MTS Systems Corp
Q4 2014 Earnings Call Transcript

Published: 11 Nov 2014

[Operator:]

Good day, everyone, and welcome to the MTS Systems Fourth Quarter 2014 Earnings Conference. Just a reminder, today's call is being recorded. And at this time, it is my pleasure to turn the conference over to the Chief Financial Officer Sue Knight. Please go ahead, Sue.

[Sue Knight:]

Thank you, Lorie. Good morning and welcome to MTS Systems Fiscal 2014 Fourth Quarter Investor Teleconference. Joining me on the call today is Jeff Graves, President and Chief Executive 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 10-Q and 10-K. The company disclaims any obligation to revise 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 accounting principles, or GAAP. These 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 now begin his update on our fourth quarter results.

[Jeff Graves:]

Thanks, Sue. And good morning, everyone. Thank you for joining us for our fourth quarter investor call. We appreciate having the opportunity to discuss our financial results for the quarter and for our fiscal year 2014, which ended in late September, and to provide you with 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 the R&D and product development groups within automotive, aerospace, energy and infrastructure OEMs worldwide. This business is fueled by our customers 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 that 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, which have only recently begun to show signs of life within the slowly improving economy. Fortunately, in spite of a fairly tepid macroeconomic environment, 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 messages for the quarter. First, we finished the fiscal year with record orders which were up 8% and record backlog which positions us well for growth on our new fiscal year. Orders in the quarter of $164 million also set a new single quarter record reflecting the strength of our technology offerings and robustness of our global markets. I will provide you with additional orders related information in just a moment. Second, our revenue and earnings per share results were certainly not on par with our expectations and ended the quarter below our prior forecast. By business unit Sensors results for very strong and on forecast as we continue to find a strengthened global market for our technology and our team executed very well under these opportunities. Test, as noted in last quarter's call, continue to be challenged in the fourth quarter by the historically high level of backlog and the high custom mix which has been flowing through engineering and manufacturing. These issues prove to be more impactable on the fourth quarter than we had anticipated. I will discuss in more detail the Test leadership change and the actions that are underway to improve operational effectiveness so that we become more predictable on our revenue growth, more profitable and more capable of scaling the business to execute on our growth objectives going forward. And as our third key message today, our outlook for fiscal 2015 considers the favorable global macro trends, the continuation of the positive market momentum that we experienced in fiscal 2014 and the $326 million of opening backlog that we began the new fiscal year with. Given these tailwinds, we expect to deliver double-digit growth in revenues and earnings per share in 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. I will provide some additional context about our guidance ranges later. Now, I will review orders for the quarter and for the full year. Total company orders of $164 million set a new record as both Test and Sensors delivered growth on the quarter. Orders increased 2% on a relatively tough prior year comparison. Adjusted for currency, orders were up 4%. Sensors and Test were up 4%, 2% respectively. Record backlog of $326 million increased $36 million or 13% compared to the prior year and was up 5% on a sequential quarterly basis. The majority of the increase was expectedly test driven given the compared short lead times for our Sensor products. Thus we begin fiscal '15 with $36 million more backlog than we began fiscal '14. Now, I will provide you with some additional context on orders and backlog by business unit. Beginning with our Sensors business we will first discuss the quarter and then the full year. Sensors orders in the quarter were again strong. Orders growth was 4% and excluding currency orders were up 5%. All of the growth this quarter was in our mobile hydraulics products segment as our industrial products is more heavily tied to the overall global economic performance. From a geographic perspective in the fourth quarter Europe led the way with 8% growth. The Americas declined 4% on the high level of blanket orders that we received in fiscal '13 it did not repeat this year and still remain very solid by historical standards. Asia was up 5% including 6% growth in China. Excluding currency, Asia orders increased 7%. 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. Next, I'd like to review Sensor order results for the quarter by market. Industrial was flat because we previously mentioned FY '13 blanket orders in the Americas. We experienced a continued relation of the previous quarter demand trends included power, plastics, energy for our China distributors. All these applications require our precision measurement sensors to improve industrial machine performance. Moving to the mobile hydraulics markets. Although less than 20% of the total sensor business today, it remains the fastest growing sensor market. Growth in the fourth quarter was excellent up 25% driven by higher demand in the Americas and a significant new motor cycle suspicion application in Europe. While sensors is a short cycle business, backlog at the end of the quarter was a strong $16 million, a year-over-year increase to 9%. This backlog is comprised of approximately one-third blanket orders, which is scheduled to be delivered over the next several months; and two thirds of quickly turning business that we delivered in the first quarter. This high level of blanket orders is a strong signal of the strength of our customer's backlog and their increasing confidence in the future. Finally, looking at the full year sales performance for sensors orders of $108 million for fiscal '14 were simply terrific. Orders growth for the year was 11% including 9% industrial growth and 26% mobile hydraulics growth. Our demonstrated success combined with positive market trends give us confidence about our future growth prospects in