MTS Systems Management Discusses Q3 2013 Results - Earnings Call Transcript

Aug. 6.13 | About: MTS Systems (MTSC)

MTS Systems (NASDAQ:MTSC)

Q3 2013 Earnings Call

August 06, 2013 10:00 am ET

Executives

Susan E. Knight - Chief Financial Officer and Senior Vice President

Jeffrey A. Graves - Chief Executive Officer, President and Director

Analysts

Liam D. Burke - Janney Montgomery Scott LLC, Research Division

Dan Capozzo

Adam M. France - 1492 Capital Management, LLC

John Franzreb - Sidoti & Company, LLC

Operator

Good day, everyone, and welcome to the MTS Systems Third Quarter 2013 Earnings Conference Call. Today's call is being recorded. At this time, I would like to turn the conference over to Sue Knight. Please go ahead, ma'am.

Susan E. Knight

Thank you, April. Good morning, and welcome to MTS Systems' Fiscal 2013 Third Quarter Investor Teleconference. Joining me on the call today is Jeff Graves, President and Chief Executive Officer.

I'd like 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 an isolation or as a substitute for GAAP measures.

Jeff will now begin his update on our third quarter results.

Jeffrey A. Graves

Thank you, Sue, and good morning, everyone, and thank you for joining us for our third quarter investor call. We appreciate having the opportunity to discuss our financial results for the quarter and our outlook for the fiscal year.

In today's call, I'll first discuss key takeaways for the quarter, followed by a summary of our orders and backlog results. Sue will then discuss the rest of the quarterly financials. Following Sue's comments, I'll provide an update on our outlook for fiscal 2013, and then open the call for your questions.

There are 3 key takeaways for today. First, we did what we said we'd do in the third quarter. We communicated in our Q2 conference call that the conversion timing of the Test backlog was heavily skewed to the fourth quarter, so you should expect third quarter revenue will be relatively flat with the second quarter, but earnings will be higher, and that's what we delivered.

Second, orders were down in the quarter, despite having a very strong opportunity pipeline. Our Test customers remain committed to their R&D investments, the delays resulted from increased scrutiny of capital spending given the economic volatility. We believe this is a matter of timing, not direction or commitment on the part of our customers. Sensors orders were up sequentially again this quarter, which is a good sign. I'll provide you with additional context for orders in both businesses in a few moments.

Third, we have the backlog to deliver a strong fourth quarter and are confirming our previous full year outlook range. I'll provide more details after Sue's comments.

Now before I go further, let me remind you about the nature of our 2 businesses and the market dynamics we're now experiencing. The larger of our 2 businesses is Test, which provides highly engineered testing systems and services to product development groups within automotive, aerospace, energy and infrastructure OEMs worldwide. This business is fueled by our customer's R&D and development spending on new products, and these markets are growing in response to strong macroeconomic drivers, which we believe will be sustained for several years to come. This market exposure sets us apart from many other companies.

Our second business 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 been in a multi-quartered trough, driven by ongoing sluggishness in the global economy, from which we are only now beginning to see some modest improvements. With this as a backdrop, let's now review orders for the quarter.

Total company orders for our third quarter were $130 million, down 12% from last year. Adjusted for currency, orders were down 11%. Our first half of year trend of modest growth in Test and a decline in Sensors was reversed in the third quarter as we had year-over-year growth in Sensors for the first time in 6 quarters, which was positive news. Sensors and Test were 19% and 81% of total orders, respectively. Backlog of $283 million is relatively flat compared to the prior year and remained strong by historical norms.

Now I'll provide you with some additional context on orders by business segment, and I'll start with Sensors. This quarter marked the first time in 6 quarters that we've had year-over-year growth, and is the second quarter in a row of sequential increase. Sequential orders were up 3%. While specific end markets, such as the steel and some industrial markets in Europe remain weak, we're pleased to see growing strength in some markets that have historically been tied to the general economy and are trending in a positive direction, such as wood, plastics and fluid power. As we previously stated, inventory levels in the supply chain are very low, so increasing orders is generally reflective of increasing demand for capital equipment.

