MTS Systems Corp
Q1 2019 Earnings Call Transcript

Published: 4 Feb 2019

[Operator:]

Good day and welcome to the MTS First Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Brian Ross, MTS Senior Vice President and Chief Financial Officer. Please go ahead.

[Brian Ross:]

Thank you, Karen. Good morning and welcome to MTS Systems' fiscal 2019 first quarter investor teleconference. Joining me on the call today is Jeff Graves, our President and Chief Executive Officer. I want to remind you that we will make forward-looking statements today as defined by the Private Securities Litigation Reform Act of 1995. Future results may differ materially from these statements, depending upon risks, some of which are beyond management's control. A list of such risks can be found in our latest SEC Forms 10-Q and 10-K. We disclaim any obligation to revise the forward-looking statements made today based on future events. This presentation will also include reference to non-GAAP financial measures. These measures are used by management to evaluate the operating performance of the company over time. They should not be considered in isolation or as a substitute for GAAP measures. A reconciliation of our non-GAAP measures to the nearest GAAP measures can be found in our earnings release. I will now turn the call over to Jeff.

[Jeff Graves:]

Thank you, Brian and good morning everyone. We appreciate you joining us for our call this morning. As usual on our call today, Brian and I will highlight the performance for the quarter and our view to the rest of the year. But I have to say at the offset, this quarter the most significant change is the exceptional growth in our backlog and new business. At the end of our first quarter of fiscal 2019 our backlog exceeded $500 million for the first time in our company’s history, representing a 24% growth in consecutive quarters and a whopping 45% growth year-over-year. These figures were exceptional for us, particularly considering that we ended our fiscal 2018 on a high note with a record backlog to that point in time that positions us well for fiscal 2019. The sales performance reflects the strength of our technology offerings, our broad geographic exposure and the span of our market verticals in both the Sensors business and our Test and Simulation business. There are many who have followed our company are aware our focus in recent years has been on executing a growth and diversification strategy, capitalizing on our market leading sensors and test and simulation equipment along with a strong focus on providing optimal service to our valuable customers across the globe. In short, we are leveraging the strong core technologies in both of our business units, and prioritizing the long-term new products and services in adjacent markets to both accelerate our growth and diversify our market exposure. While momentum has been building for some time, this quarter I believe it’s become very clear to everyone through the consistent momentum in order weights and the dramatic increase in size and quality of our backlog. We expect to see this momentum continue, translating to sustainable value creation for our customers and our shareholders alike. While we've been very pleased with our organic orders performance and backlog growth, another example of our continuing diversification strategy is our acquisition of E2M Technologies last November. As a reminder, E2M complements our existing Simulation business from both a technology perspective, and through entry into two new high growth adjacent markets, flight simulation and entertainment, which is commonly referred to as theme parks. While the acquisition of E2M occurred late in our first quarter, the integration has gone well and our expectations for delivering top line growth as well as accretive margins to MTS in fiscal 2019 remains unchanged. This is a model we would expect to continue to executing opportunistically in the future. With these general comments out of the way, let me share a few more details on our first quarter fiscal 20 19 financial performance, which Brian will add more detail to shortly. In the first quarter, we generated orders of $125 million in our Test and Simulation business, which is a 15% increase over prior year and orders of $98 million in Sensors, which is a 28% increase over the prior year. These results reflect a continuation of the positive momentum we've established in fiscal 2018, when we finished the second half of the year with then record orders of $456 million for the six month period. Test and Simulation orders in the first quarter were again supported by strength in the structures and materials markets with continued growth in services. Orders and ground vehicles continue to be weaker than historical norms as our customers continue to invest heavily in safety related testing of new vehicles. However, we did see a slight uptick in orders for the quarter compared to the same prior year period. Our continued efforts to drive an improved balance of orders across the higher growth Test and Simulation markets that we serve is paying off. From a Sensors perspective, we had another record orders performance in the first quarter of fiscal 2019 after having just set a record for Sensors orders in Q4 of 2018. This continued momentum is coming from broad strength across all in markets including both the industrial and test markets, which led to another outstanding orders performance and resulted in a book-to-bill ratio of 1.26 in the first quarter. Most importantly, the strength in our orders and increase