sensors both for the new fiscal year and well beyond. Next, I'll spend a few minutes on our Test order results. Similar to Sensors, Test has also set a new record for orders in the fourth quarter finishing the year very strong. Orders were $137 million, an increase of 2% on tough prior year comps. Excluding currency orders were up 4%. Results were driven by continuing strength in large orders, which we define as being greater than $5 million in value, up $16 million compared to $5 million last year. Base orders are $121 million were strong but down 6% for the quarter on a comparative basis for the prior year. From an application standpoint, orders growth was driven more strongly by our structures and our ground vehicle market segments as new product labs continue to need added capacity and improved testing technology to accommodate the demand for new vehicle types and new infrastructure investments worldwide. Geographically, Asia was strong for the quarter delivering growth of 10%. This was partially offset by a 10% decline in Europe driven by investment timing compared to last year. As in prior quarters, we continue to experience a high mix of custom or engineer to order volume. Custom orders increased 11%, while standard products were down 7% on a comparative basis to prior year. Next, commenting on the 58% deferral rate within our pipeline of future opportunities, which we measure as total dollars differed as a percentage of -- beginning in quarter 12 month pipeline. It was slightly above our historical average rate in the mid 50 percentile but not unusual when compared to the historical norm. 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 have experienced over the last 18 months. At the end of the fourth quarter, our 12-month pipeline of opportunities stood at $836 million, up 2% compared to the prior year and reflective of the healthy continuing demand for R&D testing to support our customers’ new product development around the world. Sequentially, the pipeline declined 6% driven by a high booking level of purchase orders in the final weeks of the quarter. However, by the end of October, our sales team had the chance to catch up from end of year orders conversion and an opportunity pipeline for test; it increased once again to over $860 million reflecting continued strength in our test markets and our new technology offerings. This leaves us in a continuing strong position for sustained growth in the year ahead. 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 slightly from $20 million to $18 million. The Americas were strong, up 14% from new multiyear contracts. The other reasons we're down primarily due to multiyear contracts that were placed earlier in the year. These contracts were replaced break in fixed volume that we had previously would have had anticipated so the net effect is one we would have anticipated. Our service engineers were also acquired in part to support the installation of large complex custom projects, which are currently in high demand by our customers. While it's exciting from a longer-term of installed base perspective, the strain on resources in the short-term is impactful. For the full year, service orders were up a sold 7% over fiscal 2013, growing from $76 million to over $81 million. This growth for the year is attributed to the drive for multiyear service contracts, increases in software solution sales, and in our move to remote monitoring for the labs to our new Echo technology. Given the positive reception, we have experienced by our customers in our service offerings and our large and rapidly growing and sold base of test equipment worldwide, we believe the opportunity for sustained profitable growth in Test services is excellent. Moving on to Test products. Orders of $119 million for the quarter were up 5%, more strongly driven by our structures and Ground Vehicle market segments. In Ground Vehicles, orders of $63 million were up 3% on a comparatively strong fourth quarter last year. It was the second time this year that quarterly ground vehicles orders exceeded $60 million. This quarter's results included one large $7 million order for an Asian Automotive OEM, which compares to one $5 million European large order in the prior year. In the Materials Test market, orders were down 3% in the quarter to $35 million. We had solid contract test lab results in the Americas following some delays in third quarter. These gains were offset by some softness in Europe and Asia. Structures, which is our third product market, had an outstanding quarter with order growth of 29%. As we 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 were $22 million, including a $9 million Asian order for a seismic bearing test system. This extremely large bearing test system is designed to isolate buildings and other structures from the effects of earthquakes. For the full year, test orders were $507 million, up 8% over fiscal 2013. This strong performance was led by growth in the Americas and in Asia. From a product perspective, the full-year performance was driven by growth across all of our major product segments but was dominated by ground vehicles and structures markets, which were up 6% and 33% respectively. In broad terms, these markets were propelled by the focus of our customers to understand vehicle dynamics in an environment of rapidly increasing automobile technology complexity and the investments by our customers and laboratories to support energy exploration and transmission, as well as civil engineering infrastructure markets and aerospace worldwide. The next topic is test backlog. For the third quarter in a row, the test backlog which represents booked orders that are not yet delivered, has increased in this case to $310 million setting another record high. Backlog growth increased year-over-year and sequentially by 13% and 6% respectively. All of the increase in the quarter was product related. Service backlog was flat at $25 million on strong fourth quarter revenue. As previously noted, we began fiscal '15 with $35 million more in backlog than we began fiscal '14, which is a strong position for us to be in at the start of the year. To conclude my remarks on test, we're very proud of achieving 8% growth in the full-year, including 7% growth in services and 8% growth in products. There was no meaningful currency impact in the year. Our results confirm that test has the product and service solutions that are global customers need to confidently develop new products worldwide. Now I'd like to turn the call back to Sue for some additional financial detail on the quarter. Sue?

