Jan 26, 2010
Executives
David Hugley - VP, General Counsel, and Secretary Dr. James Truchard - President, CEO and Co-founder Alec Davern - CFO and SVP, Manufacturing and IT Operations John Graff - VP, Marketing and Investor Relations
Analysts
Anthony LeGree - JPMorgan Mark Douglas - Longbow Research David Yuschak - Madison Williams & Company Richard Eastman - Robert W. Baird Ajit Pai - Thomas Weisel
Operator
Good day, everyone, and welcome to the National Instruments fourth quarter 2009 earnings conference call. Today's call is being recorded.
You may refer to your press packet for the replay dial in number pass code. The replay will be available from 7:00 p.m.
central time today and will end at midnight central time on January 31st, 2010. With us today are David Hugley, Vice President, General Counsel, and Secretary; Alec Davern, CFO and Senior Vice President, Manufacturing and IT Operations; Dr.
James Truchard, President, CEO and co-founder and John Graff, Vice President, Marketing and Investor Relations. For opening remarks, I would now like to turn the call over to Mr.
David Hugley, Vice President, Corporate Counsel, and Secretary. 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 growth and gaining market share, a global economic recovery, future operating leverage, strong gross margins, release of new products, revenue and earnings per share guidance and expected tax rates.
We wish to caution you that such statements are just predictions and that actual events or results may differ materially. We refer you to the documents the company files regularly with the Securities and Exchange Commission including the company's most recent quarterly report on Form 10-Q filed October 27, 2009, and our annual report on Form 10-K filed February 27, 2009.
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 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 today are all time record operating income, 22% sequential revenue growth in Q4 and record quarterly revenue in key product areas. While 2009 was one of the most challenging financial periods in the company history, our investments in R&D and field sales, coupled with excellent execution throughout the organization has allowed us to outperform the industry.
I was pleased with our ability to deliver strong sequential revenue growth and record operating income in Q4. As we head into 2010, I am very optimistic about our position in the industry and are planning our investments both to take full advantage of the recovery and to deliver strong profitability as the global economy moderates after the recovery.
Our business model has allowed us to sustain profitability throughout the recession, while continuing to invest in strategic initiatives to drive future growth and to keep us at the forefront of innovation. In our call today, Alec 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. Alec?
Alec Davern
Good afternoon. Today we are pleased to report that revenue for Q4 was $202 million, up $37 million, or 22% sequentially from Q3, and flat year-over-year.
After two quarters of very strong sequential growth, we returned to year-over-year order growth in Q4, with orders up 2% over Q4 2008. Our year-over-year revenue growth in the quarter was lower than our year-over-year order growth, due to a record $8 million net increase in deferred revenue, which primarily resulted from very strong sequential growth in software sales.
Non-GAAP gross margin in Q4 was up 220 basis points sequentially and 77.5% and was up 170 basis points year-over-year. Our ability to significantly increase our gross margin sequentially and year-over-year is attributed to the success we have had in driving down component costs, improving manufacturing efficiency and to the high value that customers see in our products.
Operating income was an all-time quarterly record. GAAP operating income was $36 million, a 65% increase over Q4 2008.
Non-GAAP operating income also set a quarterly record of $42 million, up 50% over Q4 2008. This represents a non-GAAP operating margin of 21%.
For the full year, our non-GAAP operating margin was 10.5%, which we regard as a very good performance through the bottom of one of the most difficult economic cycles since NI was founded. As you may recall, in Q4 of 2007, NI recorded an $18 million noncash tax gain related to our Hungarian operations.
This year in Q4, the company incurred a noncash tax charge related to an opportunity created by a new corporate income tax law in Hungary, which became effective on January 1st of 2010. Under the new law, companies will receive a double tax deduction for qualified R&D expenses starting in 2010.
As a result, NI has taken a noncash charge to write off $21.6 million in tax assets, which NI had on the balance sheet related to Hungary but which we now do not expect to utilize. The $21.6 million charge reduce both our GAAP and non-GAAP earnings per share by $0.28 in Q4.
The new law will reduce NI's future taxable income in Hungary and provides NI with a more competitive tax situation in Hungary going forward. Including this $0.28 per share noncash tax charge, net income for Q4 was $2.4 million with fully diluted earnings per share of $0.03 and non-GAAP net income was $9.7 million with fully diluted earnings per share of $0.12.
EBITDA or Earnings Before Interest, Taxation, Depreciation and Amortization was a new all-time record of $46 million, or $0.58 per share for Q4 and for the full year was $87 million or $1.11 per share. The reconciliation of our GAAP and non-GAAP results is included in our earnings press release.