in our backlog is the underlying reason we have confidence in our ability to achieve double-digit top line growth in Sensors moving forward. The first quarter orders included the second purchase order associated with our Department of Defense contract giving us a total of 2 funded orders of roughly $20 million each, which are now included in our backlog. As a reminder, our DoD Sensor contract inclusive of all options totals approximately $187 million over the next five to seven years. From an overall company perspective, we’re very pleased with our backlog position. Our performance from this perspective in the quarter was very very strong. We believe this is a significant leading indicator of our ability to deliver on our expectations for growth and expansion and profitability in fiscal 2019. More importantly, we believe the market dynamics which we are experiencing will continue to provide momentum and further strength this key leading metric. Moving to our top line performance, revenues from our Test and Simulation business were up 6.2% in the first quarter, compared to the same prior year period, reflecting solid follow through from our strong orders performance in the second half of 2018. We believe this is repeatable, as we continue to take advantage of opportunities in the non-ground vehicle sectors, of our Test and Simulation business, namely materials and structures, as well as tests and simulation services, which have all been experiencing growth. In addition, E2M will expand its contribution through our revenue base in the Test and Simulation business as we fully integrate it throughout the remainder of the year. As I mentioned last quarter, we’re working hard to diversify our business within the test and measurement space, reducing our overall exposure to ground vehicle development markets over the longer term. While this market segment has been a part of our business for decades, it brings with us somewhat higher volatility, which can be disruptive to our workforce planning and our financial performance. Therefore over time, we’d like to preferentially grow in adjacent markets where we’re seeing increasing demand trends, and where we can leverage our world leading technology expertise in force and motion control. As a result of these efforts, Test and Simulation equipment sales to our ground vehicle customers was approximately 25% of our total revenue in Q1 of 2019 down from its historic levels of 35% to 40% and we expect our long term target of 15% to be achievable. Demand for our Sensors products continues to be steady, as industrial markets across key geographies were supported by economic strength and favorable market trends. Sensors revenue growth of 2.6% in the first quarter compared to the same year prior year period was strictly attributable to the timing of shipments and will increase throughout the year driven by our strong backlog position and continued robust sales. Of note during the quarter, we had minimal shipments on our two purchase orders associated with the DoD contracts, which were approximately $40 million combined in a longer term in nature. We expect these orders to turn to revenue equally in fiscal 2019 and 2020, which is a slight deviation from the normal commercial order to revenue cycle for our Sensor business. Over the next three quarters, we expect revenue to increase related to these DoD orders, as we have now completed the reconfiguration of our production lines to support higher volumes, and we will be ramped up to full production by the second half of this year. With the outstanding orders performance in Q4 fiscal 2018 and Q1 of fiscal 2019 and continuing broad market strength, we continue to expect fiscal 2019 to be another year of double digit growth for our Sensors business. As for our view ahead, and for our Test and Simulation business while we continue to plan for volatility in the ground vehicle sector as we move through 2019, the growth in our 12 month opportunity pipeline indicates increasing stability in this market vertical. We expect our structures market to be stable, with a slight positive trend, but as always, lumpy quarter-to-quarter due to the size of individual projects that characterize this sector. Test and Simulation services, again had an excellent first quarter and we continue to believe our service businesses and under penetrated and underappreciated part of our core Test and Simulation business. The benefits from this portion of the business will be increasingly impactful to our customers and to our shareholders in the quarters and years ahead. From a Sensor’s perspective, I'll repeat what I said last quarter. Our in-markets remain healthy, and our new product pipeline strong. We simply need to keep doing what we’ve been doing, that is focusing on execution and providing unparalleled total customer satisfaction. We're positioned very well in Sensors. One other popular question that I'd like to address is our business in China and trade tariffs. As many of you know, we've focused on our China markets for many years, and they represent an area of significant growth for our company. We continue to see strong demand in this region, with an increase in year-over-year orders. In addition, we’ve experienced only minimal macroeconomic impacts from the tariff enactments and we feel we’re well positioned to navigate not only the important export challenges, but can also minimize any long term efforts of raw materials inflation. Now I'd like to turn the call over to Brian, to further discuss our financial results and our outlook.