[Sue Knight:]

Thank you, Jeff. My remarks today will summarize our fourth quarter results based on a year-over-year comparison. Fourth quarter revenue of $143 million, declined 8% and, as Jeff previously commented, was less than our forecasted range. The currency impact was immaterial. While we had record backlog at the beginning of the quarter and sensors result came in as we expected, the test business results were less than expected. I'll comment further on test in just a minute. Looking more specifically at revenue by business, sensors revenue of $28 million was up solidly at 6%. Regionally, all three geographies delivered growth rates in the low-to-mid single-digits. Moving on to test, revenue of $169 million, declined 10%. While test revenue was forecast to be weaker than the prior year because of the slower turning custom mix and backlog, the operating inefficiencies associated with our record backlog and our peak engineering workload, as noted in our third quarter call, were more impactful than we had anticipated. In addition, standard product order timing also negatively impacted revenue results in test by approximately $2 million. Our current test backlog of $310 million is $35 million higher than it was last year and all of this increase is in custom. Today, custom backlog as a percent of total backlog is at a record 71%, compared to 67% last year. Thus, improving test backlog execution and predictability is our top priority. Jeff will be talking more about what we are doing in a few minutes. Moving on to the rest of the P&L, gross margin was $56 million, a decline of 16% on a revenue decline of 8%. And then, favorable mix in both sensors and test combined with negative leverage on lower volume contributed to the decline. As it relates to revenue, gross margin declined at 4.2 points to 39%. More specifically, sensors gross margin increased 1% to $15 million on a 6% revenue increase, as well as a higher mix of mobile hydraulics and certain lower margin industrial sensors. While the sensors gross margin rate remains very strong at 55%, it was down 2.2 points from the prior year. As we discussed last quarter, we expect this relative mix to continue in the near-term as we aggressively pursue the higher volume mobile equipment application opportunities. At the same time, we continue to look for manufacturing and sourcing opportunities to expand margins. Test gross margin declined 22% to $41 million on a 10% revenue decline and the gross margin rate declined 5 points to 35%. This result reflects the impact of negative leverage, high custom mix and the operating efficiencies associated with scaling our business operations for both the current backlog and future growth prospects. In general, 3 points of the rate decline was due to the custom mix, 1 point was due to the volume and 1 point from operating inefficiencies. My next topic is operating expenses. Operating cost increased $0.50 million or 1%. R&D spending declined as some test engineering resources were reallocated to work on backlog conversion. Selling costs were essentially flat and G&A increased due to higher compensation related and legal and consulting expenses. As a percent of revenue, operating expenses were 28%. This is within our normalized range of 27% to 29%, but it is an increase of 2.4 points compared to the prior year because of lower revenue. EBIT declined 43% and essentially all of the change was attributable to test volume. EBIT as a percent of revenue declined from 18% to 11%. Sensors EBIT rate of 22% was excellent and the test EBIT rate was uncharacteristically low at 8%. My next topic is taxes. The tax rate in the quarter was 30%, which was a few points below our historical average rate in the low-to-mid 30% range. The rate looks favorably impacted by an international tax planning benefit of 6 points, compared to the prior year the rate increased by 8 points. That increase was exclusively due to a prior year R&D tax benefit that favorably impacted the rate last year. Earnings per share of 71% compares to $1.36 in the prior year for the reasons I previously mentioned. And finally, I'll complete my remarks with a summary on cash. The cash balance remained strong at $60 million and the net debt level is zero. In the quarter, cash increased $4 million. Operating cash flow of $16 million was good. We paid out $5 million in dividends, spent $4 million on capital expenditures and reduced the outstanding debt by $5 million. On a full year basis, we are pleased about our healthy operating cash flow of $65 million and returning cash to shareholders through $18 million of dividend and $31 million of share purchases. That concludes my remarks for today. I'll turn the call back to Jeff for his final comments. Thank you.