Q4 was a very successful quarter and there are some clear positives to take away. First, the global PMI continued to improve with the quarterly average of 54.4 indicating that while global industrial production is down significantly year-over-year, it did see a strong sequential expansion in Q4.
Second, we saw a strong improvement in large orders closing in Q4. Third, our component pricing and efficiency efforts in manufacturing continued to pay off, allowing us to increase our non-GAAP gross margins by over 200 basis points sequentially and provide a structural improvement in our gross margins going forward.
Fourth, our strong performance resulted in an all-time quarterly record for operating income, with non-GAAP operating margin increasing from 10% in Q3 to 21% in Q4. From a product point of view, orders for our instrument control products were flat year-over-year in Q4, while orders for our instrumentation and graphical system design products were up 3% year-over-year.
Taking a two-year view, orders for instrument control products which made up 7% of revenue in Q4, were down 31% compared to Q4 of 2007. I believe that this is likely a good approximation of the net decline in the overall test and measurement and the two years since the start of this recession in December of 2007.
In contrast orders for the rest of our products were up 2% compared to Q4 of 2007. Now, turning to the balance sheet, inventory decreased by $2 million during the quarter as revenues surged.
Given the strong recovery of our business, we anticipate that inventory has reached its trough for this cycle and that we will see some increases starting in Q1 of 2010. Cash flow from operating activities continue to be strong at $136 million for the year, up from $122 million in 2008.
For the quarter, cash flow from operating activities was a new record of $45 million. As of December 31st, the company had $289 million of cash and short-term investments, up $12 million from September 30.
This cash balance is net of $9 million in dividends paid during the quarter and $16.4 million used to repurchase 574,000 shares of NI's common stock in Q4 at an average price of $28.55 per share. I think the key point to appreciate and understanding our longer-term performance is to know that during the two difficult years since the start of the recession in December of 2007, NI has generated $257 million in cash flow from operating activities.
This paid out $72 million in dividends and used $138 million for the purchase of 5.6 million shares of NI's common stock at an average price of $24.89 per share. We also announced today that the board of directors approved an increase in the quarterly dividend to $0.13 per share payable on March 1st, the shareholders of record on February 8th.
Now I'd like to make some forward looking statements. The trends in the global PMI turned significantly more positive in Q4 averaging 54.4 for the quarter.
However with the global PMI averaging only 45 for the last six quarters, there would have to be sustained strength in the global PMI if global GDP is to recover to 2008 levels. We are planning our investments both to take full advantage of the recovery and to deliver strong profitability as the global economy moderates after the recovery.
As we laid out at our investor conference in August, our intent is to continue to drive operating leverage until NI's annual revenues recover to the record level seen in 2008 and as a result we will be very careful about adding fixed cost in 2010. Similar to 2009, our hiring plans for 2010 are modest.
We are currently budgeting to grow our R&D and field sale account moderately and to essentially offset this increase by allowing attrition to reduce head count in other areas of the business. Our guidance anticipates strong year-over-year revenue growth in Q1 with the midpoint of our guidance representing a new first quarter revenue record.
Our earnings guidance also anticipates strong gross margins and a record first quarter non-GAAP operating profit. This follows the all-time record operating profit in Q4, positioning NI well for 2010.
Now turning to specific guidance for Q1, we currently expect revenue for Q1 to be up significantly year-over-year and to be in a range of $192 million to $202 million. We currently expect the GAAP fully diluted earnings per share will be in a range of $0.24 to $0.32 for Q1 with non-GAAP fully diluted earnings per share expected to be in a range of $0.30 to $0.38 per share.
Our guidance includes the full restoration of employee salaries generally effective February 1st and the automatic available pay increase which would result from the significant year-over-year revenue and profit growth assumed in our guidance. As these are 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, rescheduling of customer orders, expense overruns, manufacturing inefficiencies, effective tax rates and foreign exchange fluctuations.
In summary, we are very pleased with the rapid recovery that our business delivered in Q4, despite the continued severe weakness in industrial capacity utilization. Our goals are to maintain these gains and to focus on delivering significant operating leverage in the recovery.
Now I'll turn it over to John Graff, Vice President of Marketing.
John Graff
Thank you Alec. The diversity of our business has proven to be a powerful asset throughout the recession.
Over the last decade, we have transformed from a transaction-focused PC peripheral company to one that continues to find better ways to serve our high volume transactional customers, while also closing large system sales in high end test industrial and embedded applications. The strong sequential revenue increase in Q4 was driven by record quarterly revenue in a number of product areas, including CompactRIO, modular instruments, USB data acquisition and our academic products.