[Brian Ross:]

Thank you, Jeff. I will move right into our first quarter fiscal 2019 results with focus primarily on year-over-year quarterly comparisons. Jeff already touched upon the orders backlog and revenue performance. So I will start with gross margin. Our gross margin rate for the quarter declined by 160 basis points compared to the first quarter of fiscal 2018, but held fairly steady with the fourth quarter of fiscal 2018. Test and Simulation gross margin rate decreased by 160 basis points due to the continued investment to improving sustainable long term project execution tools, the E2M acquisition inventory fair value adjustment from purchase accounting valuation, and a slight increase in variable compensation expense. An important metric to call out for our Test and Simulation business is that income from operations increased from 4.7% to 5.8% of revenue when comparing current quarter results to last year, which shows a concerted effort by our team in improving overall bottom line performance. The gross margin rate for our Sensor’s segment declined 140 basis points versus the same quarter results in fiscal 2018, because of production inefficiencies incurred from the introduction of new products and a mix shift from lower revenue in the high margin energy sector being replaced with revenue from lower margin markets. Compared to the fourth quarter of 2018, we saw a nice sequential rebound back to near 50% gross margin, which is our target for this business proving that the unusually low margin in the fourth quarter was temporary in nature. In addition, both segments have ongoing programs that have begun to lower their cost structures and drive product productivity improvements. Operating expenses of $60.3 million decreased by $1.1 million from the prior year quarter as we continue to manage costs closely to keep our expense leverage aligned, with the needs of our business and to be prudent in the investments we undertake to drive profitability. We achieve this decrease despite incurring acquisition related expenses of $800,000 and an additional intangible amortization of $400,000 from the acquisition of E2M. Net interest expense of $6.8 million was consistent with the prior year quarter, which is attributable to our significant pay down debt in fiscal 2018, offset by the additional funding drawn on our revolving credit line for the acquisition. We continue to expect interest expense to be $6.5 million to $7.5 million per quarter for the rest of fiscal 2019. The effective tax rate of 6.2% for the first quarter includes an additional discrete tax benefit of $1.3 million due to the true up of and finalization of the measurement period for the Tax Act that was enacted in December of 2017. Without the discrete benefit from the Tax Act, our tax rate would be 17.8% in line with our guidance for the full fiscal year effective tax rate of 15% to 19%. Fourth quarter adjusted EBITDA of $30.1 million increased 12% versus the prior year quarter, with improved top line, and bottom line performance from our Test and Simulation business. Our improved performance in Q1 yielded us GAAP diluted earnings per share of $0.54 per share and our adjusted diluted EPS was $0.59 per share. Our EPS performance for Q1 has us positioned well to achieve our full year diluted EPS guidance, which I will talk about shortly. We ended the quarter with $70.4 million in cash, which is in line with where we ended fiscal 2018. We ended the quarter with total debt of $466 million which is up about $78 million from the beginning of the year. We drew approximately $80 million from our newly renegotiated revolving line of credit to pay for the acquisition of E2M. Total acquisition costs are expected to be no more than $1.5 million of which we recorded $800,000 in Q1, 2019. Going forward, we expect strong free cash flow and available cash balances to help us pay down our debt. As a