[Jeff Graves:]

Thanks, Sue. Before we open the call up for Q&A, I’ll briefly recap fiscal year 2014 results and our fiscal 2015 guidance. Let's begin with a recap of our fiscal 2014 results. There were several noteworthy positives. We had record orders in both sensors and tests exceeding $600 million for the first time. Our investments in R&D and sales and our growth focus resulted in strong 8% orders growth. Also our sensors business achieved double-digit orders and revenue growth, while increasing profitability and our $65 million operating cash flow was excellent. However, these results were clearly overshadowed by our execution and predictability challenges in the test business that negatively impacted our revenue and earnings performance. As I commented in our third quarter call, we're aggressively working to improve our product and service flow so that we can significantly improve operational efficiency and business predictability. In particular, we are focused on two things. First, optimizing engineering production and service execution through implementation of new processes and full utilization of our new IT systems. And second, improving global supply chain management through organization realignment and source rationalization. We know what actions need to be completed; it will take a little longer than we initially expected to achieve the desired result. In particular, I'm very pleased with Dr. Bill Bachrach, he is now leading the test business. He has a proven track record of leading technology businesses, most recently our sensors business. Under his leadership, sensors has become a business that consistently and predictably delivers strong financial results on the top and bottom line and meets its customer commitments. I look forward to communicating about our test business progress in fiscal 2015. My last topic for the day is our fiscal 2015 guidance. As I mentioned in the headlines, we're forecasting revenues in the range of $615 million to $645 million. This is 9% to 14% growth compared to fiscal '14 and is consistent with our goal of double-digit annual revenue growth. The basis for this range is three-fold. First, the growth in the beginning backlog is $36 million from which we should realize 3 to 4 points of growth. Second, we remained bullish on our new order opportunities based on the number of sensor sales pursuits that have advanced to the customer prototyping phase, the strength of the test opportunity pipeline and the overall favorable market environment for the company. And third, we have confidence that we will build back crash leadership, test will improve its efficiency and its predictability. In regard to earnings per share, our guidance range of $3.60 to $4 for the year is volume driven and also includes margin rate expansion in both businesses with the majority of the increase in test. The year-over-year growth rate is expected to be 20% to 33%. While we acknowledge that these guidance ranges are wider than our historical ranges, we believe they are appropriate until we've established predictability in our test business. We will refine the annual guidance ranges as we progress throughout the year, but we will not be providing specific quarterly guidance. We do anticipate the revenue and EPS in the first half of the year will be less than the results in the second half of the year. As always, the actual results will vary based on the timing of new orders and the benefits of improved product and service flow in test. Before I wrap up my comments and shift to Q&A, Sue, I just want to thank you with your upcoming retirement that we announced early in the year at the end of this calendar year and given your 13 years of experience with the company you've made tremendous contributions. And I know I speak on behalf of the employees and the board of directors in thanking you for your contributions. And I believe I also can say that from our shareholder standpoint. Over your tenure, certainly, the value of the company has risen substantially and it’s a reflection of your leadership. So thank you very much for that. And I think it's a testament to a great leader when they're able to hire and train their replacement with succession planning. And we proudly announce the promotion of Jeff Oldenkamp into your role up on your retirement. So thank you very much for that. Much appreciated.