Looking at a two-year comparison helps provide more clarity on a relative performance in the industry. In contrast to the declines we have seen in our legacy instrument control business over the past two years that Alec mentioned earlier, we have been very pleased to see revenue from the key product areas of CompactRIO and RF increase nearly 50% since 2007, validating the R&D and field sales investments we have made in these areas.
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 approximately $3,800 at the end of 2009, a 9% increase compared to 2007. Additionally, orders over $20,000 reached 40% of business in Q4, matching the highest point in the history of the company.
Software products had strong sequential growth in Q4, resulting in record quarterly orders. Growth was driven by software seats and Volume License Agreements, or VLA's.
Growth in VLA orders is an indicator that even during a downturn customers continue to recognize the value of receiving greater access to NI's software and the efficiencies it delivers throughout the development cycle. Another technology that affects our broad business is Windows 7.
Interest in Windows 7 has already been much higher than customer interest in Vista. We have partnered with Microsoft in several marketing initiatives since they see NI as a company that is well positioned to help them reach engineers and scientists.
And we have seen a strong response from customers considering using Windows 7 in new systems as they look to NI as a thought leader in how the technology will affect them. Our low cost data acquisition products saw strong sequential uptick, led by our USB, wireless, Ethernet and C-series-based devices, which all delivered record quarterly revenue for Q4.
We have continued to build our web channel for transactional products such as these, which has allowed our field sales force to focus more of their time on larger system sales in other areas of our business. Our distributed I/O products saw record quarterly revenue in Q4 and our FPGA-based CompactRIO products saw record annual revenue as well.
CompactRIO continues to see success in prototyping and high volume deployment applications in industries like oil and gas (inaudible) and automotive and transportation. The combination of LabVIEW and CompactRIO allows engineers to quickly prototype new designs and achieve a faster time to market.
NI recently announced a new version of LabVIEW for designing robotic control systems. With this new software, engineers and scientists can implement ideas faster, with seamless deployment to real time embedded and FPGA hardware like CompactRIO and can integrate with a variety of processing platforms, third party software tools, and prebuilt robot platforms.
Another example where NI is improving the software experience for industrial embedded applications is our collaboration with DENSO Robotics, a leader and pioneer in manufacturing automation using robotics technology. The collaboration integrates NI measurement and vision technology with DENSO Robotic arms, allowing engineers and scientists to reduce costs and shorten development times.
Our PXI modular instrument products also experienced record quarterly revenue and we were very pleased to see our RF products deliver record annual revenue. We believe this growth validates the investment focus we have on RF.
With software defined PXI RF measurement systems, engineers can test WiMAX, wireless LAN, GPS, GSM, WCDMA and many other wireless standards while performing these same tests up to 10 times faster than traditional RF instrumentation. Another area where our modular instrument products saw success was in semiconductor applications.
In Q4 NI introduced 10 new PXI products to expand the capabilities of the PXI platform for mixed signal semiconductor tests. As the semiconductor industry has started to rebound, customers are seeing NI as a stable supplier in the industry that is able to deliver dramatic benefits including lower test costs, power usage and floor space.
An example of a customer reaping the benefits of the NI test platform was at Panasonic, where they selected NI software and the PXI platform for the automated testing of new computer printed circuit boards, including those in their new Toughbook Rugged Laptops. The NI solution allowed Panasonic to integrate multiple measurement functions into a single PXI test system, reducing the physical footprint by more than 50% and significantly decreasing power consumption.
Operator
Ladies and Gentlemen, please stand by. Please go ahead.
John Graff
An example of a customer reaping the benefits of the NI test platform was at Panasonic, where they selected NI software and the PXI platform for the automated testing of new computer printed circuit boards, including those in their new Toughbook Rugged Laptops. The NI solution allowed Panasonic to integrate multiple measurement functions into a single PXI test system, reducing the physical footprint by more than 50% and significantly decreasing power consumption.
We saw strong performance once again in our sales to academic institutions in Q4, another key area where we saw record quarterly and annual revenue. Academic sales have been a focus area for us over the past several years.
In addition to benefiting from a financial consistency and stability of academic institutions, we believe teaching science and engineering students how to make measurements and design control systems using LabVIEW and NI hardware will provide strong returns in the long-term as these students graduate and enter the industry. In summary, we were pleased to see strong sequential revenue growth throughout many areas of the business, and a return to record quarterly revenue in several of our strategic and key growth areas.