reminder, before this deal, we had reduced our debt for eight consecutive quarters, and we currently forecast our leverage ratio to decline to 3.5 times or below by the end of fiscal 2019, through a combination of that pay down and improve adjusted EBITDA performance. I would like to discuss a few points regarding our E2M acquisition. We are executing nicely on the near-term integration strategy, which is enabling E2M to execute on their 2019 financial performance. We continue to project the E2M business to deliver top line revenue of approximately $30 million for fiscal 2019 with strong operating margins that are accretive to MTS Test and Simulation margins. The results of E2Ms operations are included in our Test and Simulation business unit. E2M hit all our marks in the quarter indicating progress for the full year, even with having only been included in earnings since the purchase date of November 21st 2018. We have recorded preliminary purchase accounting amounts in our consolidated financial statements and amortization of $400,000 within G&A for intangible assets acquired as part of the acquisition. We expect to record a total of $3 million in amortization expense for fiscal 2019 or approximately $900,0000 in each of the remaining three quarters. In addition, we’ve recorded a preliminary $1.7 million inventory fair value adjustment that increased inventory during the quarter. Approximately, $400,000 was recognized through cost of sales in the first fiscal quarter of 2019, with approximately $1 million to be recognized in the second quarter, and approximately $300,000 in the third quarter, all of which costs are recorded as additional cost of sales. Beginning in fiscal year 2019, we adopted the new revenue recognition standard under ASC 606 as issued by the governing bodies. While there is a relatively immaterial impact to revenue and earnings, the effort and expense incurred to prepare for and to adopt this standard over the last couple of years should not be overlooked and I would like to recognize the finance and accounting teams along with the entire MTS organization for their work, for the adoption of the standard. Moving onto our guidance. We remain confident in our fiscal 2019 full year guidance of revenue of $830 million to $870 million, GAAP diluted earnings per share of $2.30 to $2.60 and adjusted EBITDA of $122 million to $142 million. These expectations are supported by our outstanding first quarter any backlog, a return to growth and our Tests and Simulation business, continuing strong momentum in our Sensors business, improving business mix, the E2M acquisition and slightly positive contributions from the revenue recognition standard adoption. In addition, we are introducing a new guidance metric this quarter, adjusted diluted earnings per share. We believe this metric puts us more in line with other industry players and makes it easier for you to compare us to other companies. For fiscal 2019, we expect adjusted EPS to be $2.42 to $2.72 per share. The reconciliation to GAAP earnings per share can be found in Exhibit-F of our press release. The add back adjustments include, acquisition related expenses, restructuring charges and the fair value step up of inventory for the acquisition of E2M. In summary, we are pleased with our financial performance for the first quarter of fiscal 2019 especially with the phenomenal backlog delivered by both businesses. We were well served by a strategy that includes expanding our portfolio of products and rapidly growing sensors markets, and staying focused on meeting the demands for a new Test and Simulation solutions due to evolving technologies and favorable demographics. As part of the diversification piece of our strategy, we are very pleased to add a high quality business enterprise, like E2M at a time when its business model is gaining momentum in size. I will now turn the call back over to Jeff.