[Sue Knight:]

Thank you, Jeff.

[Jeff Graves:]

Okay. With that, I'd like to open it up for Q&A.

[Operator:]

Thank you. (Operator Instructions). We'll go first to John Franzreb at Sidoti.

[John Franzreb:]

Jeff, if I heard you correctly, it sounds like there is two fixes you want to execute in test. One sounds like better utilization of your new IT system. And second was, I believe, that you said supply chain management. Does that suggest that the biggest problem in the current order book that's the headwind is the way you are pricing the jobs isn't efficient?

[Jeff Graves:]

No, John. It actually has nothing to do with pricing. It's more -- I would tell you the complexity of the jobs we've been winning over the last several quarters requires very detailed planning of engineering and manufacturing resources and very tight integration with your supply chain on delivery of parts. So it's more of the execution of the orders, it's not in the pricing of the product. It's the execution of the orders once we get them and it's -- we spent a lot of money, we've upgraded our internal operating system substantially over the last year. It's not really a function of using the tools, making sure folks are trained. And then, we have upgraded some of our operational areas particularly in the supply chain management to make sure that not only we drive the quality but we're also making sure our suppliers are there to support us with the lead times that we need. So I feel good about the organizational changes and the upgrades we're making. And IT systems are fabulous; we just have to use them effectively. It would be nice if the complexity level were down on what we're winning, but you can't complain about record orders levels. It's wonderful to have the business and to see the strength in the market. So we just need to execute those orders better into revenue, which is the big driver of EBIT performance.

[John Franzreb:]

Yes. I mean that's good. I’m trying to understand the fix. I mean the fix is better utilization of IT. That would suggest that you are winning the job but it's not as profitable as it should be --

[Jeff Graves:]

Well, John, that may be the outcome but I want to be very clear. It’s not a pricing issue in the market; it's a resource availability and execution issue internally that drives inefficiencies. We're -- we got record volume going through the plan and it’s not only record levels its record complexity levels and in making sure you have the right numbers of engineers, the right skill sets and a smooth flow into procurement and manufacturing, that's the hang up. Now, it's reflected in poor margin performance, you're correct, but piece of that is certainly volume driven. We’re just coming up short on revenue, and then there are inefficiencies when you're trying to hold delivery dates and making sure you did stuff out the door. So it is a combined effect of volume and cost but it's -- if I want to be clear on a pricing effect in the marketplace.

[John Franzreb:]

Okay. I also heard you -- I heard you say in your prepared remarks that you move some engineering talent out of the service side to help with the workflow of some of these complex projects.

[Jeff Graves:]

Oh, no.

[John Franzreb:]

Did I hear that properly or --

[Jeff Graves:]

No, there is a drag. These systems when they're installed, John, are extremely complicated. As an example, last Monday I was in Stuttgart for a grand opening of an incredible rolling road system that goes inside of a wind tunnel. I mean we consumed probably 55,000 engineering man hours designing and building this thing. When you install it, it takes a very high skill level and often our service engineers are dragged into that and are involved. So while we would -- we would like them to be dedicated to servicing the installed base, certainly, they were record level of custom equipment that we're shipping right now is a drag on everybody in the field as well. It's very normal to have them involved, it's just we're installing a ton of equipment right now, John, and it's very high-tech complicated big projects. So it’s just taking a lot of manpower in the field. So that is a kind of a short-term drag on the services business to a certain extent. It's good problem to have, it’s wonderful equipment. It's going to need maintenance for the next 20 or 30 years. But it is a short-term drag on some of the service folks as well.

[John Franzreb:]

Okay. What was service revenue in the fourth quarter?

[Sue Knight:]

John, I don't have that number off the top of my head. For the full-year, service revenue was --

[John Franzreb:]

Either one is fine. I can back it out. I can back it out, yes, the full year one.

[Sue Knight:]

7% to 8%.

[John Franzreb:]

The revenue was up 7% to 8%?

[Sue Knight:]

For the full year, that's right.

[Jeff Graves:]

Similar to orders.

[Sue Knight:]

Similar to orders.

[Jeff Graves:]

Yes. Similar to orders, correct.

[Sue Knight:]

Yes.