Our ability to continue investing in new product R&D and expanding our field sales force throughout this recession is a testament to the strength of our business model. With that, I'll turn it over to Dr.
T.
Dr. Truchard
Thank you, John. While 2009 was undoubtedly one of the most challenging and turbulent periods in the history of the company in one sense, from an industry leadership point of view, 2009 may be one of the best years in the history of the company.
We have taken advantage of the opportunity created by the recession to continue to innovate, acquire key talent, and strengthen customer relationships. I believe our commitment will lead to major shifts in the positions in many players in the industries we serve and create an opportunity for a permanent shift in the industry leadership.
Throughout the downturn we continued to run the business in a way that we believe best aligns with the long-term interest of all of our stake holders, employees, shareholders, customers, and suppliers. Our goals as we exit the recession will be to continue providing a great place to work for our employees to develop their careers, driving strong, long-term profitability for our shareholders, producing high quality innovative products for our customers and deepening our relationships with our suppliers.
It is this focus on long-term success that allows us to remain profitable, even as we maintain our strategic investments in new product R&D and expanded our field sales force during one of the most significant downturns in company history. Our investments in new product R&D are delivering significant benefits to our customers as we help them lower costs, reduce risk and shorten design cycles.
National Instruments is helping our customers solve some of the world's most significant, scientific and engineering challenges through our ability to leverage the latest technology like multicore processers, [0:11:39.8] and wireless network. Related to our investment in R&D, I would like to welcome Phil Hester to NI leadership team as our new Senior Vice President of Research And Development.
Phil brings 30 years of technology, industry knowledge and technical expertise to NI, most recently as Senior Vice President and Chief Technology officer at Advanced Micro Devices and before that in similar positions at IBM. I believe he is well suited to lead our global R&D organization and I am confident that Phil will provide the leadership and strategic direction in new application areas that will advance our graphical system design vision.
Finally, I would like to thank and congratulate our employees for NI being named to the Fortune 100 best places to work for the 11th consecutive year. Our employees are one of our biggest assets of the company and continue to drive the innovative culture that makes National Instruments a great place to work and a leader in the markets we serve, regardless of the economic environment.
In summary, while 2009 was one of the most difficult years in company history, I am very pleased with our execution on long-term strategic vision and I believe we are very well positioned to take advantage of the recovery. We remain dedicated to delivering highly differentiated new products to increase market share in our existing markets and drive growth in new application areas, while deepening customer relationships and loyalty to our field sales force.
This strategy has enabled National Instruments to be a model of consistent growth and profitability throughout our history. We remain committed as ever to the success of our customers, suppliers, employees, and shareholders.
I will be at the Thomas Weisel Conference February 9th in San Francisco and hope to see you there. We will now take your questions.
Operator
(Operator Instructions) And our first question will be from Anthony LeGree with JPMorgan.
Anthony LeGree - JPMorgan
I wanted to know a little bit more about your deferred revenue going forward here. You've shown 26% growth I believe year-over-year and your deferred revenue meanwhile, overall revenues were down 17.5%.
Can you talk about that pattern? Do we expect deferred revenue to continue on that clip forward?
Alec Davern
I think it's a good question. It's Alec here.
Certainly the increase in deferred revenue in Q4 had a lot to do with the strong recovery of the business in the fourth quarter. We would expect to see the growth rate of deferred revenue moderate in the next couple of quarters and anticipate that that increase in deferred revenue in Q4, which was the highest of a single quarter ever of $8 million, that that will be of a benefit to revenue in the coming quarters.
Anthony LeGree - JPMorgan
And then the follow-up would be, so if I model out 2010 here in terms of revenue, it may give you sequential seasonal growth. It looks like you're above the 20% revenue growth for the year.
Now, during your analyst day in August, you gave the high end of 20% growth. Can you talk a little bit about if you happen to be above that 20% growth, the expense ratio that you would see going forward?
John Graff
Well, obviously I think we have two goals in the company. Number one is to ensure that we're driving long-term growth.
We have to grow the business, 20% plus over a longer period of time. And our second business goal is, our company goal is to drive 18% non-GAAP operating margin.
So, we would be focused on both of those goals as we go through 2010. If we see a situation where we do see above 20% year-over-year growth, I think that gives us an opportunity to make some incremental investments.
What we will be also taking a hard look at leverage factors that we have laid out in terms of expense growth relative to revenue growth and keeping them very much in mind as we go through the year.
Operator
And we'll take our next question from Mark Douglas with Longbow Research.
Mark Douglas - Longbow Research
So Alec with the world looking better, what are your plans for your cash forward?
