MTS Systems F2Q09 (Qtr End 3/28/09) Earnings Call

| About: MTS Systems (MTSC)

MTS Systems Corp. (NASDAQ:MTSC)

F2Q09 (Qtr End 3/28/09) Earnings Call

April 23, 2009 10:00 AM ET

Executives

Susan E. Knight - Vice President and Chief Financial Officer

Laura B. Hamilton - Chairman and Chief Executive Officer

Analysts

John Franzreb - Sidoti & Company

Liam Burke - Janney Montgomery Scott LLC

Michael A. Hamilton - RBC Capital Markets

Operator

Please stand by. Good day, everyone. And welcome to the MTS Systems Second Quarter 2009 Earnings Teleconference. As a reminder today's call is being recorded. At this time it is my pleasure to introduce Ms. Sue Knight our Chief Financial Officer. Please go ahead ma'am.

Susan E. Knight

Thank you, Vicky. Good morning and welcome to MTS Systems fiscal 2009 second quarter investor teleconference. Joining me on the call today is Laura Hamilton, Chief Executive Officer and Chair.

I'd like to remind you that statements made today, which are not as 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 overtime. They should not be considered in isolation or as a substitute for GAAP measures.

Laura will now begin her update on our second quarter results.

Laura B. Hamilton

Thank you Sue. Good morning and thank you for joining our call. We're going to cover today the business results for the quarter. We're going to cover our perspective of the global business environment and the implications for MTS.

Our outlines for today, I'll start with headlines. I'll go through the orders detail. Sue will go through the rest of the financial details. We'll come back to business environment and close with outlook.

We have five headlines for our second quarter. The first is about orders and our Q2 orders at $69 million were down sharply due to worldwide economic decline. We had anticipated about a 30% decline but actually we're down about 47%. Our second headline was that in February we did take action to reduce our cost structure in response to these market conditions. We eliminated about a 150 positions which equates to about $10 million of savings.

As in February we also made some tough choices between priorities and where to spend more and where to spend less. But we are making those tough choices. Our third headline is about the full year outlook. And while there is much uncertainty we can say that if orders continue like the second quarter we would expect full year revenue to be down approximately 10 to 15% with earnings per share down approximately 50%.

Our fourth headline is that in March, Alfred Richter joins MTS as the Senior Vice President of Test. Alfred comes with expensive expertise with Groupo Entoliene (ph) a European based automotive supplier where Alfred worked in product development, operations and business growth. Alfred is a strong leader who'll be great for the Test business. He and I will be transitioning my test responsibilities over the next several quarters.

And our last highlight -- headline is really about the long-term, and that we remain very confident about our ability to both manage through these difficult times today as well as to use some to strengthen our position for long-term success. Let me shift right now to orders and again try to provide as much information as I can for you about what's happening at MTS. I will stress again, its difficult to use quarterly order as basis for analysis, but given these uncertain times we need to do it and try to gain as much insight as we can.

From a total company prospective Q2 was down 27% over Q1, which seems at times to be the most significant comparison. And this does reflect a worsening economy over from Q1 to Q2. This also resulted in the reduction in our backlog of 20% from Q1 to Q2. At $69 million we were down 47% from last year which was our company peak. This is about three points of currency and also includes 5% pick up from the acquisition of SANS.

From the 10000 foot view what's happening. We see that consumers are spending less around the world that global business contraction is still playing out. There's too much capacity around the globe. That capital spending has slowed significantly and this is both in manufacturing and R&D as companies work to preserve cash. Credit markets are still an issue and stimulus money is just barely getting started.

Let's shift to Test orders for a minute. What's significant this quarter was the further decline from the first quarter. We were down 31% over Q1. We started the quarter with many-many opportunities that were planned to close in the second quarter. And as the quarter progressed, we saw more and more delays. And I guess the best way to describe it is a quote that came from one of our sales managers which was; it takes time for the message at the top to get all the way through the organization.