[Jeff Graves:]

So the orders -- from an orders basis, John, we were up from the let's say the mid 70s to 80s, lower 80s --

[Sue Knight:]

Up 7%.

[Jeff Graves:]

Up 7%. So we felt really good about that in the face of hiring and training a bunch of folks and then having them also involved in some of the more complex installations. We feel pretty good about that job. Okay.

[Sue Knight:]

Yes. John, that will be in our K that we file in a couple of weeks. So you'll have visibility to that.

[John Franzreb:]

Okay. Thank you, Sue. And one last question, if I may, Jeff. I know you're not providing some -- you're not proving quarterly EPS guidance, but maybe if you give us a sense of the magnitude of the first half versus second half or with the first half of this year, the up or down versus the first half of last year, anyway you want to kind of bracket that and give us a sense with kind of earnings profile in the coming year?

[Jeff Graves:]

No, quite honestly, John, the best I can do for you is the -- is the full year number. I feel really good about that number, both the revenue number and the EPS number. I feel really good about that. I do know the first half will be much softer than the second half will be, I can't give you relative comparison. I'd love to give you more guidance but its, we've got just so many moving parts right now I just am not comfortable giving shorter-term guidance, giving relative performance.

[John Franzreb:]

Okay I'll get back in queue. Thank you for taking my questions.

[Jeff Graves:]

Thanks John.

[Operator:]

(Operator Instructions). And we'll go next to Jim Ricchiuti at Needham.

[Jim Ricchiuti:]

Hi, good morning.

[Jeff Graves:]

Hey, good morning, Jim.

[Sue Knight:]

Good morning, Jim.

[Jim Ricchiuti:]

Hey Jeff, I'm wondering as we look at the test business, has the nature of the business changed a bit in terms of the profile now being skewed more so to custom than in the past?

[Jeff Graves:]

It's a great question, Jim. And I'm going to answer it and Sue maybe give a little bit longer historical perspective, but I don't think it's a permanent change, John. But I think there has been a lot of pent up demand for high-end custom projects out there and we've seen over the last few quarters increasing orders rates. So they've been in our pipeline for some time, customers were dragging their feet on placing the orders and these are big sophisticated rolling road systems for wind tunnels, big bearing testing machines for infrastructure and seismic testing, especially in Asia. So big complex engineering projects that are higher ticket items, that customers think deeply before actually placing the order. They know they need them, they're in the pipeline for a long time and the demand just has been pent up. So what we saw, if you back to, and probably the timing is wrong, to the middle of '13 a big spike up and deferrals and then that's been coming down, down, down in recent quarters, until now it's kind of a historical norm. So I think you see the flush out of some of those big complex projects that our big ticket items and customer were -- had just been dragging our feet on that. So the buildings have largely been there, they know they needed to do it, but they just didn't want to place it. It should be that to a little bit more comfort in the world. In terms of the economic recovery, I think they're feeling pretty good about it. And Jim, just flat out their customer demand for new products, whether it's a building that's resistant to an earthquake or a new car or a new airplane I mean, their end customers are wanting to buy more and more of these new products faster and faster and they just flat out need the testing capacity to get there. So I think it's a -- it's been some pent up demand and their customers are screaming for new products, so they have to have the testing capacity to get there. So I am -- as I said in the prepared remarks, I am glad to see it back in historical norms. I think as we look at our pipeline going forward it skews towards kind of normalcy in terms of standard versus custom product, which helps us from a smoothness of flow through the factory. And it gets kind of back to John's question previously how rapidly that worked its way through the system and everything, it's still a bit less predictable so we're not comfortable with shorter term guidance. But the trend that we see it right now is kind of toward a much more normal environment going forward over the next several quarters. So I don't -- Sue, do you want to comment on the -- on -- when before you've seen this amount of complicated product coming through the factory?

[Sue Knight:]

Sure. So in my tenure, I've seen this high level of relative custom mix in backlog only once before. So, between that data point and to Jeff's point, as we look at the test opportunity pipeline which gives us visibility into what we think is likely to close in the next 12 months that opportunity pipeline looks normal to us. We never know who is going to order what, when exactly on quarterly a basis, but it has shifted back to a more normal composition as compared to a custom centric mix.