Sensors orders were $24.9 million, up 2% year-over-year. Adjusted for currency, orders growth was an encouraging 6%. Sensors orders for industrial equipment were flat, as the 22% increase in the Americas and new customer wins in China were offset by a 9% decline in Europe and negative currency impacts from the yen. Sensors used in mobile hydraulic applications experienced a strong upward movement in the quarter, with orders growing 12%, indicating some improvement in volume from the applications we're already on and an increase from previous design wins, which are now being translated into orders as new customer platforms begin to shift. These trends are encouraging.

The cyclical downturn in Sensors that began a year ago appears to now be trending in a positive direction, with 2 sequential quarters of growth. Backlog in Sensors business at the end of the quarter was $15.9 million, up 10% year-over-year. Sequentially, backlog is up 1%.

In summary, we're cautiously optimistic about our recent order trend, but recognize there continues to be the threat of global economic volatility that can impact demand for our Sensors. We've invested in additional sales resources this year, particularly in China, to win new applications for our products. We believe this will continue to not only offset the lower volume on some existing equipment, but it sets the stage for a healthy growth rates in the future.

Next, I'll spend a few minutes summarizing Test markets and orders. Despite a continuing strong opportunity pipeline, Test orders in the third quarter declined 15%. We experienced a continuation of the order timing delays that impacted us in the second quarter. Internally, we track the deferred opportunities in the pipeline so that we can better understand what's happening in our markets. A normal deferral rate is about 50%. This deferral rate was trending up into the low 60s in the second quarter, but further increased in the third quarter to 70%. Our customer is telling us clearly that they must make investments in their R&D infrastructure for Testing in order to support their increasing demands for new products, but they're currently taking a more cautious approach to releasing the capital authorizations and placing purchase orders. While our win rate remains consistent and strong, this increased deferral rate impacted orders in the quarter for our Test business. Test orders in the quarter were $105 million, down 15%. There was a very minimal impact from currency. The large orders, which are highly variable from quarter-to-quarter, were $6 million in the current quarter, compared to $20 million last year. This accounted for 11% of the 15% decline.

Base orders declined 4%, primarily due to softness in the Americas for certain smaller Test systems. Similar to the market results in the first half of the year, ground vehicles led the way with a 17% increase, liquid materials declined 4% and structures was down 71% as there were no large seismic orders this year compared to the $20 million in last year.

In services, we're getting good traction from increased orders for our new offerings, including annuity service contracts and repair and calibration services. With that overview, I'll provide you with some additional color in each of the Test markets.

Beginning with ground vehicles. 17% growth in the third quarter was driven in part by a $6 million rolling road system in the Americas, as the American auto companies reinvest in new product development capacity. Year-to-date, ground vehicles is up strongly at 20%. There are 3 broad categories underlying this growth. First, automotive OEMs and tire manufacturers are spending R&D to improve fuel efficiency. Second, new automotive lab development in China has driven a 34% increase year-to-date in China orders. Based on the strength of our technology, we're proud to have secured major positions in over 70% of the domestic Chinese automotive OEM labs, positioning us well as the China auto consumption expense in the decades to come. And third, motorsports Formula 1 racing companies are using MTS, leading their aerodynamic testing technology to improve their performance. Our ongoing success in Formula 1 testing solutions helps keep our company at the forefront of testing technology for the entire automotive industry.

Moving next to materials testing markets. Orders were down 4% in the quarter and flat year-to-date. U.S. and Canada government orders started to pick up again in the quarter after a weak first half of the year. Demand for static testing -- materials testing systems was up 17% in Q3, and up 7% year-to-date, driven by China. These increases were offset by softness in Europe. The 71% decline in structures in Q3 was largely driven by timing of large projects. There were no large orders this year, compared to 2 large seismic systems last year, totaling over $20 million.

My last comment in this section of my remarks is about the Test order pipeline. Roughly $800 million of pipeline remains strong, up 8% year-over-year. While the recent order delays were disappointing, we're well positioned to win whenever our customers decide to proceed with their projects.

Now I'd like to turn the call back to Sue for additional financial detail on the quarter. Sue?

Susan E. Knight

Thank you, Jeff. My remarks today will summarize our third quarter results based primarily on a year-over-year comparison. Third quarter revenue was $135 million, down 5%. Adjusted for currency, revenue declined 3%. Both Test and Sensors were down on a comparative basis, but this result was consistent with our expectation, given the delivery timing profile of our Test backlog. This quarter-to-quarter lumpiness is characteristic of the Test business.