So there are people in the organization preparing request for capital that get these requests go up to chain and by the time they get to that fifth signature is when they're finally getting stopped. And it's hard to predict which of them will get through and which of them are going to stop. And that's a lot of what we experienced in the second quarter.

On a year-over-year basis, at $53 million we were down 49% over last year. We saw a 6% pickup from the SANS acquisition. About half of our decline is from orders greater than $5 million. In the current quarter they -- we had no orders greater than 5 million compared to last year where we had three orders totaling $29 million. From a mixed perspective custom is down about twice as much as the rest of the business. I guess it does makes sense if you think about the larger the dollar amount the harder it is to get capital approval today.

From a geographic perspective the Americas came in at $18 million, which was down 52%. In the Americas this is down across all markets. I think what is most important to stress is that we're not down because of the betrayed Detroit passenger car market, because if you go back to last year we didn't really have a lot of business in Detroit last year either.

Interestingly though ground vehicles in the Americas was down 72% year-over-year and that's because last year included one large $7 million order in non-passenger car ground vehicles. So we did the things that helped to keep up last year which were non-Detroit based passenger cars sell (ph) South America as well as agriculture, construction and NASCAR are not helping us this year.

In Europe we came in that $19 million and we were down 28% of which eight points of that is currency. So at 20% down in the organic business this quarter we were really helped from some Formula One business. So really we're seeing the same kind of decline but it was a good quarter for Formula One. We are specifically seeing in Europe that Eastern Europe and Russia which were strong in '08 are seriously being hurt by the current economy.

Asia at $17 million is down 60% over the last year. If you take out the pick up which is about 16 points from SANS we were down 76% in the organic business. Two-third's of this is from orders greater than $5 million. Again zero this quarter and last year we did $23 million.

Japan and Korea continue in a deep recession. And China, while its growing, has -- is growing slower than 2008. But it also appears that the slow down in China which was pretty strong in the second quarter is going to be more temporary than in the rest of the world. We're beginning to see China infrastructure investment, specifically this quarter we had an order in rail. And we see more opportunities in the pipeline.

From a market perspective ground vehicles was down 49%. Half of that decline was ordered greater than $5 million. The other half is a combination of worldwide automotive, construction, agriculture, heavy truck and motor sports. Infrastructure is also down about 50%. And if you -- that includes net of a positive 13 point pickup for SANS. So organically down 65% again about half of that is due to the orders greater than $5 million. Aero is down about 40%.

So let's talk for a minute about the opportunity pipeline and we've just begun talking about this over the last few quarters. So to remind you what this is, these are the opportunities that we are pursuing that when one become order. We quantify the pipeline only in terms of those opportunities that have dates expected to close within the next 12 months. One of the things that we've down with the opportunity pipeline -- one thing that makes it's harder is that there's more uncertainty both in how large the size of the potential order as well as estimating the close date.

So we continue to apply more and more rigor to trying to get those -- the estimate as accurate as possible. But its challenging in this kind of environment. So we've applied more rigor to the pipeline and the opportunity pipeline in terms of dollars is growing. It's up 20% since the beginning of the year for those things expected to close within the next 12 months.

Our quoting activity level is high which makes us optimistic. At the same time we need to be cautious that the opportunities are actually going to be funded. And it's more difficult today to commercially qualify these leads. There is some linkage in our pipeline to worldwide stimulus. But accurately predicting is more challenging than other. From a backlog perspective we closed backlog at a 166 million which was down 20% from Q1 as I said. The only other thing I'd highlight in terms of the test backlog is that we've seen two cancellations in the quarter, but they were less than 1% of the total backlog; so its still insignificant.

From our outlook for Test, the impact of the global economy clearly intensified in the second quarter. As we look forward, there are reasons for us to be cautious. If you look across general consumer and business confidence remains low. Some are forecasting more declines, like in Europe and increases in unemployment. Cash conservation and access to capital are issues that remain and we've seen now two sequential quarters of weakening demand.