Alec Davern
We've consistently responded to that question. We have three primary goals in order for our cash.
Number one is for dividends, number two is for opportunistic stock repurchasing. And in the call I really tried to highlight how we've deployed cash over the course of the last two years.
We have had cash flow from operations in the last two years since the start of the recession in December of '07 of about $257 million of which we paid out $72 million in dividends and used about $138 million to repurchase stock at a little under $25 a share. So our strategy has been dividends, number one; opportunistic stock buybacks, number two and then strategic acquisitions, number three.
And that set of priorities continues to be the same as we look forward. Certainly we also had a strategy of being prepared to deal with the recession, which is why we have contained or retained a significant amount of cash for a considerable period of time.
And we will continue to have that same strategy as well, where we will want to retain flexibility financially as we go forward. But certainly, I think we have demonstrated in the last two years, a very tough two years, an ability to generate significant cash and that's obviously a good thing for our shareholders.
Mark Douglas - Longbow Research
Right. Any stock repurchase announcements or anything at this point?
Alec Davern
The company continues to have authorization from the board to continue to repurchase stock and we'll evaluate that as we go forward.
Mark Douglas - Longbow Research
Okay. And then John, can you talk about just some of the particularly strong verticals.
You talked about a lot of your products but what verticals are you looking at? Semi test was one but what others are leading to the strong orders?
John Graff
Sure, Mark. Obviously as you're well aware, the diversity of our business across industries has been one of the keys of our long-term success.
If we look in Q4, as you mentioned, and we highlighted in the call, semiconductor, we definitely saw the rebound there and saw very strong growth in sales to the semiconductor industry. Also in communications and consumer electronics, another one we highlighted.
This has kind of continued the last few quarters as sales into educational or academic institutions. And we also saw a strong growth into energy.
On the flipside, industries where we saw some weakness includes (inaudible), sales into the instrument and ATE industry, as well as to automotive and research organizations. But again that diversity, no end vertical is more than 13% of our revenue.
That diversity continues to be a strength for us.
Mark Douglas - Longbow Research
Right, and then people are responding and you said too that they are more looking at NI more favorably with Windows 7 versus Vista, right?
John Graff
Yeah, I mean clearly much improved compared to Vista. One of the things over 20 years of being a technology supplier, we've always had to work very closely in staying abreast of the changes in operating systems and usually engineers and scientists, they want to know how new operating systems, new technologies can help them.
Vista, to put it blank, was just clearly a disappointment for a lot of people. We didn't see much response.
But now with Windows 7, we're very pleased with the interest we're seeing and that could be a positive outlook for this coming year if there is a return to businesses buying or replacing personal computers.
Operator
And next we'll go to David Yuschak with Madison Williams and Company.
David Yuschak - Madison Williams & Company
Great quarter, guys. As far as your geographic market, certainly Asia has been kind of a focal point for a lot of people as far as the recovery is concerned and it certainly shows up in the your results in this quarter, particularly when you see Europe and America is still lagging.
Can you give us some perspective as to how you see that may be kind of flowing out? Is Asia going to continue to be the leader here and maybe other markets don't really pick up until later, or give us some sense as to what you're seeing domestically in Europe relative to that performance in Asia.
Alec Davern
It's a good question, Dave. Certainly Asia had the best year-over-year growth performance in Q4, and our Asian team has consistently done an excellent job of execution, but I think it's also true of our sales operations teams in Europe and the U.S.
Asia did see the slow down earlier than the rest of the world in our business in 2008 and into early 2009. So we definitely anticipated that from a year-over-year point of view we would see Asia turn positive earlier than the other regions.
And that's obviously what we're seeing come to pass. In terms of the relative performance of the three regions, it's very interesting that as we went through, I guess what we're now calling the great recession, we saw with very little time delay, a highly synchronized decline in the PMI in all three regions.
And now we have seen the reverse phenomena take place where we've seen a highly synchronized recovery in the PMI in all regions. So I think the broad-based economic metrics that we match, or we watch look reasonably favorable today in all three regions.
Europe is a little bit behind the U.S. U.S.
is a little bit behind most of Asia but all moving in the right direction and one of the key points I've tried to highlight in the call is that when we look at the global PMI, the inventory element of that index is still well under 50 and after six quarters averaging only 45. I think the strong PMI we're seeing right now is not a surprise.
David Yuschak - Madison Williams & Company
And then my second question, as you look at the strength in the system sales in this quarter, you're almost back to where you were. It looks like mid-2008.