Summarizing the results by segment. Sensors revenue of $25 million was down 3%. Adjusting for currency, revenue was flat. Europe, our largest market representing 50% of the total business, was down slightly at 2%; Asia declined 9%, driven by currency; and the Americas were flat. Test revenue of $110 million declined 5%. Adjusting for currency, revenue was down 4%. The Americas and Asia were down 3%, and Europe declined 11%. Our third quarter beginning backlog in Test was strong, with project timing skewed to the fourth quarter. We are expecting a record level of Test revenue in the fourth quarter as we work through the backlog to meet our customers' requirements for both shipments and progress on longer-term projects that are in progress.

Moving on to the next topic. At $55 million, gross margin was down 14% on 5% lower revenue. The decline was Test driven. The consolidated gross margin rate declined 4.5 points to 40.4%, still a respectable outcome.

In Sensors, gross margin was flat year-over-year, despite a 3% decline in revenue volume. This was the result of a very strong growth margin rate of 58.7%, up 1.5 points compared to last year, marking the strongest quarterly growth margin rate in many quarters. Both mix and operational variances were favorable.

In Test, gross margin of $40 million was down 18%. Approximately half of the decline was due to lower volume and negative leverage, 30% from product mix and 20% from higher operational variances, including higher engineering indirect costs and warranty.

Planned investments and facility improvements and service expansion also increased costs in the quarter, and they are foundational for achieving the growth in both products and services in the future. At 36%, the gross margin rate was down 6 points compared to last year and flat compared to the previous 2 quarters. Higher volume is expected to drive a higher gross margin rate in the fourth quarter.

My next topic is operating expenses. At $38 million, expenses were down $7.3 million or 16%. Adjusting the prior year's expense for the $7.8 million government settlement cost, expenses increased $0.5 million. Higher R&D investments and sales cost were partially offset by lower professional service and consulting fees and lower variable compensation expense. As a percent of revenue, operating expenses were 28%, down 4 percentage points year-over-year, reflecting the actions we took early in the third quarter to curtail discretionary spending, given the order delays.

At $16.8 million, EBIT declined $1.5 million. Comparing year-over-year results, excluding the government settlement cost, EBIT declined $9 million or 35% because of lower gross margin as previously discussed.

EBITDA as a percent of revenue was 12.5%, compared to 12.9% last year as reported, which included an approximate 5.5 point negative impact from settlement costs. Sequentially, the EBIT rate increased almost 2 percentage points, with the key point that we committed to in our last communication.

Transitioning next to tax. The quarterly rate was approximately 31%, compared to approximately 48% last year. The prior year's rates was negatively impacted by approximately 14 points due to the settlement costs, which were nondeductible for tax purposes. Adjusted, the prior year rate was approximately 34%. The remaining 3 percentage point decline this year is primarily related to the R&D tax credit and the year end tax return true-up.

Earnings per share of $0.72 was up 22% on a reported basis, and down 33% adjusted for the impact of the government settlement.

Finally, I'd like to close with some comments on cash. At the end of the quarter, the cash balance remains strong at $54 million, up $7 million from last quarter. We had $17 million of operating cash flow that was driven from earnings. Working capital increased $5 million. The higher levels of unbilled receivables and inventory were built in preparation for a strong fourth quarter. The decline in advances due to fewer orders over $2 million also contributed to higher working capital utilization. These increases were partially offset by good progress on customer collections, which resulted in a $14 million reduction in billed receivables.

Additionally, capital expenditures were $9 million, and we paid $5 million in dividend. In the quarter, we completed our $35 million accelerated share repurchase agreement, retiring an additional 128,000 shares in addition to the 533,000 shares that were retired at the beginning of the program last September. This represents approximately 4% of the outstanding shares of the company. Since we have completed the accelerated share purchase, we did implement a 10b5-1 repurchase program in the third quarter as we continue to deliver excess cash to create shareholder value.

That concludes my prepared remarks for today. I'll turn the call back to Jeff for his final comments. Thank you.

