MTS Systems Corp
Q1 2015 Earnings Call Transcript

Published: 3 Feb 2015

[Operator:]

Welcome to the MTS Systems first quarter 2015 earnings conference call. Today’s conference is being recorded. At this time I would like to turn the conference over to Andy Cebulla, Director of Investor Relations and Treasurer.

[Andy Cebulla:]

Welcome to MTS’ fiscal 2015 first quarter investor teleconference. Joining me on the call today is Jeff Graves, President and Chief Executive Officer and Jeff Oldenkamp, Senior Vice President and Chief Financial Officer. I want to remind you that statements made today which are not a historical fact should be considered forward-looking statements 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 the company’s latest SEC Forms 10Q and 10K. The company disclaims any obligation to advise forward-looking statements made today based on future events. This presentation may also include reference to financial measures which are not calculated in accordance with generally accepted account principles or GAAP. The measures may be used by management to compare 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 any non-GAAP measures to the nearest GAAP measure can be found in the company’s earnings release. Jeff will not begin his update on our first quarter results.

[Jeffrey A. Graves:]

Thank you for joining us for our first quarter investor call. We appreciate having the opportunity to discuss our financial results for the quarter and update you on our outlook for fiscal 2015. First, let me remind you about the nature of our two business units. This may be particularly helpful for those newer to following our company. The larger of our two businesses is test which provides highly engineered testing systems and services largely to R&D and product development groups within automotive, aerospace, energy, and infrastructure OEMs worldwide. This business is fueled by our customer’s spending on new products and these markets are growing in response to strong macroeconomic drivers which we believe will be sustained for years to come. This market opportunity sets us apart from many other companies. Our second business unit is sensors which provides products which are essential for automating heavy industrial equipment and increasing the precision and safety of heavy vehicle systems that utilize hydraulic controls. These sensor markets are directly tied to industrial capacity utilization and heavy equipment demand. Fortunately, in spite of fairly tepid macroeconomic environments, the growth in what some refer to as smart machines, as a percentage of the overall market, is growing more rapidly and therefore providing accelerated growth opportunities for our sensors beyond simple GDP driven market expansion. This is exciting and we believe sustainable in the years ahead. With this backdrop I’ll start with the headlines. There are three key takeaways for the quarter. First, results for the first quarter of our fiscal 2015 came in largely as we had expected. Despite significant headwinds from currency translation, revenue grew 3% and our earnings were up 15% excluding the restructuring activities in the prior year. If you exclude the negative effects from currency, revenue grew a healthy 7% in the quarter. Backlog remains near record levels and our operating cash flow for the quarter was solid. Orders in the quarter continued their solid performance, being relatively flat year-over-year with base orders growing 4% in the quarter. I’ll provide more color on orders shortly. Second, as we’ve discussed in prior earnings calls, the test gross margin rate continues to be affected by negative product mix resulting from the high level of custom content in our backlog flowing through our engineering and manufacturing processes. We would expect this to moderate to more historical levels in the future. Although the test margin rates are not where we would expect them to be in the long term, we’re pleased with the progress we’ve made to improve our operational efficiencies and scale our business to support future growth opportunities. We’re on track to become more predictable in our revenue growth predictions, delivery higher profitability with expanding margin rates, and become more capable of efficiently executing higher order levels going forward. We anticipate this work will take us a few more quarters before we begin to substantially see the results of our efforts. Also, as we previously announced at the outset of the fiscal year last October, we asked Dr. Bill Bachrach who had done a terrific job of leading our sensor business to assume leadership for the test business. Bill hit the ground running and I’m very pleased with the impact he’s had on the business in a short period of time. Then in January, Mr. John Emholz joined MTS as the new leader for our sensor business. John brings a strong background in hydraulic systems and a track record of success as a global business leader that make him an ideal person to lead our sensor business going forward with its rapidly expanding global opportunities for growth in smart machines. We’re pleased with the smooth transition both of these leaders have made and we’re excited about the future of our two business units under their direction. As our third key message today, we’re affirming