Is a lot of that coming out of maybe the Asian market because it's been so much stronger? Are you seeing more adopters across the weaker markets like Europe and North America?
John Graff
David, this is John. The return of the large system sales and orders that we saw in Q4 really has been across all regions.
You're exactly right. The last time it peaked was the middle of 2008.
If you recall back then, that even as the industrial economy was starting to slow down, we were seeing great success, especially with the large system level orders and then as the recession hit that dropped off. Q2 and Q3 of this year, we were seeing this partial reemergence and were really pleased to see, basically a return to strong system level sales and that’s something that obviously is factored into the guidance we provided on our expectations for Q1.
David Yuschak - Madison Williams & Company
The pipeline that you spoke to, so you're starting to see more of that starting to come back in the real orders and given some of your earlier comments about a lot of businesses out there, but it never went away?
Alec Davern
Yes, exactly. One of the reasons why we continue to feel really good about the continued investment in the field sales organization, we just continued to have feet on the street and our guys are doing a great job of identifying, working, and staying in touch with these opportunities.
And we think that's going to pay off for us obviously as the economy recovers.
John Graff
An interesting anecdote on top of that David is if you look at the recovery of that business back to the levels, the previous peaks that we saw, it's at a time when industrial production globally is still way below where it was in the middle of '08. Capacity utilization globally is still dramatically lower than it was in 2008.
So we're able to recover to these revenue levels, despite what, in absolute terms they are still very, very bad metrics out there in the industrial economy. But the PMI indicates that those metrics are going to get better going forward.
But the key for us is because we offer such a disruptive value to our customers, such a higher ROI, once our customers are making money again, they are willing to invest in these high ROI projects. So, I don’t believe we're seeing a lot of capacity expansion out there in the industrial economy today.
But as the fear subsided, the high ROI projects are getting released and that's allowing our business to grow as you would expect in this timeframe.
David Yuschak - Madison Williams & Company
So the comments you said in the past about some concerns about capacity utilization, restraining some of those potentials, you're seeing less of that in the [trends to date]
John Graff
Not really. Capacity utilization is still very low.
What I'm saying is that the key for our business, I think in terms of driving our orders is that our customers are profitable of making money. And even though their capacity utilization is still low, because we offer such a disruptive value and can lower our costs, they are willing to invest in our products even when they already have low capacity utilization because of the economic value it drives.
If we see capacity utilization return anywhere towards the normal levels, and certainly the PMI is indicating that we'll see these metrics improve as we go forward, that would certainly be an incremental positive for us.
David Yuschak - Madison Williams & Company
Okay, thanks.
Operator
And next we'll go to Richard Eastman with Robert W. Baird.
Richard Eastman - Robert W. Baird
On the large order size, 40% of sales, a couple of things there. One is, does the backlog there give you significant confidence in the first quarter?
And is it fair given the growth in large orders to look at your historic seasonal sales pattern and try to run that out for next year?
Alec Davern
Well, obviously, Rick, I want to avoid trying to give guidance for the full year. At this stage, we're just going to give guidance for Q1.
What I can tell you is certainly the recovery in business overall and our ability to gain business during a downturn when the industry overall is still I think down pretty significantly indicates our ability to penetrate new markets and take share in this timeframe. If we look at the last number of quarters, obviously in Q4 of '08, Q1 and Q2 of '09, we underperformed a seasonal pattern.
And if you look back to the PMI, typically when the PMI is very weak, you will see that happen. In Q3 and Q4 of '09, we outperformed the seasonal pattern and the PMI has been pretty strong.
And so, I would look to history to guide your decisions on that point but we don't want to give revenue guidance for the year at this stage.
Richard Eastman - Robert W. Baird
Do you think this dynamic of large systems as a percentage of your total sales, how do you see that impacting the business going forward? I'm not looking for guidance but it would seem like that characteristic would influence either sales patterns, backlog, gross margin.
Should we just be ignoring that system sale component?
John Graff
Certainly not. You should not be ignoring it in terms of understanding the business.
My take on it is that growing the large system business for NI gives us lots of leverage.
Alec Davern
It's certainly a good thing for operating margin as we go forward. The other point I'll make is and I think this is a really key point to understand what's going on in the industry and what's happened in NI in the last two years.
If you look at the data that’s on the slides that are accompanying the call on the web, you’ll see that once we entered the recession and once the U.S. PMI went below 50 in December of ’07, NI's large order business continued to grow rapidly.
So, going into a moderate industrial recession didn't have any noticeable negative impact on the rate of growth of our system level business, orders over 20,000, as John talked about. In fact, although the scale was growing, the rate of growth year-over-year accelerated through Q4 of '07, Q1, Q2, and Q3 of '08.