At the same time, looking forward, we think there are reasons for the optimistic. Global stimulus is starting. And if you look at China, there's opportunities in rail, steel and automotive; the US is talking about spending on energy and transportation. Europe has stimulus in place in the automotive sector and Japan is looking at investment and energy and aerospace.

Another reason to be optimistic is that china is growing and we're well positioned given the execution of our China growth plan to participate. So we're looking at both scenarios, the more cautious and the more optimistic, and we're preparing our pass forward to be ready when the future unfolds.

Let's shift now to Sensors order. In the second quarter at $16 million Sensors orders were down 17% from Q1 resulting in a backlog decline of 13%. Second quarter was very similar from a monthly order demand to November and December of Q1. Q1 was higher because of the benefit that we saw in October which was really before the decline started accelerating. Sensor orders were down 37% from last year of which three points of that is currency. We experienced decline in all geography and our weakest market segments were plastics, wood and metal forming.

We did see some order strength in medical, energy and infrastructure projects; for example in gas and water turbine applications. In March we also saw some first signs of improvement in Europe and China steel. Although this is still early and hard to tell us it's a trend. By geography the Americas were down 22% over last year. The Industrial machine OEMS remained down in plastics, wood and metal forming and we're clearly seeing that weak players are struggling financially.

Medical, energy and fluid power were up in the Americas. What we can see in fluid power is that we're actually taking market share because our orders are increasing while the overall industrial numbers are down significantly. We also see energy across both our traditional and alternative market. Europe was down 43% of which eight points of that is currency, were down 35% in local currency.

We see industrial weakness in plastics and machine tools and -- but we also see that order levels may be stabilizing somewhat at the end of the second quarter. In Asia we were down 44% over last year and this is net of a positive five points of currency, was down 48% organically. We see that the Japan industrial machine markets are very weak, driven by low exports for machine builder particularly in plastics.

The steel markets in China are now trending upward in February and March after being extremely slow November through January. An infrastructure in China, particularly oil and gas remained active. By application we see decline where end markets are tied to home and building construction, consumer products and packaging, automotive and road construction. But we see increases in fluid color, energy and medical.

I'm going to talk just for a minute about mobile hydraulic which is small over all about 10%, but strong growth potential. Mobile hydraulics in the quarter was down 62% versus being up 16% in Q1; and this is driven by weak demand for construction equipment. Definitely we are seeing that excess inventory at dealers is forcing large production cut backs in Q2. For example, Caterpillar had been ordering at about a 1000 units per month and has dropped below a 100 units per month.

Agriculture market are softening but do remain active and we are winning new applications. What -- so we know what'll be on the next model, but volumes in terms of how much how much demand and how fast it will turn up are uncertain. From a Sensors outlook perspective the reasons to be cautious are -- around the order outlook are similar. General consumer and business confidence and the extent of the remaining inventory correction is uncertain.

November to March demand is relatively consistent but the reasons to be optimistic are that China demand is picking up; steel, industrial controls and fluid power markets are showing early signs of possible stabilization. And government funded programs may create incremental demand in infrastructure, for an example an application could be -- that we're working on is a gate control for a water dam and in military what we're working on military vehicle application. So we see strength in these areas and the opportunities for new application. Again we're working both scenarios to ensure we're prepared.

At this point I'll turn this over to Sue for financial details.

Susan E. Knight

Thank you Laura. My discussion today will focus on revenue and earnings results for the second quarter. I will also discuss our cash flow and cash balance at the end of March. And I'll begin with revenue and earnings.

In the quarter revenue was growth was driven by Test backlog. At a 108 million the year-over-year decline of 4% included 5% organic decline and 3% negative currency impact which was partially offset by four points from SANS. Revenue increased in the America's but Europe declined, and Asia was down due to weaker volume in Japan, Korea and China.

Moving to Test revenue, test was $91 million which was 4% higher than last year. The 4% growth was made up of 1% organic growth on 4% lower opening backlog and five points from SANS. Currency had a negative impact of 3%. The quarter for Test included 6% increase in the Americas, 4% decline in Europe and an 8% increase in Asia including SANS. Excluding SANS Asia revenue declined 9%. As a reminder revenue results by geography forecasts (ph) are more reflective of backlog than it is of current quarter of orders.