our guidance for fiscal 2015 with revenues in the range of $615 million to $645 million and earnings per share in the range of $3.60 to $4.00 per share. Our basis for this outlook is the continuing positive market momentum for R&D and new product development spending by our global customers across both business units. This increasing market opportunity is reflected in the record level of our test opportunity pipeline which is up 6% compared to the prior year or 9% on a constant currency basis and stood at $923 million at the end of the quarter. This record opportunity level demonstrates the strength of our technology offerings and the robustness of our global markets. These market indicators combined with our strong backlog of orders, which is up 9% year-over-year and the progress we’re making on improving our operational capabilities in test, provide us confidence to affirm our guidance to deliver double digit growth in revenues and in earnings per share in fiscal 2015. I’ll provide some additional context about our guidance later in the call. Now, I’ll review orders in more detail for the quarter. Total company orders of $135 million decreased 2% but were up 1% on a constant currency basis. Sensors and test were down 4% and 2% respectively excluding large orders in test as defined by orders greater than $5 million. Test base orders increased 6% driven by an increase in the ground vehicles market. Backlog ended a historically strong level of $314 million, an increase of $25 million or 9% compared to the prior year and was down 4% on a sequential quarterly basis including the effect of currency from a record high level at the end of fiscal ’14. All of the increase was expectedly test driven given the comparative short lead times for our sensor products. Thus, we began our second quarter with $25 million more in backlog than the prior year. Now, I’ll provide you with some additional context on orders and backlog by business unit. Sensor’s orders in the quarter were solid in the Americas and in Asia with some softness in Europe. Order growth was significantly impacted by the effects of currency. Orders declined 4% however, on a constant currency basis orders were up 2%. The growth excluding currency this quarter was in our industrial markets while the mobile hydraulics product segment was flat. From a market perspective, the industrial market was down overall 4% but on a constant currency basis was up 3%. We experienced a continuation of previous quarter demand trends in medical, wood, wind energy, fluid power, plastics, and steel end markets. All of these applications benefit from our precision measurement sensors to improve industrial machine performance and safety. Moving onto the mobile hydraulics market, growth in the quarter was relatively flat. During the quarter we saw customers managing their end of year inventory levels with some customers pushing out orders into the second quarter, particularly in Europe. However, we believe the general outlook for the mobile hydraulics market for the remainder of fiscal ’15 looks very positive. This is supported by the strong construction markets particularly in the US. Although growth in the first quarter was relatively flat, over the long term the mobile hydraulics market remains the fastest growing sensor market as our customers continue to put a priority on developing smart machines for their end customers. Next, let’s review sensor order results from a geographic perspective. In the first quarter, the Americas led the way with a 11% growth as orders in both industrial and mobile hydraulics markets were up. Industrial growth was driven by medical and wood processing orders while the increased mobile hydraulics orders were from the construction market. Overall, Asia declined 4% but excluding currency was up a strong 8% driven by demand in both China and Korea. We remain very excited about our growth prospects particularly in China as these OEMs develop more sophisticated machinery and equipment for domestic use and for export. Europe declined 13% or 5% on a constant currency basis driven by general market weakness and inventory management at the end of the calendar year. While sensors is a short cycle business, backlog at the end of the quarter remains strong at $16 million flat year-over-year. This backlog is comprised of approximately one-third of blanket orders which are scheduled to be delivered over the next several months and two-thirds of quickly turning business that will be delivered in the second quarter. This high level of blanket orders continue to be a signal of the strength of our customers’ backlog and their confidence in the future. Next I’ll spend a few minutes on our test order results. Test orders in the quarter were $111 million down 2% in absolute terms but up 1% on a constant currency basis. Base orders, which are orders less than $5 million were strong at $106 million up 6% year-over-year, as I stated earlier, driven by continued strength in the ground vehicles market. The modest overall order decline was driven specifically by large custom projects which were $5 million in the quarter compared to $14 million in Q1 of last year. This difference is typical of the quarter-to-quarter test variability. From a market standpoint, orders growth was driven most strongly