So while we went through a moderate industrial recession, we were still able to grow that business very well. In fact grew the whole company in a 15% annual rate year-over-year, despite the PMI being negative.
But a reason for that is that disruptive value where we're taking market share. What happened, of course, in Q4 of '08, is panic set in and people stopped spending any money which made things very difficult.
But I think the growth of our system level business and the amount of disruptive value it offers our customers I think helps us achieve one of our core goals, or did help us achieve our core goal in that timeframe which was to be able to grow our overall company over 10% during a moderate recession. And so that's a key part of our strategy that Dr.
Truchard drove us on in the last decade to be able to grow in a moderate recession.
Richard Eastman - Robert W. Baird
Okay, okay. And then just a question.
On the gross margin, I guess what I'm hearing you say is structural improvement driving the component costs down. Are you comfortable that we would model a 77% gross margin for all of next year?
Alec Davern
Well, as I said in previous calls, I felt that the value we were gaining from driving structural change in our component pricing was being somewhat masked by the very low utilization in our production facilities in Q1, Q2, and Q3 of 2009. Now that the utilization was not that high in Q4 because we also saw inventory fall in Q4, but utilization was much better in Q4 and hence we're seeing the true value of our efforts on the component side show through in the fourth quarter.
In our guidance for Q1 on the call, I talked about expectation for strong gross margins in Q1 and certainly we feel like we were targeting these component reductions to be sustainable over time. I don't want to give specific guidance for a full year at this point, but that's kind of some background.
John Graff
As long as utilization stays up, there's no reason we don't give any of that back.
Richard Eastman - Robert W. Baird
Okay. And then just one question for John.
Then I’ll get back in queue. John, just kind of given your end here of '09, can you give us any split between the 93% of the business that would be virtual instrumentation in any industrial embedded piece?
Can we just get some rough size of the two pieces if we wanted to try to put a growth rate on each?
John Graff
Yes, we've talked about this in the past and I think a little at the analyst conference. It's hard to explicitly do it.
Any combination of our hardware and software products could be used, anywhere from a laboratory setup or a traditional kind of research test to a oil well vibration monitoring system, which is clearly an industrial application. I think we've talked in the past that through some customer surveys where we kind of ask how they are using our products, we estimate that 20% to 30% of our revenues could be classified as industrial embedded.
So that's in this kind of gross overall macros sense. The other thing is obviously some of the commentary you hear us talk about in the call with some of the products that are really targeted towards these industrial embedded applications, CompactRIO being the most prominent one.
We continue to see really strong growth with CompactRIO and our FPGA based platform. It's taking us into new applications that we hadn't served before.
Oil and gas is one, transportation monitoring system in airplanes and on trains, jet engine testing. These were things we weren't serving or solving with our previous virtual instrumentation products.
So we see industrial embedded as a large potential opportunity for us. We're investing to evolve our platform and we really feel good about the growth prospects in that area.
Richard Eastman - Robert W. Baird
Okay, very good. Thank you.
Operator
(Operator Instructions). Next we'll go to Ajit Pai with Thomas Weisel.
Ajit Pai - Thomas Weisel
A couple of quick questions, I think the first one is just looking at your software maintenance revenue, I think it was down about 11% year-over-year, even though your products have been (inaudible) up. So could you give us some color as to whether that's just volatility in the business or whether that's actually trailed the system sales by a few quarters and then also over the next couple of years where you expect that to arrive as a percentage of revenue?
Alec Davern
Ajit, it's Alec here. The drop in and maintenance year-over-year is really just a follow-through.
Obviously the overall revenues of the accompanying orders became challenged starting in Q4 of 2008. Our revenue recognition from revenue that's deferred is typically over 12 months and so it takes a period, a time for a drop in orders in software sales to flow through into the revenue component.
And so that shows the revenue piece recognition catching up with the trend in orders. Now, obviously that pattern changed direction quite significantly in Q4 in terms of the deferred revenue number having a record increase, and that will cause in future quarters the maintenance revenue component to increase in terms of absolute dollars.
Ajit Pai - Thomas Weisel
On the gross margin of that deferred revenue is higher than your corporate average. Is that fair?
Alec Davern
Well, what happens with the $8 million in deferred is that it doesn't count in revenue in Q4. And so that doesn't offer any gross margin benefit, because it doesn't show up in the income statement at all.
So it will be 100% gross margin business or revenue that will show up in the gross margin calculation in future quarters.