From a market perspective ground vehicles was down 16% and aero our smallest market increased 39%. The infrastructure market was up 25%, of which 17% was attributable to SANS. Moving to Sensors revenue; revenue in the quarter was down 32% negatively impacted by a decline in the incoming orders. Currency had a negative impact of 4% and the organic growth declined 27%. Geographic demand was similar to the orders decline, with the Americas down 27%, Europe declined by 35% and Asia was down 27%.

Moving on to gross margins, margin dollars decreased 4.6 million or 10%. As a rate to revenue, margins declined 250 basis points driven by a 240 basis point decline in Sensors on lower volume. The Test build (ph) margin rate decreased by 110 basis points. The net impact of the reduction of variable compensation expense and severance cost was an increase to gross margins of 700,000 or 60 basis points.

Moving onto tax growth margins; at 35.7% the margin rate compared to last year's rate of 36.8% at 35.7. In the organic business the gross margin rate of 35.4 compares to 36.8% and includes a high mix of custom projects which is lower margin revenue. While the margin rate in backlog has trended up in the last couple of quarter as we finished the development projects and cost reduction assets have been taken, the benefits were offset by indirect factory expenses, including warranty costs that were up $2 million year-over-year, majority of which is attributable to one system. This increase in warranty negatively impacted the margin rate by 210 basis points.

Test results also include a $1.3 million inventory write-down which negatively impacted the rate by 120 basis points. SANS gross margin rate was very strong at 42.6% which increased the Test segment margins by 30 basis points. The results included half a million dollars of expense associated with the valuation of inventory as fair (ph) market associated with the position. Approximately $0.5 million of remaining valuation related expense will flow through second half results.

Gross margin dollars in Test were flat of 32.5 million excluding the impact of the SANS inventory markup gross margin dollars increased 2%. In closing on the margin rate discussion with Sensors, margins declined from 56.4 to 54%; but remained very healthy. The cost reduction actions that have been taken are helping maintain good margin rate performance, gross margin dollars declined 4.8 million or 35%, on 32% less revenue.

Next subject is earnings before interest and tax; earnings declined 28% or 4.1 million from 14.7 to 10.6 million. Excluding SANS, EBIT decreased 2.9 million. The results include a $3.9 million benefit from a reduction of variable compensations that was partially offset by $2.8 million of severance cost in the quarter. As already discussed SANS results in the quarter included inventory valuation cost of approximately $0.5 million. We expect that we will be able to record revenue later this year as we ship product as compared to recording revenue on acceptance. This is a subject we talked about last quarter and we expect to have the processes and contracts in place to make that adjustment in the latter half of the year.

Operating expenses for the company were down 8% or 2.4 million in the quarter. SANS expenses were 3.2 million, but when you compare the operating expenses of the organic business they declined to 17% or 5.6 million to 26.6 million. We realized benefits of cost reductions in the quarter from our response to the early signs of an economic slow down on our business. The net impact on operating expense of the reduction in variable compensation expense and the additional costs associated with severance is a reduction of 400,000 in the quarter.

Last year's results included a gain of 900,000 from currency related hedging (ph) items compared to a loss of 1.2 million this quarter or 2.1 million year-over-year negative impact. The loss is due to the significant currency volatility which was about 6% in the Euro in the end. Year-to-date hedging losses are $300,000. We had a lot of variability in the quarter but, year-to-date relatively modest.

The EBIT rate in total for the company was down 330 basis points from 13.1 to 9.8. Moving to the segment EBIT rates, Sensors rate declined to 31% on lower volumes from 21.8 to 14.6, primarily due to the gross margin reduction. Operating expenses were down 22% or 1.8 million. The Test segment EBIT rates excuse me, Test before SANS was essentially flat at 10.8. A 16% reduction or $3.8 million decline in operating expenses was offset by the combined impact of warranty, inventory write-off and currency related hedging losses. Including SANS which had a loss in the quarter of 1.2 million, the Test EBIT rate was 9% compared to 10.7 last year.