[Jeff Graves:]

Thanks, Brian. So to reiterate, we’re off to a solid start to the year. The clear highlight for Q1 was the significant growth in our backlog during the quarter and the support it provides to our outlook for growth and profitability in the year ahead. While this backlog growth rate may be hard to improve upon, we do expect overall strength to continue in each of our business segments as we move through the year. As I stated last quarter, when we introduced our thoughts on fiscal 2019, we’re strongly focused on three key tenants. First, we need to keep executing on Sensors. Second, we need to continue taking advantage of the strength in our non-vehicle related Test and Simulation opportunities. Third, we need to successfully integrate our newest acquisition of E2M technologies without any loss of momentum in their current business, which is on an excellent trajectory. So far, we’re executing well on each of these tenants and anticipate continued success moving forward. With that, Brian and I are happy to take your questions. Karen, I'll turn it to you.

[Operator:]

Thank you. [Operator Instructions] Our first question is from John Franzreb with Sidoti and Company. Please go ahead.

[John Franzreb:]

Good morning Jeff and Brian.

[Jeff Graves:]

Morning, John.

[John Franzreb:]

Jeff, I’m going to start off where you started off with the backlog, and ended for that matter. Could you just talk a little bit about the strength you seeing in both materials and structures and what's driving that demand?

[Jeff Graves:]

Yes, John, it’s a few very specific things. And thanks for asking. On the material side, there is an absolutely absolute explosion in two key areas. One is the use of advanced materials like carbon fiber composites. They are they are quickly moving from high end large aircraft application, to smaller aircraft and on now to ground vehicles and many other applications the carbon fiber composites are just booming. And with that the need for in customers and developers of the material to test those materials. It's -- it requires an awful lot of testing in order to develop the design data. So advanced materials is one of it, and you could lump in there a new aluminum alloys and some other lightweight high strength materials, but that whole wave of light weighting of vehicles is really sweeping many industries. The second broad-based driver of our material test business is additive manufacturing. With the advancement in the equipment technology for making parts throughout the manufacturing, the ability to make really exotic geometries is increasing very fast. The unusual part though, is the material properties you additively manufacture something are often very unique. So they have to be tested. And we've been spending lot of money on R&D to develop that capability and we’re now fielding equipment that’s very targeted toward the additive manufacturing market for testing. So, on materials, those two broad trends are really driving it, and it’s very global. I would tell you from U.S., Western Europe, China and India and elsewhere those few trends are very global. On the structure side, John, there is a fairly clear interest in developing safer, more reliable civil infrastructure, meaning buildings and bridges. And we had a unique very long-term position in making test equipment to test the impact of earthquakes and other seismic events or even tsunami events on that civil infrastructure. So, we’re doing very well in that area. They tend to be large lumpy projects, but with the increase storm activity in the world and earthquake events, a lot more countries have a need and the money to invest and basic understanding of how to design to buildings and bridges that are safe. So we’re selling a lot of that equipment around the world and its something that we are I think very uniquely and well-positioned for. So though that – and then you’ve got the usual, in structures, you’ve got the usual aircraft expansion. There’s new air craft being launched and we’re very good in that business as well. So, you've got the ongoing trends for aircraft manufacturing and other heavy vehicle type application that require what we would classify as structural testing activities.

[John Franzreb:]

Okay. Now that some of those jobs come in earlier than you anticipated in the first quarter. And as a result there was bigger than expected order intake in Q1?

[Jeff Graves:]

Well, I wouldn’t say that, John. The large structural stuff is a bit unpredictable. So, yes, one order did come in. It wasn’t abnormally large. So, it didn’t unduly influence the backlog, but we might have expected in Q2, it really came in Q1. We’ve got other things out in Q3 and Q4 which may shift forward, backward as well. So, structure is just a bit of a lumpy business, but we also had I would point out a fairly significant order in Q1 of last year in the structures areas as well. So the year-over-year comparison is still very valid. So, I wouldn’t say it’s unusual, I was please to get a large order in Q1, but it didn’t unduly shift the backlog.

[John Franzreb:]

Okay. And then, so can you just give us the sense of what test was your backlog legacy? If you exclusively E2M, what it kind of look like on an organic basis?

[Jeff Graves:]

Go ahead, Brian.

[Brian Ross:]

Yes. So, John, overall, if you look at where we ended the year last year, our backlog was roughly about $415 million, a really strong orders here within in the quarter and we saw sequential growth roughly in the 10 plus percent range. So that’s the organic without the acquisition.

[John Franzreb:]

That’s test organic or companywide organic?

[Brian Ross:]

That’s – sorry, companywide organic and that’s split between both businesses.

[John Franzreb:]

So, when we test organic, because I know you have a double-upping in the DoD job in the quarter or so?