Ajit Pai - Thomas Weisel
In the future, exactly. And then the second question is just looking at your tax rate.
You talked about this benefit, the charge you took in Hungary and then R&D in the future, for you getting the double benefit of that. You're still guiding to 18% to 22% and assuming 20% this year for your tax rate, why wouldn't your tax rate be falling faster because of that?
Alec Davern
We will be looking at that as we go forward into future years. For now I'm comfortable with the tax rate of 18% to 22%.
And we'll review that again, probably next in some detail at the NI week at investor conference in August as we start to formulate plans for 2011.
Ajit Pai - Thomas Weisel
Got it.
Operator
We'll take a follow-up from Mark Douglass with Longbow Research. Mr.
Douglas, please check your mute function.
Mark Douglass - Longbow Research
Okay, sorry about that. Yeah, on the R&D expense, I was little -- it's set down in the quarter, even though sales were up significantly.
So is that going to be kind of the run rate then? We're going to be closer to this 16% non-GAAP then for a little bit or approaching maybe 15% with orders up so strong?
Alec Davern
It's a good question, Mark. Our target is 16% of revenue going into R&D on a non-GAAP basis.
As you are well aware, that's a conscious decision we made as a company back in the early 2000s, to grow that from 12% of revenue at that time to 16% of revenue with an intent to drive the long-term growth of the company. During the start of the great recession, I guess in December or Q4 of 2008, we saw R&D as a percentage of revenue spike up because the revenues were under pressure.
And that was most severe in Q1 and Q2 of 2009. Our intention all along was to bring R&D as a percentage of revenue back down to 16% as our longer-term target and we're certainly glad to see us hit that target in Q4 of 2009.
But our intent on a longer-term going forward will be to maintain that at 16% of revenue for non-GAAP.
Mark Douglass - Longbow Research
Okay. Just a little surprised because it went up sequentially, not as a percentage, but absolute in the third quarter.
But then with an even stronger revenue increase sequentially, it actually went down. So I was just kind of getting a feel for what happened there?
Alec Davern
It's just a pattern of seasonal expenses and software capitalization and vacation etcetera. But from a percentage of revenue, our long-term target is to hold that at 16%.
Mark Douglass - Longbow Research
Right, right.
Alec Davern
Any other questions, operator?
Operator
We do have one more question in queue and that’s a follow-up from David Yuschak with Madison Williams & Company.
David Yuschak - Madison Williams & Company
You indicated that fourth quarter, first quarter you do get a seasonally slower period. And you've kind of given us an idea how much seasonal decline there has been.
Could you just recall for me what that number is?
Alec Davern
Well, it depends on what time period you pick, but if you pick the '02 to '07-'08 timeframe, excluding the large sequential drop that happened in Q1 of '09 the average sequential drop is usually 5% to 6% sequentially from Q4 to Q1. Obviously the midpoint of our guidance is to outperform that and with the order flow we've seen so far in January and the opportunities we see in front of us, obviously we're setting guidance to exceed the seasonal pattern, the average seasonal pattern in the first quarter.
David Yuschak - Madison Williams & Company
Okay, and then one last question. As far as your expansion to Southeast Asia, what kind of condition because I think you pushed that back because of this great recession, what kind of conditions do you think you would need to try to maybe move it back up?
Alec Davern
Well, the plan originally was back in 2008 to open up operations sometime in 2010 and that plan was really from the middle of 2008. So as we look forward now, we're guiding to the highest first quarter revenue in the history of the company in Q1.
So we're looking for Q1 revenue to exceed revenue of Q1 2008, and that's obviously putting the issue of the Malaysia facility back on our consideration. Our current plan today is to open that facility and start production sometime in 2012.
By that date we'll be somewhat flexible based on how we see revenue trends this year. It can be moved in or it can be moved out, depending on need.
David Yuschak - Madison Williams & Company
Okay. And then how much do you think you could move it in logistically?
Alec Davern
Logistically, we could probably pull it forward 9 to 12 months if that became necessary but I feel quite confident, the capacity that we have in Hungary right now, we have an ability to drive the company's revenues beyond $1 billion. So we'll be watching that as we go through this year.
But right now I feel very comfortable about our ability to manage the business with the productive capacity available to us today. We have no further questions, operator.
Is that correct?
Operator
That is correct.
Alec Davern
I would thank everybody for their time today. Dr.
Truchard will be presenting at the Thomas Weisel Conference as he said on February 9th in San Francisco. If you would like to schedule a meeting, please contact our Investor Relations department.
Thank you.
Operator
And that does conclude our presentation. Thank you for your attendance.