Moving onto the subject of tax; tax expense for the quarter was 2.9 million compared to 1.9 million last year. The higher expense was due to an increase in the tax rate from 13% to 28%. Prior year results included 3.7 million of benefit associated with the repatriation of earnings from Japanese affiliates that was a non-recurring event. The comparable rate for last year without the benefit would have been 37%. So this year's rate is down substantially.

Net income decreased 44% to 7.5 million and earnings per share were down to $0.44. The higher tax rate, lower income from operation and currency related losses, negatively impacted earnings per share by $0.10, $0.09 and $0.09 to respectively.

I'll finish the detailed discussion of the second quarter with a few comments on cash. We ended the quarter with $99 million of cash which is a decrease of $6 million in the quarter. Operating cash flow was 10 million primarily due to earnings. Capital expenditures were 2.8 million and we purchased approximately 125,000 shares for $3 million. Our cash remains invested in bank deposits, treasuries and money market funds. That's the conclusion of my remarks, now I'll turn the meeting back over to Laura.

Laura B. Hamilton

Thanks Sue. So let's just do business environment and I think there are three areas to talk about and we'll talk about this briefly. But when you think about business environment, there's the status of the economy, there's stimulus and then there's strategy in terms of dealing with these times. So from a status of economy, right now there's a lot of data that supports that things worsened in the second quarter and that some believe the data says the decline is slowing.

A couple of key factors that relates us; U.S. manufacturing output shrank in March for the 14th consecutive month. About March new factories orders rose to the highest levels since August. China's first quarter economic growth slowed -- was the slowest in almost 10 years which we clearly felt, but China's year-over-year exports which also fell 17% in the month of March, the fifth straight monthly decline was less severe than February's 25.7% decline.

So, economy clearly -- not so clearly, but is clearly uncertain. If you go to stimulus, stimulus is not going to be a one-for-one offset with the decline. But if you look at stimulus and you just take China, the U.S., Japan and Germany, stimulus exceeds $2.5 trillion. And we'd only need a small piece of that. So in some areas we see stimulus helping to restore funding of previously planned investment. And an example of that would be China automotive.

In other areas like the U.S. and at SAS they're increasing their funding which historically they funded one out of 20 proposals, and they've stated that they plan to fund one out of two proposals. But all these proposals must have already been submitted and what's interesting for us is these previous submittals that were declined could be with MTS customers. So we're going back and looking at all orders that had been cancelled and we're looking back to see if these are opportunities that might come up now.

You look at stimulus and its funding spending at government laboratories, universities and private business around the world, in areas like infrastructure, energy and the environment which are areas that have aligned with the mega trends that -- where we've always seen opportunity. The third element about the business environment is strategy -- and strategy in this environment. I've pulled three articles, one from Harvard business review, then New Yorker and Fortune.

And these articles are advising companies to seize advantage in a downturn, plan (ph) tough and turn crisis and opportunity into opportunity. But if you read deeper the advice is encouraging two things. One is, conserving cash, which is not good for people following capital equipment or tied to capital equipment; but the other thing the advice is encouraging is that you position your company for the future. Which is about product development which is about what MTS enables customers to do.

So you put all of this together and the uncertainty of tomorrow is yet to play out. So what's our response and our outlook given all of the uncertainty. Our first response is that we're managing through the downturn and the uncertainty. We are aggressively pursuing markets and customers who are spending money today, and we're helping customers find alternative solutions to financing when necessary. We are reducing our spending where it makes sense; while also increasing investment in key opportunities to create more value for our customers tomorrow.

And we are continuing to use scenario planning to be prepared, while we are maintaining and leveraging the strength of our balance sheet. As we've said without significant improvement in second half orders we could see full year revenue down approximately 10 to 15% and earnings per share down about 50%. We are cautious because of the continued weakness in capital spending. But, we remain positive about the potential impact of global stimulus and industrial market stabilization.

