers in the US from what I saw in the paper today, it looks like a 15% or 16% annualized drop in industrial production in the United States during the fourth quarter, a massive drop in capacity utilization in the United States in the fourth quarter which looks highly probable to drag on into Q1.
What we've seen obviously in the third quarter, in Q4, we saw our instrument control business drop 30% year-over-year and as we indicated in the press release in the call, we expect that to deteriorate from a year-over-year point of view even further in Q1. So what we appear to be seeing is a collapse, if you like, in end of line production test business and that is where we are getting most of our caution from.
If you look at our business and you move away from a product line point of view and you move away from a geographic point of view and you think of it in terms of end markets, production test is a big portion of our business. Government, aerospace, defense, academic, national labs, all wrapped up is another big portion of our business.
R&D into commercial enterprises is another big portion of our business. In those areas, it looks to us like the government's area, defense, academic segment is likely to continue to be well funded and, potentially with the increase in funding from multiple stimulus packages around the world, may actually see an increase in funding in 2009.
So that's likely to be stable. R&D from a commercial point of view is probably going to take some impact, but probably not that severe.
The biggest shift and change that's happened quite rapidly as we went through the last four months has really come in production tests.
Mark Moskowitz - JPMorgan
Okay, and the second question, I hear you on the cost savings that you're telegraphing for the coming year, but I just want to get a sense in terms of the OpEx savings. How much could be in the invested products if you don't get your bill material benefits from some of your renegotiations you're talking about right now?
How much would you use to redeploy back in the pricing to move business?
Alex Davern
I'm not sure I understand the question, Mark. You say, if the bill material changes don't come about?
Mark Moskowitz - JPMorgan
That's right.
Alex Davern
Okay. So, let me perhaps reflect on that.
What we're including in our budget at this point in time is only changes that we have agreed on. So, we do not have included in our spending budget assumptions of future pricing changes to come.
We do have a project team working on that, but in terms of the budget that we're communicating today, minus 3%, that only includes cost changes where we already have agreement on those cost changes from our vendors.
Mark Moskowitz - JPMorgan
Okay, thank you. I'll jump back in the queue.
Alex Davern
Okay. Thank you, Mark.
Operator
And next we'll go to William Stein with Credit Suisse.
William Stein - Credit Suisse
Thanks. Just first, a clarification guys.
Am I getting this right, that you are not providing revenue guidance for Q1, but you are providing margin guidance? Did I hear that correct?
Alex Davern
Within a range, Will, yes, that's correct.
William Stein - Credit Suisse
Okay, great. Then a couple of other quick ones; software maintenance you're disclosing now, what about software license sales?
Is that meaningful? Are you disclosing that going forward?
Alex Davern
Well, let me reconcile a little bit for you if that will help you. Typically, over the last number of years, we've communicated that overall software revenue is approximately 20% of the company's revenue.
When we've talked in terms of that software revenue, we have included this maintenance revenue as part of that overall chunk of business. Due to the very different nature of the maintenance revenue and its recurring nature, I've gotten a lot of questions from investors about the scale of that number.
They would like to see visibility into it. And as our user installed base has increased over time, the scale of it, as a percentage of our overall revenue, has also increased and so, for that reason, we've chosen it break it out because it's such a different revenue stream.
Well, at this point, we don't intend to break out software license revenue as a separate line item.
William Stein - Credit Suisse
Okay, great, and then one other quick one. Can you tell us what gives you the confidence to suggest that you'd start seeing normal seasonality in Q2?
Alex Davern
Okay, so, that's a good question. Obviously, we don't know where Q1 is going to fall out at this point in time, but when I take a look at where we stand, I think it's likely that it may form a base point.
That is, I will caveat that that is an expectation we have at this point in time and we could be wrong in that. But when I look at it, the reasons that I see this as a likely case as number one, we have had a collapse, I think, in industrial production in the United States in Q4.
We have seen significant impact from customer shutdowns through the first half of January. We have, I believe most companies, are going through a fairly major re-budgeting exercise right now, and I think there's a fair degree of paralysis as a result of that.
And then the other issue I will put in is, I think we have seen a fairly dramatic drop already in that portion of our business that's related to production test. And so, those are the primary reasons that I feel will start to see our seasonal pattern start to reemerge.
Now, I wouldn't want to promise that it will be the exact average of the last six-year increase in Q2 which is what we are going to see in Q2. So, I wouldn't want to be that specific, but I think in directional terms, it is likely that we will see some sequential increase in the second quarter.