by our ground vehicle market segment as our customers’ investments were made aligned with the priorities of expanding test capacity on a global scale improving testing technology to meet development challenges such as reducing CO2 emissions and improving vehicle ride and handling for existing and new vehicle types. Geographically Europe was strong for the quarter, delivering growth of 12%. This was partially offset by an 8% decline in the Americas compared to last year driven by investment timing. As in prior quarters, we continue to experience a high mix of custom or engineered to order volume. Custom orders increased 9% while standard products were down 11% on a comparative basis compared to prior year. Next I’ll comment on the test opportunity pipeline. At the end of the first quarter our 12 month pipeline of opportunities stood at a record $923 million, up 6% compared to the prior year and 10% on a sequential quarterly basis. This growth in our identified opportunities for future sales is reflective of the healthy continuing demand we see for testing capability in R&D and new product development by our customers worldwide across our automotive, aerospace, infrastructure, and advanced materials market segments. From a geographic standpoint, while Asia remains a very exciting environment for both our traditional and our new customers, we are also seeing continued investment in the Americas and in Europe as our customer’s testing capabilities are updated to address the rapid introduction of new product technologies. This visibility into future demand builds confidence in our ability to deliver sustained growth in the year ahead. As a reminder, another key metric we use to monitor the health of our opportunity pipeline is the deferral rate within the pipeline. This is measured as the total dollars deferred as a percentage of the beginning of the quarter pipeline. The metric declined in the quarter to 54% compared to 62% a year ago and 58% at the end of the fourth quarter and is now in line with our historical average rate in the mid 50% range. . This is encouraging as it will tend to decrease the volatility of our orders performance and assist us in resource planning compared to the volatility we experience when the deferral rate changes rapidly as it did at certain times over the last few years. Now, I’ll spend a few minutes to provide context in the product and service order results for the test business. Within the quarter, service orders declined 14% compared to the prior year from $21 million to $18 million on an absolute currency basis. The Americas were flat year-over-year while the other regions were down. Our service engineers continued to be redirected to support the installation of the unusually high level of large complex custom projects. The strain on resources in the short term continues to impact our service order growth. While this is painful in the short term, it’s exciting from a longer term perspective as our installed basis is growing at record rates and now exceed $4 billion. Given the positive reception we’ve experienced by our customers in our service offerings and our large and rapidly growing install base of test equipment worldwide, we believe our opportunity for sustained profitable growth in test services remains excellent and that orders growth will return as our workforce expands and our high demand for custom test systems moves back to historically normal levels. Moving onto test products, orders of $93 million for the quarter were up 1%. Product order growth was negatively impacted by large order timing. Excluding large orders, base product orders were up 13% again, mostly driven by our ground vehicles market segment as I already mentioned. In ground vehicles, orders of $50 million were up 25%. This quarter’s results included one large $5 million OEM order in the Americas for an advanced higher testing system which compares to one $6 million large Asian order in the prior year. In the materials test market orders were down 15% in the quarter to $29 million. We had solid demand for engineered content and geo mechanic solution in Asia but this was offset by softness in the Americas and Europe due to timing of orders for contract test labs in universities. The structures market was down 26%. As we’ve said in the past, structures is the most volatile on a quarter-to-quarter basis because of its large custom order composition and this quarter was no exception. Orders in the quarter were $14 million compared to $19 million in the prior year. This quarter included no large orders in excess of $5 million compared to the prior year which included an $8 million Asian order. Excluding large orders, the structures market was up an impressive 27% from investments in product reliability testing and in aerospace for engine development testing in Europe. In broad terms, these markets were compelled by the focus of our customers to understand both air and ground vehicle dynamics in an environment of rapidly increasing system complexity and by investments from our customers in laboratories to support energy exploration and transmission as well as civil engineering infrastructure markets and aerospace worldwide. Now I’d like to turn the call over to Jeff Oldenkamp for some additional financial detail on the quarter.