And we remain confident that we are taking the appropriate actions. We are maintaining focus on our plans for long term success, and we have the people and the financial capability to strengthen our position for growth when the economy improves. So that's the end of our prepared remarks and Vicky, would you open us up for the Q&A session?

Question-and-Answer Session

Operator

Absolutely. (Operator Instructions). We'll take our first question from John Franzreb with Sidoti & Company.

John Franzreb - Sidoti & Company

Good morning, Laura and Sue.

Laura Hamilton

Hi John.

Susan Knight

Good morning John.

John Franzreb - Sidoti & Company

I guess my first question is the variance in the order book down 47% versus your expectations was down 30%. What was the biggest outlier in the drop in the orders compared to your expectations?

Laura Hamilton

I think it would be that -- so I think as we went through the first quarter we had experienced more breadth of automotive worldwide. And so I think that two differences were the depth; that it was much more of a complete pause and a stop. Where people said wait, I don't know what I'm going to do yet. And that pause wasn't about automotive it was pretty much everywhere.

So, I think if you look at the second -- our second quarter from the economy in general I think a lot of companies just said we're going to wait before we make any more decisions. And capital spending is one of those decisions that can be put on hold for three months, six months or 12 months.

John Franzreb - Sidoti & Company

Okay, then I guess in a related question, can you talk a little bit about what the Sensor demand is like post second quarter? I imagine that's a lot of OEM direct sales volumes, so you'll you would see it snap back to that or continued degradation of that, more visibly than you would; sooner than you would in the Test side. So can you talk a little about Sensor order trends in April?

Laura Hamilton

Yeah, so I would say no change in April. No snap back and no rapid decline, pretty much steady state.

John Franzreb - Sidoti & Company

Okay, it's stayed at that current level -- the exit level was in March?

Laura Hamilton

Yes.

John Franzreb - Sidoti & Company

Okay, all right. Last question is the -- I call it -- its call implied guidance for the second half of the year. Now I did this back on the envelope here so if I'm wrong I apologize but, full year revenues down 10 to 15% implies full year EPS down 50%. If I got it right, that suggests a core -- run rate per quarter of roughly $86 million okay. And roughly EPS of -- roughly $0.17, $0.18.

Now if I look back historically, in the beginning of fiscal 2004 you're running roughly that same kind of a revenue number, but doing EPS $0.35 and $0.30 respectively back then. And you've recently taken cost out of the business. So I'm kind of having a difficult time trying relating (ph) your expectations being so low, compared to some of those historic numbers in the past. Can you kind of walk me through that logic?

Laura Hamilton

We're thinking. One of the things is that there's a lot of differences from who we were back in 2004, so we haven't down reconciliations in 2004. I think so we do call it guiding. A big piece of this is how the backlog turns and what we are trying -- so it's not atypical for us to have variable quarters. So, I understand what you are saying about our new run rate but I don't know that you can ever take one quarter of ours and multiply it 10 fold and show what we ever did in a year. So, I think we are struggling with your methodology.

John Franzreb - Sidoti & Company

What I simply did is took some of the mid points of the numbers that you gave and I compared into the past. And then and I agree that you are not the same company that you were in 2004, if anything you've taken out some cost, some fixed cost versus some variable spend going through. But I was just looking trying the things at apples-to-apples basis in that. And I had a tougher time, because I think if I look back in 2004's backlog -- let's see you're running lower than that. But, I'm just trying to get from here to there?

Laura Hamilton

And I'm not saying that you are doing about number. I'm saying using one quarter to extrapolate an annual is too hard for us to do. So, it depends on the mix of orders. Liked Sue talked today the mix of custom versus standard and quick turns is where -- it has a dramatic effect on that. Stock compensation expense is a big variable from quarter-to-quarter and annually. So there -- I can't tell you to take the fourth quarter and start annualizing it and why it doesn't relate to another quarter that we had five years ago. I can't give you that today.