[Jeff Graves:]

So the growth within the quarter as far as backlog, for test along from year-end – sorry, let me look at the last year.

[Brian Ross:]

It’s finished around 346, I believe.

[Jeff Graves:]

Yes. That’s okay. Go ahead and then Brian will be checking the numbers for you John. Go ahead.

[John Franzreb:]

Yes. I guess one more question around, if materials doing so well, structures doing so well, it sounds like ground vehicle is the offset here. Can you talk a little bit about what's going on in ground vehicle especially in light of what we’re seeing lower production rates and sales expectations in calendar 2019?

[Jeff Graves:]

Yes, John. We’ve seen what I – what I would tell you factually, we had a slight uptick in ground vehicle test orders. It’s still well below historic norms. But we did actually have a small uptick in orders. So, I would interpret that to mean that, people are starting to spend money again on durability and performance testing for ground vehicle, primarily cars. There are a lot of new products being launched and they had -- our customers had a preference to their money on safety, but we see some of that coming back now. I still anticipate it to choppy, but it was nice to see a little uptick. It didn't contribute substantially to orders and backlog, but it was nice to see an uptick and that had drawdown in vehicles. So it was on certainly on the low end of performance, but it was at least stable and growing a little bit. So Brian you want to come back to that [Indiscernible]?

[Brian Ross:]

10% growth from the year, so roughly if we’re at 346, yes, that same amount, but…

[John Franzreb:]

So it’s for test growth?

[Jeff Graves:]

Yes. Test growth rate that John asked about.

[Brian Ross:]

Yes.

[John Franzreb:]

Great. Thanks a lot guys. That’s all I have. I’ll get back into queue.

[Jeff Graves:]

Okay. Thanks John.

[Operator:]

[Operator Instructions]. Our next question is from Rich Kwas with Wells Fargo Securities.

[Rich Kwas:]

Hi. Good morning, Jeff.

[Jeff Graves:]

Good morning, Rich.

[Rich Kwas:]

How you’re doing?

[Jeff Graves:]

Good.

[Rich Kwas:]

Just a few questions here with regards to the DoD business, the 20 million, the two contracts. I think, Jeff, you mentioned about or maybe just Brian talking about the contribution equally. What do mean by that in terms of – is that the dollar amount equally over the next three quarters? And what’s the cadence of that 40 million? How does that roll in to the numbers here? What's the timeframe?

[Jeff Graves:]

So, Rich, in Q1 we had very little -- very minimal contribution revenue from the bookings on that. So, if you remember, we got $20 million PO in Q4 and another 20 million here in Q1. We have virtually no revenue in Q1 from that. And quite frankly, we spent the end of our fiscal 2018 and early 2019 and reconfiguring the production line for this anticipated volume that’s coming. So we landed the two POs, one in Q4, one in Q1 here. We go virtually no other revenue in Q1. We’ll ramp through Q2, but we really want to hit production strides on those first orders until the second half of the year of Q3 and Q4. And that comment about splitting it, what that it really translates to is we’ll realize about half of the revenue from that 40 million here in queue and correct me, Brian, if it’s [Indiscernible] in fiscal 2019 and about half in 2020.

[Rich Kwas:]

Okay. Okay. And so, it sounds like this is going to be within the 2020 for the year for 2019, the majority of that should be booked in that FQ3 of Q4, right. Is that way you want to think about?

[Jeff Graves:]

Yes. It should turn the revenue. Yes, the POs are firm. It's in backlog. You should turn the revenue in the second half of the year, Rich.

[Rich Kwas:]

And then, as we think about 2020 that run rate continues over the balance of the four quarters of 2020, it should be relatively even contribution over the course of 2020?

[Jeff Graves:]

Yes. Correct. I would expect given that run rate in the second half of the year and that PO would be primarily fulfilled -- I'm thinking, Brian, for this half of 2020. And then we’re again Rich, we’re very optimistic that full contract of 187 million. So we’ve now booked $40 million of it with all the options on and its worth of 187. So, if this military funding continues and the things we would expect that to live into its potential looking out in to 2020 and beyond.