[Jeffrey Paul Oldenkamp:]

My remarks today will summarize our first quarter results based on a year-over-year comparison. First quarter revenue of $143 million increased 3% and 7% on a constant currency basis driven by record backlog at the beginning of the quarter. Looking more specifically at revenue by business, sensors revenue of $24 million was down slightly at 2% and up 5% on a constant currency. Regionally, the Americas delivered excellent growth of 11% while both Asia and Europe were down mainly driven by currency. Moving onto test, revenue of $118 million increased 4% and grew 7% on a constant currency basis. The strong performance resulted from the record high opening backlog and we are beginning to see indications of improvement in our operations which allowed us to turn some of our backlog more quickly. While the revenue performance in test was good and within our expected range, as noted in our fourth quarter call, we have an usually high level of slow turning custom mix and backlog. This results in the need of a higher level of overtime, rework, and other organizational inefficiencies. We are continuing to work through the backlog and to improve the operation inefficiencies associated with this high level of backlog. Test backlog ended the quarter at $298 million, still near record levels. Today custom backlog as a percent of total backlog increased in the quarter to the low 80% range, about 20% higher than historical level. This will likely have a negative impact on margins over the next few quarters as we work through the customer backlog. Moving onto the rest of the P&L. As a reminder, in the first quarter of the prior year, the test business recorded $4 million in restructuring costs for workforce reductions and other related costs. These costs impacted gross margin by approximately $2 million and selling and S&G expense by approximately $1 million each. I will first explain the GAAP financial results which includes the restructuring costs in the prior year. I will then summarize the non-GAAP results excluding the restructuring costs so the operating results are clear. On a GAAP basis gross margin was $57 million, an increase of 4% on 3% higher revenue. As a rate to revenue, gross margin improved 50 basis points to 40%. Operating expenses increased $600,000 or 2% and EBIT increased 9%, and as a rate of revenue improved 60 basis points. Earnings per share improved 53% to $0.90 compared to $0.59 in the prior year, though this was in part the result of a lower tax rate which I will explain in a few minutes. I will now transition to the non-GAAP operating results comparison. Gross margin of $57 million decreased 1% and the gross margin rate to revenue decreased 1.3 points to 40%. The decrease in the gross margin rate was driven by unfavorable product mix in both businesses. More specifically, sensor’s gross margin decreased 6% to $13 million on a 2% revenue decrease as there continued to be an unfavorable mix of mobile hydraulics and certain lower margin industrial sensors. While the sensors gross margin rate remains very strong at 53%, it was down 2.3 points from the prior year. We expect the margin rates to return to the mid 50% range going forward. Test gross margin of $44 million was relatively flat while the gross margin rate declined 1.1 percentage points. This result reflects the impact of the high custom mix in backlog as well as continued operating inefficiencies associated with scaling our business operations for the future growth prospects, both of which we discussed in the prior quarter. As Jeff mentioned, we are pleased with the progress that we have made to improve our operations but it will take more time to achieve the level of efficiencies we need to support our growing business. We anticipate this negative mix will continue through the next few quarters of the year but will begin to moderate as we reduce the high level of custom backlog and achieve operational improvements. My next topic is operating expenses. Operating costs increased $2.3 million or 6%. R&D expense declined slightly due to capitalizing a half million as part of software development opportunities. Selling costs increased a half million primarily from the timing of selling activities to drive future order growth. G&A expense increased $2 million compared to the prior year from higher compensation related costs related to the departure of the former test senior vice president and general manager, increased consulting expenses associated with a transitional service agreement and higher legal costs. As a percent of revenue, operating expenses were 29%, within our normalized range of 27% to 29%. EBIT declined 17% to $15 million but the decline would be 11% if we were to adjust for the next transactional losses from revaluation of our receivables denominated in Euro and Yen. The decrease was driven by the previously mentioned lower gross margins in both businesses and higher operating expenses. EBIT as a rate to revenue declined 2.5 points. Sensors EBIT rate of 16% was lower than normal from lower margins and slightly lower revenue and the test EBIT rate continued to be lower at 9% driven by the higher content of custom revenue and operational inefficiencies. My next topic is taxes. The tax rate in the quarter was 7% which was unusually low and well below our historical average late in the low to mid 30% range. The rate was favorably impacted by the retroactive reinstatement of R&D tax credits which provided a tax benefit of $2.1 million in the quarter and in an adjustment related to the completion of an IRS audit which provided a benefit of $1.8 million in the quarter. These items combined reduced the effective tax rate by 26.4 percentage points. In the future, we expect the tax rate to return to the low to mid 30% range. Earnings per share of $0.90 compares to $0.78 in the prior year. This includes $0.25 benefit from the tax items I just mentioned. Finally, I’ll conclude my remarks with a summary on cash. The cash balance remains strong at $55 million and the net debt level if $10 million of debt. In the quarter cash decreased $5 million. Operating cash flow of $13 million was good. Our working capital requirements required the net use of $6 million during the quarter. Accounts and unbilled receivables were higher in the quarter but were largely offset by an increase in advanced billings and accounts payable. Inventory was higher by $7 million primarily to fund future revenue growth. We paid out $5 million in dividends, spent $12 million to repurchase approximately 181,000 shares, and spent $4 million on capital expenditures. That concludes my remarks for today. I will turn the call back to Jeff for his final comments.