Jeffrey A. Graves

Thanks, Sue. My final topic before we take questions is our outlook for the full year. As communicated in our last call, the Test backlog conversion in our fiscal fourth quarter is expected to be high, resulting in record full year revenue. Thus, we're pleased to confirm our full year outlook range for revenue of $560 million to $575 million, which equates to a 4% to 6% organic growth rate for the year. We're also narrowing the EPS range to $3.30 to $3.60, reflecting the expected mix of products and services in the quarter. With record volume flowing through our Test plants, and a robust pipeline of future opportunities, we're continuing our infrastructure upgrades, primarily centered on our IT systems and business processes and Test. These investments will allow us to not only increase our order intake rates but deliver products with increased efficiencies and provide great aftermarket service support to our customers, enabling our future growth. With our technology leadership position, our outstanding customer base and a modernized infrastructure for executing our Test business, we're excited about the future at MTS.

That concludes our prepared remarks. I'll now turn the call over to April for the Q&A session. April?

Question-and-Answer Session

Operator

[Operator Instructions] And we'll first hear from Liam Burke of Janney Capital Markets

Liam D. Burke - Janney Montgomery Scott LLC, Research Division

Jeff, could you give us a little more color on the progress you're making on the aftermarket service and product initiatives?

Jeffrey A. Graves

Yes, Liam. It's really pretty much tracking right on plan. I mean, we've been in a real hiring mode the last, oh gosh, the last 6 quarters of hiring basically field techs and some higher level of service technicians to either call on the customers or live with customers. That training period unfortunately ranges from 6 to 12 months, so we've been in that mode for the last 6 quarters. Those folks are starting to get some real traction. We got more folks than ever on site with customers, and that continues to drive growth in the service operations and spare parts business around the world. So I'm really pleased with the progress. We expect double-digit kind of performance this year in terms of service growth, and I think it's really tracking right where we thought it would be.

Liam D. Burke - Janney Montgomery Scott LLC, Research Division

Great. Sue, you sort of outlined the working capital needs for the quarter and then year-to-date, where you're still in a negative cash flow position. Understanding that you didn't have the prepayments of some of the larger projects, do you still anticipate working capital trends to reverse to the point where you'll be cash flow positive for the year?

Susan E. Knight

We do. Given the investments we've made in the third quarter to position a strong fourth quarter, we expect that to turn positive from a cash flow point of view relative to working capital in Q4.

Operator

[Operator Instructions] And we'll hear from Dan Capozzo of Invicta.

Dan Capozzo

Yes, just going back to the services business. Can you help us kind of get a sense of this in terms of the investments and the infrastructure when you expect that to kind of tail off? And then also, just kind of looking on a year-over-year basis, the services revenue looks about flat. So just, again, trying to understand when we could start seeing some of the growth start to materialize.

Jeffrey A. Graves

Yes, Dan. Along those lines, in terms of the investment, there's 2 parts of the investment. And part of it is the people investment, in terms of hiring and training folks that I just commented on. And once those folks actually get to the field, you'll start seeing the benefit of them. So I think, again, you'll start seeing growth in -- a more substantial growth in Q4 and throughout next year as those people really get traction in the field. In terms of the investment requirement, the other part of it is an IT investment. Basically, as you develop the field sales force, you have to have very routine things, like scheduling programs and parts ordering systems that are modern and up-to-date. So just to make the field force efficient. So we're making those IT investments now. Those will extend through next year and really, hit the ground running with those and in the full year roughly '15 for us. So they'll be coming online throughout '14. So there's an IT investment, there's a people investment. Again, I'm anticipating this year kind of 10% growth rates, Dan, overall in services. And not only from the people aspect of conducting the service, but also the new offerings that we have out there in terms of just trying to sell value packages with our equipment for extended maintenance and warranty. So we'll -- we would expect to see, from an order standpoint, being up 10% on the year this year in services. That will flow through the revenue, and I would expect that double-digit growth rate to continue then in the next year to come.

Dan Capozzo

Okay, great. And then just thinking, again, with the growth rate here, given the kind of bookings seem to be flattening out a little bit. Is the real uptick kind of a 2015 story as the services fix...