[Rich Kwas:]

Okay. And then, I guess on ground vehicle side, if we – some of the other industrial players and automation companies have talked about weakness and project activity, weakness in MRO, inclusive in the U.S. North American market. When you look at that business, I know you realize having an uptick in orders here on year-over-year basis slight uptick. But when you look at the business regionally speaking are you seeing any sort of meaningful weakness when you look at China, Europe, North America and China is been weak in terms of underlying retail sales for a period of time. At this point Europe has starts to soften up recently. Just curious in terms of what you're seeing around that activity particularly on the on the auto side within the ground vehicle?

[Jeff Graves:]

Yes. It’s interesting. From our perspective the overall spending levels have been down, but from a geographic perspective it’s very uniform. Across Europe, the states and in China, and the frustrating thing for us has been – our orders are derived from their spending on new product testing. And they have been developing lot of new products. They just have been doing this type of testing that requires our equipment. It’s been more safety testing. So, again, we anticipate at some point that trend will shift back, but what we’re seeing right now is pretty, pretty uniform performance around the world and at a historically low level, but stabilizing. Okay. So, we did see a slight uptick in orders. I don’t want to over sell that. It wasn’t glamorous but it was nice to see at least the arrow were pointing upward and not downward and it’s pretty in uniform around the world. So that’s what I can tell you about it. They do have a wonderful array of new products they’re developing and they’re spending a lot of money on it. But unfortunately, a lot of its going into safety, from our perspective it doesn't fuel our business much.

[Rich Kwas:]

Okay. So, it’s pretty uniform, nothing significant across various geographies?

[Jeff Graves:]

Correct.

[Rich Kwas:]

Okay. And then, just housekeeping question for Brian, with regards to the restructuring here that was taking in the quarter, was that for the core business and was that in cost of good sold?

[Jeff Graves:]

I know, so for the restructuring, it was just kind of the ending piece of what we took action on in China over a year ago, so that program rolled out. And its – there’s some city and then cost of sales yes, and a little bit in the operating line.

[Rich Kwas:]

Okay. So that covers both. Okay, great. All right. That’s all I had. Thanks so much, guys.

[Jeff Graves:]

Thanks, Rich.

[Operator:]

And we’ll take another follow-up question from John Franzreb with Sidoti and Company.

[John Franzreb:]

Yes. Jeff, could you just help me understand why you can participate more in the safety side of the business in ground vehicle, especially since you mentioned earlier, safety side, its what you’re benefiting from the structures market. And I mean, I'm also curious if E2M bring something you could also leverage into the ground vehicle market? Could you just talk a little bit about that greater dynamic there?

[Jeff Graves:]

Yes. Sure, John. Very specifically, the safety that is done now, safety testing is done now in automotive is for crash avoidance. So it's related to these new more autonomous cars avoiding a crash. Historically it’s been survival of the crash and that’s very specific crash flood kind of equipment and stuff. We’re in that market very early, but this many -- it starts couple of decades ago. We’re in that market early. We didn’t participate broadly and don’t now. But the money they’re spending now John is on crash avoidance and its really track testing. So getting out in real-world environments and trying to avoid a crash, so that that equipment is not mature. The equipment that used for that is very OEM specific and its very fluid market. So, we've not found the right entry point in crash avoidance testing. And we can really at this point identify what a good return on the investment would be. So we haven’t participated largely. The OEMs have mainly been a do-it-yourself shop in that arena and doing a lot of track testing. So that’s the story on safety. Eventually the durability of the car, the aerodynamic of the car, the equipment that we may to support that will come back in as a need. But right now it's been predominantly safety in testing. You asked a good question about E2M. With the E2M technology and expertise we have our broad capability for simulating, driving environment, so doing driving simulators and that does open opportunity because those are used much more extensively in autonomous vehicle development, so to look at the interface between the car and the driver during autonomous driving. So, we do have an opportunity there, and it’s -- but we also have some marvelous other opportunities in flight simulation and in entertainment that were clearly going to exploit. So what we’ll continue to do in ground vehicle simulation, we will do activities there on a very focused way, but it would compete with what we do and other market adjacencies.