[Jeffrey A. Graves:]

Now I’d like to update you on our full year revenue and EPS guidance ranges. As I mentioned in the headlines, we’re continuing to see positive market momentum and confirmation of the favorable global macro trends that we’ve discussed in prior quarters. This is supported by the record test opportunity pipeline, the high level of quoting activity we have in both our test and sensors businesses. Further, we feel good about the near record level of backlog heading into the second quarter which will help drive growth for the remainder of our fiscal year and beyond. Lastly, we’re on track to improve operational execution in our test business enabling us to more efficiently turn the high level of custom backlog and scale our operations to support the growing business. Based on these factors, we’re affirming our previously issued guidance for both revenue and earnings per share. Revenues are forecasted to be in the range of $615 million to $645 million and earnings per share in the range of $3.60 to $4.00. This represents 9% to 14% growth in revenue compared to fiscal 2014 and 20% to 33% growth in earnings per share. Much of our growth in the fiscal year is based on turning the high level of custom backlog as well as margin expansion in the test business driven by the previously mentioned operational efficiencies that are underway. Therefore, we expect the second quarter to show slight improvement over the first quarter excluding the positive effect of tax benefits that we received in the first quarter and the second half to deliver strong results than the first half. We will continue to refine our annual guidance range as necessary was we progress throughout the year. In addition, as Jeff and I both noted in our discussion regarding the first quarter results, fluctuations in foreign currency can have a significant impact on our financial results. Although we have hedging practices in place to mitigate these impacts, significant changes in currency exchange rates could impact our full year results. As always, the actual results will vary depending on the timing of new orders and benefits and improved product in service flow and test. That concludes my prepared remarks. I’ll turn the call over to the operator for the Q&A session.

[Operator:]

[Operator Instructions] Your first question comes from John Franzreb – Sidoti & Company.

[John Franzreb:]

Test Asia has been a bright spot over the years Jeff, I didn’t quite catch the order number for test in Asia. I thought I heard Europe and the Americas, I didn’t quite catch the demand profile in Asia Pacific and I would like you to maybe update us a little bit on what your customers are saying over in Asia. I know it’s a bit of a question mark these days, so can you give us a quick update?

[Jeffrey A. Graves:]