And somewhat reinforced by what I see happening in instrument control, we saw a dramatic falloff in instrument control from a year-over-year point of view in Q4. While we expect it to be worse in Q1, the rate of incremental decline has certainly slowed down from Q4, and that is another indicator that I think, however, Q1 shakes out, I think Q2 will very likely, sequentially, be better.
William Stein - Credit Suisse
Great. I will get back in queue.
Thank you.
Alex Davern
Thank you, Will.
Operator
And next we will go to Ajit Pai with Thomas Weisel Partners.
Ajit Pai - Thomas Weisel Partners
Yeah, good afternoon.
James Truchard
Good afternoon, Ajit. How are you?
Ajit Pai - Thomas Weisel Partners
Good. A couple of quick questions.
I think the first one is, just looking at the software maintenance revenue, you had 42% growth. That's really material, relative to any other business you have.
Could you give us some color as to what's driving that and also, how long the software maintenance contracts are? And on a go-forward basis also, whether the margins of this business, is it lower gross margin but higher operating margin relative to the corporate average?
John Graff
Ajit, this is John. So, I think we've commented over the last few years that we've been seeing increased success in selling a service or maintenance program along with our software licenses.
Again, this is a model pretty common in the software industry. You can really look at it in two ways.
There's the maintenance programs we sell with our single-seat individual sales of LabVIEW, which is, of course, the volume part of our business, and then the other side would be these volume license agreements where we're able to do some standardization within departments or complete organizations. So, in both areas, we're seeing good adoption in up tick, a higher percentage of people have an attach rate with these maintenance and license programs and again that's reflected in the growth numbers you see in our release.
So, I believe today it's approximately 30% of our software that now has an attach rate with these maintenance programs. The contracts are typically a year, but in some cases, are multiyear.
Alex Davern
So addressing the second part of your question, Ajit, the gross margins for this business are higher. You can do the math.
I think it's about 89% gross margin for 2008, so, definitely higher than the corporate average. We don’t track operating income and operating margin by product line, but obviously this is a good business for us and one that we have been working hard to increase as an overall percentage of our profile.
Also, I've had a lot of investors ask me questions about this, just due to the increase they’ve seen in our deferred revenue balance sheet number over time, and then, to the fact that it has obviously slightly different characteristics in terms of the recognition and recurring nature of it relative to our other revenue profile.
John Graff
And I just want to clarify one thing, Ajit. I meant to say, the maintenance revenue is about 30% of software revenue.
The attach rates are actually much higher than that.
Ajit Pai - Thomas Weisel Partners
Right. If the attach rates are higher that means that the potential to further penetrate is going to be lower, like the current kind of growth rate that you have over there.
I mean, it's not a sustainable growth rate, right?
Alex Davern
Well, perhaps, I wouldn't want to give a forecast on one element. We're not going to give a revenue forecast overall, but what I would say, Ajit, is it more applies to the size of the overall user base.
Obviously, license revenue relates to new licenses being sold and maintenance relates to the whole installed base and so, I think we still have quite a lot that we can do to improve this business over time.
Ajit Pai - Thomas Weisel Partners
Got it. And then the second question would be just about, you were planning to set up a manufacturing operation somewhere in Asia, and just given the kind of the slowdown that you are seeing right now, do you have an update on that?
Is that something you are pushing out or are you going to make use to the current weakness to actually set that up?
Alex Davern
Well, we have announced that we will be building a manufacturing facility in Penang in Malaysia, and that is absolutely still our intent. This new facility will be, the need for it is, driven by capacity expansion, and so we will adjust our plans as we need to in order to accommodate what we're seeing in the current environment.
But we are very committed to going forward with our investment in Penang and we will be also doing other functions there such as R&D and those plans will continue pretty much regardless of the current economic condition.
Ajit Pai - Thomas Weisel Partners
And when will CapEx demands be faced by the company as far as the Penang facility goes?
Alex Davern
We will be looking at a land acquisition in ’09 and then construction, realistically, is going to be sometime in ’10 or beyond.
Ajit Pai - Thomas Weisel Partners
Got it, thank you.
Operator
(Operator Instructions). Next, we'll go to David Yuschak with SMH Capital.
David Yuschak - SMH Capital
Good afternoon, guys.
James Truchard
Hi, David.