John Franzreb - Sidoti & Company

Okay. And one last question, based on the quotation activity how does 2010 play out, if this is the kind of scenario setting up for the end of 2009?

Laura Hamilton

We don't know John. We think that there's a good scenario and there's a bad scenario. And we are going to think through both of them and be prepared but we don't know. So our opportunity pipeline is up but whether or not companies are really going to commit to these kinds of investments in the next six quarters is unclear. One of the things -- we're working on things like what we call velocity, which is the ability to turn the backlogs faster. So that if we see a pickup or we're looking to see it might we able to turn it faster, these are the kinds of investments we're making now to strengthen ourselves, but we don't know the mix and we don't know the timing.

John Franzreb - Sidoti & Company

Okay, thanks a lot Laura.

Laura Hamilton

You're welcome.

Operator

Next, we'll hear from Liam Burke with Janney Montgomery.

Liam Burke - Janney Montgomery Scott LLC

Laura -- good morning Sue.

Laura Hamilton

Morning.

Susan Knight

Good morning.

Liam Burke - Janney Montgomery Scott LLC

Laura, you touched on some competitive wins on the Sensors side but could you step back give us in both segments the competitive landscape?

Laura Hamilton

Okay. Lets start with Sensors, the competitive so right now pretty much across the Board everybody's being hurt. We have some competitors that are more tied to automotive. So they are down more. And this is all hard information to get because people are privately held. So this is whatever is kind of in the market place. And so if you're tied to automotive, you're down more. And if you're tied to the lower end machines you maybe down more as well.

Like some of the plastics related. So one of the competitors being down more is pulling back and less able to provide the support that customers need in terms of designing the Sensor into their new systems. What we're trying to do is do the investment, keep the people that can work with the customers to get on the next model, so that when they start making that model and when the volumes turn up, it's our Sensors on it instead of the competitors.

The other aspect that's really important for Sensors is more about continuing to get on non magneto-strictive technology. To replace either other forms of technology that are lesser capable and right now what's happening with the economy is there's more time to talk about changes like that because capacity is not overly booked. And then to also got after applications where there's no solution today and so you're not displacing anybody. And so we continue to win those new applications, they're just not generating volumes right now that are helping offset the declines.

On the tax side, we definitely expect to see competitive intensity, because as the market goes down, everybody wants what's left. Right now in the second quarter, it was much more about the timing of programs than the approval of programs than it was about losing to the competition. I think the competitive intensity has yet to play out and this is a big piece alone being clear about what we're pursuing and where MTS is the value add solution versus the real head-to-head.

I think we're well positioned in China because we're the market leaders while they care about price and they care a lot about price they also are building capability and I think that gives us good positioning there.

Liam Burke - Janney Montgomery Scott LLC

Can I just touch on you talked about something you talked about on the Sensors side. You talked about new applications, that's always been a driver of the growth of the business. Are there any specific applications that are closer to actual market introduction?

Laura Hamilton

If you think about this -- I always talk about singles and doubles and Sensors is about -- it's like something smaller than a single. So we have to change the sport (ph) analogy. So yes, there aren't lots of so in mobile hydraulics, each month we'll learnt about how -- now we're on a potato picker and then we're on a bee picker and then we're on and so, those are not really big introductions as much as working customer-by-customer.

So we're working those as hard, if not harder than we have in the past. But the part that is uncertain is how many of those machines are going to be sold over the next 12 and 18 months, and that puts everybody back into the uncertainty of investment and capital. Now we're talking about manufacturing capital and lower dollar amount sometimes but still capital. And that -- so we are just going to keep getting on as many of these applications as we can and when it turns up we'll be able to go -- we'll grow with the growth in the end-user the machine growth.

Liam Burke - Janney Montgomery Scott LLC

Thank you.

Operator

Our next question will come from Mike Hamilton with RBC.

Michael Hamilton - RBC Capital Markets

Good morning.