Jeff, maybe I’d ask you to see if you can find the exact number for John here. But John, let me start off by talking about the relative market strength. I would tell you ground vehicles worldwide has been a real bright spot for us for the last couple of years and continues to be. We continue to see investment not only from our traditional customers in for example Germany, the US, and Japan, but obviously a growing customer base, rapidly growing customer base in Asia so that is continuing unabated. I think the ground vehicle business over there is going to be terrific for us both again from western companies that are moving in there and also the emerging domestic Chinese companies so that spending I would characterize as strong. The Chinese are also continuing to invest a great deal in their university system for study for example the effects of seismic activity on buildings and bridges, so to avoid earthquake issues in the future. That spending is spotty but I would tell you it remains strong and they’re very determined in general to have an aerospace business so we see that again, it’s a large order business so it will be spotty but I will tell you it continues to be strong. As always, we’ll have quarter-to-quarter variations but from a test standpoint, the trend is certainly upward over the next several years, I would say many years. From a sensors’ standpoint, I’ll get back to a number here in a second. From a sensors’ standpoint, it’s very interesting you see a lot of Chinese OEMs in the construction industry and other industries, and in the industrial equipment industry wanting to put our sensors into the machines to make them more precise and safe to differentiate starting based on technology rather than just price. Though it’s a relatively inexpensive easy upgrade for them to make for their equipment and it drives a lot of value to their customers, the lead times are long. We can often work at that stuff for two years to get a product qualified and we’ve been working at that. But, I am tremendously excited about the mobile hydraulics business in sensors and the industrial cooling business in sensors in Japan going forward. But I would tell you, we don’t write off the west. With the Euro going down and the Yen going down, both Japan and Germany have been traditionally big industrial equipment manufacturers and I would expect in the second half of the year that would fuel geographically some growth in those areas for export. They may not be consuming a lot of equipment but it will make those businesses more competitive so we’re excited because we have a very good foot print with those guys, a very good install base in their machines, and I think you’ll see some strength if this trend continues from the Germans and Japanese on their industrial machines as well. While I was giving you that update Jeff slide me the number here. If I read this correctly, overall Asia was down 4% but was up 8% if you currency correct for it.

[John Franzreb:]

That’s Asia test?

[Jeffrey A. Graves:]

Yes. This is in general for test, sensors relatively was flat in the quarter and it’s just acceptance timing. Again, you’ve got to currency correct but I would tell you for us Asia remains strong.

[John Franzreb:]

You laid out a scenario where the margin mix will improve in test vis-à-vis some of the restructuring actions and also custom jobs abating throughout the balance of the year. On the other side of the ledger to hit your revenue and EPS numbers what’s the more likely scenario to play out? That sensors will improve or the service business will improve through the balance of the year?

[Jeffrey A. Graves:]

I would tell you my gut feeling is I think you’ll see an uptick in sensors through the year. I think their markets remain very healthy. It was a little unusual they were flattish in the first quarter but I think their markets remain healthy. We continue to ship an extraordinary custom highly engineered product and it’s a drag on our service business from an orders standpoint. While it’s a little disappointing in terms of the rate of improvement, we continue to hire and train people in that area and it seems like every step forward we take we sell more custom equipment and they get absorbed so we’ve got to get through that push. I think services will have a bit of a headwind in terms of order rates this year. They’ve got a reasonable backlog and customers I would tell you, are interested in negotiating some larger contract longer term deals with us so that could be step function changes that come as a bit of a surprise. Those are in the mix. I can’t predict when they’ll happen but from a small orders day-to-day turns rate, our guys are occupied in different geographies at times with installing this complex equipment. On my worst days when I feel bad about the drag on orders I look at our install base growing so much in this real high end equipment and it’s marvelous. I mean, we’ve got over $4 billion now installed and the service opportunity for that kind of equipment is exceptional so I feel really good about the long term. I think the year could have a bit of a headwind on orders growth with the potential for a surprise from large contractor in services.

[John Franzreb:]

One last question about the guidance, I can’t imagine you knew about the settlement of the tax R&D credit, but that would suggest that something’s changed from your initial guidance, something’s gotten worse. [Indiscernible] and you had that tailwind benefit from the tax, could you just talk a little bit about that?

[Jeffrey A. Graves:]

Let me say something and then Jeff I’ll offer it to you too if you want to comment. I would tell you whenever you guidance there’s puts and takes. We wouldn’t have seen the currency doing what it did and that was certainly a headwind for us. We did complete and IRS audit which gave us a benefit as well which was impossible to time. I would tell you we did estimate the R&D tax credit, we did bake that into our assumptions, the continuation of that. That’s a year-by-year congressional action. They didn’t reup it, if I’m right, for two years but they reupped it for a year, but we had roughly baked that into the numbers. The audit ending in a surprise bump was helpful. The currency headwinds hurt us in an unplanned way so there were puts and takes, but nothing dramatic that’s why our guidance – with our markets staying strong, that’s why we haven’t change guidance. I feel there will continue to be puts and takes but we feel good about the year. Jeff, any other light?