David Yuschak - SMH Capital
You guys have shown an amazing resiliency here in the last five quarters of producing $200 million in revenue, even in this fourth quarter, as you described, with the kind of industrial production collapse as we have seen. And you had said earlier, Alex, that maybe in this first quarter that you are little more concerned about being more sensitive to the economy in this quarter relative to (inaudible) in recent conference calls.
The systems side of it, and the big dollar ticket numbers, have really helped to support that $200 million, as you have seen, as other things have faded. Is there any concern on your part, that whether it's the end of line production testing and audit, as some of these system sales things appear to be more vulnerable, is why you are more cautious that you reflect back on the economy, maybe more important than what you have been able to do so far in the last five quarters, kind of control your destiny by, as you said in your press release, finding business wherever it is?
Alex Davern
Yeah, I break it, rather than by product or by system versus transactional, David, I really think it comes down to the end application. As I said a little bit earlier on, I mean, you hit on the key point there, end of line production test.
I think we do not see major shifts in and around the government defense, academic, national labs type area, and not that much even in commercial R&D. But I think most production managers right now are a little bit like deer in the headlights and I think we have quite a bit of paralysis there and until that paralysis starts to recover and people start to deal with the new situation as the economy resets, I think that this is going to be vulnerable.
This has been crystal clear in a semiconductor CapEx issue area. Thankfully, our business is a very diversified and while semiconductor CapEx is a piece of our business, we are much more broad-based than that.
But when you see the broad-based industrial production numbers drop on an annualized rate of 15%, I mean, you have to take that very seriously in terms of the impact it's going to have, and I think we're seeing a very rapid significant reset of production test in a very short period of time and then we'll see where we go from there and Dr. Truchard would like to have a comment on this from a longer-term point of view as well.
James Truchard
Sure, well first off, our current concern is, I think everybody is concerned that we just don’t have visibility about the economy. But in terms of systems, actually, this is a strong area for us where we've taken on the applications that were very difficult to do with other technology and we can add a lot of value with the combination of FPGA and PXI with highly synchronized measurements and we're seeing good systems business in the areas like military, physics, and areas of research where the technology capability we have has a real good differentiation.
So, systems business is strong relatively and we are continuing to focus on this area. Matter of fact, next week I'll be at a seminar that we are putting on for big physics in France.
So, we are continuing to see nice opportunities there.
David Yuschak - SMH Capital
And then, one last question. As far as you've commented here about cutting some expenses and trying to deal with the current environment; but you still suggest that you're adding people; that compares very differently from what you're seeing in other tests and measurement companies.
Because you have been overspending on field sales, R&D continues to be there. At what point in time is the cutting expenses, are that hunkered down, or what do you think you would have to do to go another step down to cut expenses?
What kind of conditions do you think you would need to take another drastic look at expenses?
Alex Davern
Well, maybe, David, I'll break it into two parts. One, just to address the expectations we have at this point in time, is to add, as I said, about 100 people into the company next year, vast, vast majority which will be engineers.
To be clear on these, these are almost all people whom we’ve already extended offers to as part of our recruiting process. The vast majority of them are people who have committed start dates and we intend to honor those committed start dates and bring that talent into the company.
I think it would do tremendous damage to our reputation if we were not to follow through, number one; and number two, as Dr. Truchard keeps reminding everybody, we’ve got an awful lot of very valuable work that needs to be done.
So, we have a long list of projects that are well defined that we believe will be well received in the market and we want to go ahead and bring those projects to market, certainly have them in market in preparation for the recovery when that comes and Dr. Truchard may care to comment on that in just a second.
In terms of conditions, it would require, before we take another look, we will have a lot of time between now and early March. We'll be looking carefully at how the economy plays out.
We're trying to take a very conservative approach right now. We've obviously seen a dramatic change in business conditions between September and today.
We have reduced our planned hiring by about 75% or 80% from what we originally intended. So, we made a very dramatic reduction there and really focused on the long lead time hires where we can get very valuable long-term projects completed.
In terms of where we stand right now, I am comfortable where we are at the moment. I'd think, obviously, the company would react pretty much, I think, in the same vein and from the same philosophy that we had so far, where we have to see a dramatically different situation, if it was much worse again, we would take the same philosophical approach to the question of cost reductions.
James Truchard
Yes, this is a timeframe which we are hoping to gain market share and part of that gaining market share is about new products and part of it is about servicing the customer in a way, perhaps when our competitors are pulling back, we put that extra effort into it and make it possible for us to close business that we might have not otherwise and we, of course, as we have talked about in the past, are using the opportunity tracking system. So we are looking at actual customers with opportunity for us to close, and sometimes taking more effort, and we will expend some of the effort to close that business.