[Jeff Graves:]

And just one last comment, Jim. I can -- just it is very subjective feedback, but I went to this grand opening in Stuttgart last week and this beautiful new wind tunnel system state-of-the-art, best in the world. It was virtually standing remotely. We had over 100 customers there from all around the world and the numbers of people interested in advance testing technology and that are running flat out in terms of their capacity seems to be very strong right now, particularly, in the ground vehicle space but I would tell you even in the structural environment. And we also believe in a material test environment over the longer term here, it just boards well for our marketplace.

[Jim Ricchiuti:]

Got it. And thanks, Jeff. One other question. Just looking at the sensor business, surprising growth in Europe, I think you said up 8%. Just in-light of I guess what we're all hearing on the macro side but you called that I think one large order in motorcycle market. Was -- is that -- did that skew it or ex that?

[Jeff Graves:]

No.

[Jim Ricchiuti:]

I mean what kind of growth are you seeing there?

[Jeff Graves:]

Yes. Jim, that's a -- that was an interesting one to ask because it may be the availability of the new market. We haven't have really pursued frankly the automotive space and sensors dollars not really been our forte. But increasingly, with the cost of the sensors being lower you got these new applications opening up to as that are marvelous. The European numbers, it could be a little bit misleading because while the sale of the transaction occurs in Europe a lot of the equipment ends up being exported around the world. So the Europeans -- and I would tell you the American -- some of the American companies in the mobile hydraulic space particularly, and even in industrial equipment space, are very good at developing very precise machinery with our sensors and even if they are local economy is not in great shape then they export it, and they export it largely to Asia. And so we -- so it may actually be an Asian driven sale ultimately, but the actual purchase orders placed by a European company to our European operation. So you got to be a little bit careful reading Europe versus the rest of the world because transaction may occur there but it could be for exported equipment, okay.

[Jim Ricchiuti:]

Got it. But in general, it doesn't sound like you're overly concerned about underlying demand in Europe?

[Jeff Graves:]

No, in our business, Jim, it's not a huge factor because our volume in sensors right now particularly, is driven by the percentage of machines that are becoming smart. So while they're in demand maybe on a relative basis low for new things they're selling, they're selling a disproportionate number of smart machines, and those smart machines often contain our sensors. So our volume is going up even though the customers’ volume in total may not be rising dramatically, it's a percentage shift in terms of smart machines. And you see it around you everywhere in the world. I mean all machines are becoming smarter. Our sensors go into industrial products, mobile hydraulic products and our last estimate of -- for example, the mobile hydraulic space, is only about 10% of those machines that are sold or actually contain any sensing elements that we would provide. So those -- that 10% penetration going upward is what's driving our business.

[Jim Ricchiuti:]

Okay. And thank you. Sue, operating expense. Just in light of the challenges you're facing in the test business, should we assume that operating expenses are more toward the upper end of the range as a percent of revenues? In the past -- you've given in the past that you talk about a 27% to 29% range or so. And I’m just wondering, how we might think about it, that year as a whole?

[Sue Knight:]

For the year as a whole, I think we should be in mid-to-upper range on a percentage basis, because we're balancing the investment requirements as we pursue emerging market opportunities in particular. But certainly, on a quarterly basis, we're going to see volatility strictly based on the amount of revenues that flows through.

[Jim Ricchiuti:]

Okay, thank you very much.

[Jeff Graves:]

Thanks Jim.

[Sue Knight:]

You’re welcome.

[Operator:]

(Operator Instructions) And Dr. Graves, it appears I have no further questions at this time. So I'll turn the program back over to you for any additional or concluding remarks.

[Jeff Graves:]

Great. Thanks, Lorrie. So in conclusion, we're committed to becoming operationally excellent in order to achieve our growth objective of sustainable double-digit revenue growth, margin expansion and first quartile ROIC performance. We have more work to do in test, but I am confident that we'll be successful and results will be evident in fiscal 2015. Last but not least, I'm -- I'd also like to publicly thank our employees around the world for their hard work last year. They’re the best and brightest people in our industries who are dedicated to helping our customers be successful every day, and we appreciate their many contributions. With that, we look forward to speaking to you again next quarter. Thank you and have a great day.

[Operator:]

And ladies and gentlemen, once again that does conclude today's conference. And again I'd like to thank everyone for joining us.