[Jeffrey Paul Oldenkamp:]

The only thing I would say is when we came out with our guidance in November we did know about the IRS audit and we were getting close to wrapping it up. That did close in December and that’s what allowed us to book it so it was in our guidance as well.

[John Franzreb:]

If I heard you correctly, you’re using the $0.65 as your base line number for Q1 when you’re talking about sequential improvement? I just wanted to make sure I heard that correct?

[Jeffrey A. Graves:]

That’s correct. If you back out all of the tax benefits and we’re saying Q2 should be an improvement over Q1 and then we expect a stronger second half of the year to get into the total guidance range.

[Operator:]

Your next question comes from James Ricchiuti – Needham & Company.

[James Ricchiuti:]

I was wondering if you could comment a little bit about potential exposure you have to the energy vertical and what you might be seeing in that market just in light of the volatility in oil prices?

[Jeffrey A. Graves:]

Energy for us in total is a fairly small exposure. I love the business but reality is it’s probably 10% of our test business on average and it’s a very lump business. There’s two pieces of it, we tend to get in the terms of basic research by the oil and gas companies and universities that support them, we do a lot of machines that are targeted at rock mechanics which are very good for simulating deep sea oil drilling environments that the bits find themselves in and also fracing. That tends to be very basic R&D driven. Those plans don’t change very much. It’s meaningful business but it’s not high dollar expenditures for the oil and gas companies. It tends to be long range planned and we don’t expect any volatility there. We do get the occasional large system, for example, for testing pipes either for deep sea oil drilling or overland transmission. Again, that’s very long range planning and it’s driven more by safety and reliability issues rather than performance so again, I wouldn’t expect any real impact on that kind of spend from our customers, but it’s hard to predict it’s lumpy anyway so we don’t tend to lay it in. So, our exposure is low. We appeal to the very basic end of that research pyramid if you will and I don’t expect it to have a big impact on the business.

[James Ricchiuti:]

Did you break out the test service revenues in the quarter? You gave orders I think.

[Jeffrey A. Graves:]

Yes, we did. Revenues were actually up slightly. I’ll see if we can get a number for you on the call. We were actually pleased with the revenue generation from the orders and backlog. We were up 5%.

[Jeffrey Paul Oldenkamp:]

Service revenue in the quarter was $18.1 million compared to $17.3 million Q1 of last year.

[James Ricchiuti:]

Just in light of the challenges you’re facing just with respect with staffing on some of the larger projects, would you expect to return or see some return to more historical levels at least as you’re trying to grow the test business next year? Is that more fiscal ’16? It looks like you’re going to continue to face these challenges second half.

[Jeffrey A. Graves:]

Exactly, I think ’16 would return much more to normal. I continue to be surprised by the strength of these custom orders coming in, I mean, they’re marvelous machines and over their 20 or 30 year life they’ll absorb a lot of services work, but it’s a little frustrating in the short term as we get them installed and operational. I think it will be a drag in ’15. I think you’ll see that improve in ’16 as we’re predicting our mix to shift back more towards the more historical mix from this high custom content.

[James Ricchiuti:]

Just turning to sensors, is there any sense as to whether there’s a mix shift there at least for the next couple of quarters in terms of mobile industrial?

[Jeffrey A. Graves:]

That’s an interesting question. I would expect mobile hydraulics, the momentum to climb through the year this year. I think we’ll see growth in orders there. They tend to be a little bit lower gross margin in general than in the industrial sensors, but we had a particularly rough mix of product including and even within our industrial space in Q1 so it was a very abnormal quarter in that way just based on timing and order flow through the factory because there are pieces of the industrial sensor business that are lower margin than other pieces. In general I think mobile hydraulics will be a strong player through the year. I think you’ll see a margin pick up. While you would normally expect a drag from that I think you’ll see a margin pick up because I think our industrial sensors will return more to their historical margin rates. I think all-in-all you’ll see a margin improvement in sensors through the year, we just get there in a little bit funny way this time.