David Yuschak - SMH Capital
Okay. Thank you.
Alex Davern
Thank you, David.
Operator
And next we will take a follow-up question from Antonio Antezano with Macquarie Capital.
Antonio Antezano - Macquarie Capital
Thank you. If you could, expanding your, I understand you don't have a lot of visibility in the near-term, but whether you can comment on, what you see by geography: Asia, Europe, North America?
Alex Davern
Sure. When we look at the regions at the moment, I think there's weakness certainly spread throughout all regions.
When we look at Q4, obviously we saw some modest growth in the US and I think it's pretty clear that the US entered this recession first. We saw some modest decline in Europe and obviously the economic news in Europe has not been getting better as we have gone over the last number of months.
And then the biggest drop in Q4 was in the Asia Pacific region and significant impact there from our business in Japan and Asia will also, I think would be, continue to be challenged. But if we look at it regionally, our take at the moment is, as we look out the next year or so, I think it's likely that the US will probably emerge from this downturn first similar to how it led us into this downturn.
Antonio Antezano - Macquarie Capital
And just quick follow-up, you had a foreign exchange loss I think in Q4, and what should we assume for Q1?
Alex Davern
At this point, as we talked before, Antonio, this is a notoriously difficult number for us to predict. Certainly, it was a big swing in the fourth quarter when you look at $1 million gain last year and a $2 million loss this year.
We had guided in October to a $2 million loss, approximately, given the volatility we had seen in currencies through the month of October. The currency markets have been a lot more stable so far.
So, if I had to give you guidance, I would say it's to a much smaller number in Q1, but again, currency markets are very difficult to predict, so, as of now, my expectation would be a significantly smaller loss, but that could change between now and the end of March.
Antonio Antezano - Macquarie Capital
Thank you.
Alex Davern
Thank you very much.
Operator
And next we have a follow up question from Mark Moskowitz with JPMorgan.
Mark Moskowitz - JPMorgan
Thank you for the follow-ups. The first one; I apologize if I missed it, but did you say what the orders over 20,000 were as a percent of revenues and what the growth was year-over-year?
John Graff
Yeah, Mark, this is John. Orders over 20,000 came to 38% of revenue in the quarter, which was, I think, flat with a Q3 similar percentage.
In terms of growth, we did see the impact of the deterioration in the economy on all parts of the business. We saw slight growth on the larger orders and we saw a decline in the single digits for the orders under 20k.
Mark Moskowitz - JPMorgan
Okay, and then within that high order bucket, any change in the deferrals or cancellation rates you're seeing there?
Alex Davern
So, we had talked. Mark, it's Alex here, in the call on January 2 that we saw about $5 million of orders push out right before Christmas.
At this point, we have not seen any kind of repeat of that activity so far this quarter. Several of those orders have already shipped.
Several are scheduled to ship out into March. But it's our expectation that that will probably happen as we move into March that we'll see deferrals.
We didn't really have much in the way of cancellations at all, but deferrals are likely, I think, to be a bigger factor in Q1 as they were in Q4.
Mark Moskowitz - JPMorgan
And then just lastly, on tax rate, can you comment more on why the tax rate is going to be so much lower there for '09 versus '08?
Alex Davern
Well, when we look at our profile, we've been continuing to grow at a percentage of our revenue that's coming from foreign sources, especially in Hungary. As we look at that as a proportion of our business long-term moving forward, we see the opportunity for that tax rate to come down as we look at '09.
Mark Moskowitz - JPMorgan
Thank you.
Operator
And next, we do have another follow-up with William Stein from Credit Suisse.
William Stein - Credit Suisse
Great, thanks. Guys, I think, in the last downturn you used some cash to acquire other businesses to support the revenue.
Can you give us any update in that potential strategy for the company?
Alex Davern
Sure Will. That's a good question.
It's interesting, in the last downturn we really set a goal in going into '01 coming out in '03 to shift the leadership between companies in the overall test and measurement space in the course of the downturn, and I think we've really achieved that goal. We're in a much, much stronger leadership position because of our investments and because of some of our acquisition decisions during that timeframe relative to the competition than we were at that point.
Our goal through this downturn is to repeat that. We intend to be aggressive in investing not only in R&D and field sales force, but we will be looking for acquisition opportunities.