[John Franzreb:]

Got it, got it. And you touched on China in your remarks. And so were China orders up for you in the quarter?

[Brian Ross:]

Yes. Overall China we – I would say that, it’s a little bit flat for us right now, but we did have a slight uptick in the orders, so if you think of revenue and orders. But we’re still seen kind of our same type of business. In 2018 we talked about really nice growth there. It’s moderated slightly but still pretty good position for us.

[Jeff Graves:]

John, the way to think about that continuing demand is – we sell equipment as you know into new product labs, in R&D labs and China spending a boatload of money in that area to develop an automotive industry and an aircraft industry and expand basic research. So, there is a continuing demand for testing equipment in those areas that we see is fairly robust.

[John Franzreb:]

And I guess, two more question. Jeff, it seem like you were optimistic about your service revenue as it unfolds in 2019. Is there any particular reason? Are you having more success with customers? Can you just talk a little bit about that?

[Jeff Graves:]

Yes. John, services has being very well received. And it -- we continue to grow high single-digits, occasionally at double digit level of services, orders and revenue, and margins had improved now. They’re nicely accretive to the overall test and simulation business. So we love that business. Customers love that business. We are way limited by how many people we can hire and train. We went through a wave of retirement and there's a lot of people that do that work are a career-long people. We went through kind of a wave of retirements over the last few years and now that we had to replace plus we had growth. So, we've been doing a lot of hiring and training of service techs around the world. We have about 350 today roughly spread around all the major counties we do business on. And they do a tremendous job. Customers are very happy with them. So, we continue to hire and train. About 10% [Indiscernible] about 30 to 40 people say a year. And we continue to grow that business organically. There's not much we can do in the vein of an acquisition to accelerated it, but we will continue to hire and train and grow. Customers love it. They can sources this very high-tech maintenance kind of work and service work to someone else instead of doing it themselves. So it's a good feel for them. Its a great deal for us. And we love that business. I think it remains kind of underappreciated in the market, but we are right at that $100 million mark now and its an over $1 million kind of opportunity for us out there, but at least half of which is very strong margin business. So, we continue to invest heavily in it and EBIT from an R&D perspective for software upgrades, spare parts, things like this keep our equipment running which is design to run for decade. So its – we view it as a great part of the business. We expect that continue to grow high single-digit kind of levels, maybe occasionally a double-digit level going forward. So it will make more and more contribution to the businesses.

[John Franzreb:]

Okay. And one final thing, in the R&D line, maybe this for Brian. I know in the past that you can shift personnel from R&D to COGS or whatever, depending on the job cycle, but its gone down meaningfully the last two quarters. I'm wondering if there's any reimbursements there? And if you can go on that line, what do you think about the total R&D spent for fiscal 2019?

[Brian Ross:]

Yes. So it should be relatively in line with where it is for Q1 give or take a couple of percent. But as far as reimbursement, there's not. So – but I would say that we’re pretty solid on the ground with our R&D expenses we see it now.

[John Franzreb:]

Okay. Thank you guys for taking my questions.

[Jeff Graves:]

Thanks, John.

[Operator:]

And with no further questions in the queue, I’d like to turn the conference over to Dr. Graves.

[Jeff Graves:]

Thanks, Karen. So, thank you all very much for participating in our call today and for interest in the company. We look forward to updating you on our progress again next quarter. Thank you and have a great day.

[Operator:]

This concludes today’s call. Thank you for participation. You may now disconnect.