[James Ricchiuti:]

One final question, if we look at your op ex in the quarter, G&A, can you break out what might be unusual just so we maybe have a better sense of how to think about your G&A expense going forward?

[Jeffrey Paul Oldenkamp:]

When you look at the operating expenses in the quarter, as I mentioned there was some unusual items. There was the services agreement, there was the severance associated with the prior general manager of the test business and when you look at those two amounts plus there was unusually high legal expenses, you're looking at around $1 million.

[James Ricchiuti:]

Tax rate for the year, just in light of the way that’s moved around a bit, what should we be assuming for the year?

[Jeffrey Paul Oldenkamp:]

We expect it to come back to our more normal tax rate which is in the low to mid 30% range. We’d expect it to come back to historical levels.

[Operator:]

[Operator Instructions] Your next question comes from Matthew Sherwood – Cooper Creek Partners.

[Matthew Sherwood:]

I just had a quick question on the turns of the backlog and the implication for revenue. If you look at the last 10K is suggested that basically even though backlog was up 12.5% based on anticipated manufacturing schedules you only anticipated $253 of the $326 million at the time to come through as revenue which was only up about 1% from your expectation at the end of the prior year. Just trying to sort of understand how – you guys are obviously confident about good revenue growth in the back half so just in light of the slower conversion of the backlog how do those things sort of mesh?

[Jeffrey A. Graves:]

If you go back a quarter, when those orders had just been received, you can think of it as kind of an incubation period where it goes through engineering to get all finalized, the drawings all finished, and get into purchasing and manufacturing. On this big project stuff there is a lead in tail if you will where you’re really not recognizing any revenue and then you have increasing revenue recognition as you go through the project. Those projects can span anywhere from six months to a year and a half to complete and most of them are in that 12 to 18 month kind of period so you would expect with a big influx of orders on the high end, the custom end, that that revenue would increase in rate as you go into future quarters and that’s really what you’re seeing. We had a lot of orders. If you go back a quarter or two we had a lot of orders coming in, very little of it got turned into revenue and now you see that accelerating and we’re obviously projecting that to continue through the year and order rates remain high. It was a good quarter for orders, they remain high. They remain skewed towards the custom and engineered end of the spectrum which again, is difficult work but it’s very challenging we enjoy it very much, we’re very good at it from a design standpoint. We have to get better and better at it flowing through the factor and so we see that happening now and we believe, as we’ve said, we’re going to become more predictable in terms of our revenue flow and obviously then EBIT flow and performance, and we’re driving our efficiencies upwards so you’ll see that kick in more heavily in the second half of the year.

[Matthew Sherwood:]

Then just one quick one on the guidance. It seems like we didn’t really know or I guess we should have known about the $0.25 of tax benefit in Q1, but I guess the revenue guide remains the same and the EPS guide remains the same so I was just wondering are there margin issues associated with the currency because you’re not changing the revenue guide or the EPS guide, but the EPS sort of benefited from these tax rate issues that we really didn’t know about?

[Jeffrey Paul Oldenkamp:]

I’ll answer that question. When you look at the margins the big thing that impacted us was really the revaluation of the receivables which we highlighted was approximately a million, that’s where we’re seeing the negative impacts from currency.

[Matthew Sherwood:]

It’s only you take the hit when currency goes down but it doesn’t sort of flow forward?

[Jeffrey Paul Oldenkamp:]

That’s correct.

[Operator:]

[Operator Instructions] It seems at this time we have no further questions.

[Jeffrey A. Graves:]

To wrap up, thank you very much for participating in the call today. We’re pleased with our results for the first quarter with the progress we’re making in improving our operations in our test business with the expanding opportunities we’ve identified to support continued growth and with our ongoing commitment to deliver on an exciting year ahead. We look forward to updating you on our progress again next quarter so thank you very much for joining us today and have a great day.

[Operator:]

That concludes today’s conference call. We thank you for your participation.