We do want to use this downturn, which has been quite severe so far as an opportunity to take another step up in terms of leadership in this industry. However, from a pricing point of view, I am not sure that reality has hit home yet in terms of most management teams.
My own expectation, I think I said it in early January as well, is I think it's going to take probably till the April-May timeframe before people come to accept resetting of the economy into new evaluation dynamics. So at this point I would tell you that we are looking hard, but don't have any eminent decisions relative to acquisitions.
William Stein - Credit Suisse
Would the strategy be more to buy, like I think you have done in the past, customers or companies that add technology to your products, or would they be companies that are in these areas?
Alex Davern
So, I think our strategy is we are not going to really be that interested in buying revenue per se or buying customers. We are going to be a lot more focused on the technology side and, perhaps, I will ask Dr.
Truchard to if he care to comment on that.
James Truchard
Sure. Because we have a platform based solution, we do have partners that we, from time to time, acquire technologies sometimes at a lower cost and sometimes more, and that could happen again.
We don't have any specific things that we could talk about at this point. But we will be looking, because this is certainly a good time to keep our eyes open for any potential opportunities.
Technology could be interesting as well, so those will be things we will keep our eye on.
Alex Davern
Yeah, I think people will be grappling with reality pretty quickly here in the next few months.
William Stein - Credit Suisse
Very great, thank you.
Operator
And we do have time for one more follow-up question from David Yuschak with SMH Capital.
David Yuschak - SMH Capital
Help me if my logic is not correct here, guys. But it would seem, in periods like this, that a company’s factor y, for solutions and all that, be more open to looking for new ways to bring efficiencies to the factory floor because they don't want to that it's downtime now, let's take a look at this stuff versus running full out and not wanting to take the chance of anything.
Just curious as you said earlier, Alex you're kind of the deer in the headlight thing with the production people. But from a pipeline point of view, is there a logic to what I suggested that you will see more things in a way of potential opportunities in this period of time because of what's happening in kind of resetting the bar out there?
James Truchard
Exactly. We can see it in two places.
First off, with our CompactRIO systems, maybe the design team has stretched on a budget and we can come in and provide a much quicker solution for them. So they can save a lot of cash in this timeframe.
The second part is on the production floor and we are working on opportunities where we're demonstrating our equipment that, perhaps, can use less floor space, use less people to run it and so, definitely those are things that our customers are doing.
John Graff
And I might just like to emphasize the point, David, is that you heard Alex talk at a macro level. The slowdown focused in the kind of production test area.
Yet, if you look at what we commented on this afternoon, we delivered record revenues for PXI modular instruments, and I think that's just one reflection of this opportunity, as you put it, for us to go in and gain market share.
David Yuschak - SMH Capital
Would you say that pipeline as you look into this first quarter is as good as it was in the fourth quarter or the third quarter or any kind of shifts in that kind of pipeline?
Alex Davern
I think from a design activity and end of line production test, it hasn't really changed. From a buying activity, it's clearly changed, but I think what we're seeing is, one of the reasons we're pushing forward on, not only R&D, but on the sales front as well, is we have our sales marketeering, our system engineering guys working with a fair number of customers right now who are in the design phase of test systems who told us they may not buy anything for three or six months.
But if we don't get design in now, we won't have the opportunity when they do turn around and this is in the vein of what you talked about early on. It's very wise, in my opinion, for us to continue to spend the engineering dollars and the sales dollars to get those designed in now so that we can take advantage of greater market share when the economy turns.
David Yuschak - SMH Capital
But from a kind of quirky point of view, the slower the sales, the better opportunity you have in trying to do some more design work to get out in front of that potential opportunity?
James Truchard
That's what we're working on.
David Yuschak - SMH Capital
So, you keep overspending to do it?
Alex Davern
Well….
David Yuschak - SMH Capital
Thanks, guys.
Alex Davern
We’ll adjust our expenses as best we can.
James Truchard
But prudent.
David Yuschak - SMH Capital
But you've done a good job in a tough environment. I give you credit for that.
James Truchard
Thank you.
Operator
I would now like to turn the call back over to James Truchard for any additional comments or closing statements.
James Truchard
Yes. I'll be presenting at the Thomas Weisel Technology and Telecom Conference in San Francisco on February the 10th, bright and early in the morning at 8 'o'clock in the morning.
So, I would like to thank everybody for joining us today and taking the time. Thanks.
Operator
That does conclude today's conference. Thank you for participating, and have a wonderful day.