Susan Knight

Good morning.

Laura Hamilton

Good morning.

Michael Hamilton - RBC Capital Markets

You deals a little bit more color on trends you are seeing in SANS?

Laura Hamilton

Yeah. So we have been much closer to SANS now for two quarters. And what's difficult about the SANS trend is that the first quarter was probably half about the economy and half about being acquired by a U.S. based company. So it is was really difficult with the early -- they were down, somewhat somewhere we had expected. But there were so many implications of the acquisition and doing business as a U.S. owned company that that had a big effect.

So but if we pull back from that, clearly SANS biggest market is steel, and we saw an abrupt slowdown in steel and now a picking back up of that. And so SANS is probably best positioned from the total company perspective, for their markets in China to kind of maintain closer to '08 levels than the rest of the business. So we definitely see steel picking back up.

Michael Hamilton - RBC Capital Markets

Thanks. You called out the warranty impact in the quarter related to one project. Are we wrapped there or is that going to be carried over?

Susan Knight

No, I don't anticipate that they'll be more. This is a project that was sold a few years ago. We've had some recurring warranty expense associated with it and as we've tried to fix it as is, and this charge really take us to a point that we're replacing some of the key components to change the capability as a machine. So from our perspective this finishes it.

Michael Hamilton - RBC Capital Markets

Coming back around to backlog, any elements worth noting in backlog where you've got ongoing negotiations. I know you'd mentioned in the last call that you were getting some press for deferral or renegotiation?

Laura Hamilton

So I would say that -- not significant. We had its more anecdotal. We actually had one customer who came back, that was Aerospace. Thought they were going to cancel and we went back and forth multiple times and ended up booking -- maintaining the order. So we continued to field the requests and work with the customers to figure out the best solution and we haven't seen a big change increase in activity there. So same level of activity that we had.

Michael Hamilton - RBC Capital Markets

Thanks. Trying to look one more time at outlook on back half of the year and looking at it from revenue to trailing quarter backlog it looks like plan is that you're going to get some escalation in the revenue you put out to prior quarter backlog. Is that a reasonable assessment here and just to function, the environment we're in?

Laura Hamilton

That's a good question. I think when you are saying that we're turning our backlog faster is that what you're asking?

Michael Hamilton - RBC Capital Markets

You can go there, but just on a normal sequential run rate, 50 or low 50s percent revenue to prior quarter backlog. The general math in here would imply that that number starts escalating in the back half of the year?

Laura Hamilton

And that would be tied to my comments about custom being down twice as much. So custom takes longer to turn. So yeah, well our mix of standard aftermarket and service, will be increasing because of the custom being down one.

Michael Hamilton - RBC Capital Markets

Would you anticipate that that metric gets to be less important in the environment we're in?

Laura Hamilton

No, I don't think so. You know the...

Michael Hamilton - RBC Capital Markets

In other words, do we run the ability to ship more within quarter?

Laura Hamilton

I think we'll always be backlogged. What's very difficult is about -- the mix going forward is very important. And so if to your question, if it continues like this and we see much less $1 million and larger business then we'd be more turning in one to two quarters. But it all depends on -- what happens in stimulus isn't necessarily going to be all little (ph). So we don't know mix yet. But clearly the larger dollars have been under more pressure and scrutiny and got turn off the fastest.

Michael Hamilton - RBC Capital Markets

Thanks, and thanks for all of the color on the March quarter as well.

Laura Hamilton

You are welcome.

Susan Knight

Your welcome.

Operator

(Operator Instructions). And ladies, at this time, there are no further questions. Well I'll turn things back over for any additional or closing remarks.

Laura Hamilton

Okay, thank you Vicky. I guess I the one thing that I would like to close with is just the last comment about these are uncertain times but we don't it's not uncertainty about how to act in these times. I think we do feel that we are taking the right step and managing through the uncertainty, and making the tough choices between the short term and the long term. So thank you.

Operator

And that does conclude today's teleconference. Thank you all for joining and have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!