Jeffrey A. Graves

Well, there is the service element to it, which I think you'll see a continuous rise throughout '14 and beyond, Dan, and with the ticking up more dramatically in '15. But I do think you'll see a nice lift in '14. Again, our orders should be up 10% this year, which will be reflected in the higher revenue levels next year, and then I think you'll see a higher slope to that starting in '15. From an equipment standpoint, it's interesting. I mean, we were on a real terrain in terms of new order rates coming in. Q3 was interesting. We saw an uptick in deferrals. We started to see it a little bit in Q2. We saw an uptick in deferrals of projects in Q3. I spend much of the quarter on the road visiting some of our key large OEMs around the world in Europe and Asia, and their infrastructure investment continuous, but their purchasing departments are more involved. They were looking at the time of order flows and just managing their cash as they look into an uncertain economy. So I'm really pleased with the outlook in, say, over the next few years. I mean, clearly, the need for new product development of our customer base is enormous, I mean growing, driven by the emerging markets largely and other dynamics we've talked about with energy and environmental concerns. So that underlying demand is still there and very strong. The order timing rate, clearly, customers are managing cash and looking hard on when they place purchase orders for equipment. These are generally long lead time items, so I'm happy when I go and I see the foundation of a building going in or other investments that are going to call for the equipment to arrive. But we're generally the last equipment to make it to site when they're finishing a laboratory. And clearly, they have some ability to move an order around. So our pipeline remains very strong, our deferral rates of orders that we expect to win are -- is up, but our win rate remains very high. So in -- I'm always concerned about 1 quarter or the next quarter in terms of order flow, but looking out for 3 years, I think the demand, clearly, is remaining and continues to grow.

Dan Capozzo

Okay. Great, that's helpful. And just on the backlog. Can you give us a breakdown by geography and maybe what the China concentration is on the backlog?

Jeffrey A. Graves

Yes. We don't usually provide that kind of granularity, Dan. And I certainly don't have the numbers in front of me. But it's an interesting business because the -- where customers spend R&D money doesn't exactly correlate to where their factories are at and where they're making other investments in the world. So for us, in terms of our ground vehicle or automotive segment, Europe is -- continues to be strong. China, clearly, overwhelmingly, is the big force to us across most of our markets. It's moving. It continues to be what we call a developing market, but it's enormous for us. It's probably 1/3 of our revenue now, roughly, and it continues to be a great opportunity for us from materials to structures to ground vehicles, and we see continued growth in that market. So it really doesn't matter what segment you talk about. And even our Sensors business, China is just a terrific market as more and more -- the OEMs are either moving there whole. You see the rise of domestic Chinese OEMs that we can service with our technology. So you'll hear us talking about China more and more and other developing countries as they come along the same path.

Operator

Next, we'll hear from Adam France of 1492 Capital.

Adam M. France - 1492 Capital Management, LLC

Jeff, can you speak to what kind of business you're doing in Japan? Allegedly, the economy is being goosed back into shape over there, and I was just curious how you see that market.

Jeffrey A. Graves

Yes, it's interesting, Adam. I was just over there a couple of weeks ago with our sales team. And boy, what a change. With the currency devaluation that's gone on under their leader now, you really see a goosing the automotive industry, certainly, and I think they're counting on that to revive much of their economy. So you see a lot of excitement. There's a lot of folks talking about growth again, and you'll even see some construction going on. So I'm actually excited about the Japanese market, like most OEMs. A lot of the Japanese automotive guys, for example, a lot of their growth is outside of Japan. But still, a lot of their laboratories are in Japan. So again, for us, we have to manage our customer base in their home country and in the emerging markets very closely because up until the last minute, they're trying to decide where they will put these new laboratories. So I'm actually optimistic about Japan. I think it looks good for us in the future. Our customers are stronger than ever. And if you'd watch their earnings reports, they're doing well. It's a little bit different markets than the German automakers or American automakers are participating in, but very strong. So I just returned from Japan probably more upbeat than I have been in several years about the internal growth on the island and then also, the Japanese companies growing outside of Japan.

Adam M. France - 1492 Capital Management, LLC

Okay. I don't know if you've talked about this in the past, and again going back to the issue as to where the equipment goes, from what company. But how much business are you doing in Japan? Is that 5% of your total revenue base? 10%? What do you have there?

Jeffrey A. Graves

Well, it varies tremendously by market. So if you look at automotive, clearly, it's a very important business for us. You look at the successful OEMs in the world, clearly, the Japanese rank up there among the very best, and we value their business. They're growing all over the world. If you look at the structures market with seismic testing systems and things, the Japanese have always been aggressive there because they're subject to a lot of earthquakes and tsunami risk. So that's, again, a very, very good and consistently strong market for us over the years, lumpy, but a very good market for us because they are some of the leaders in building construction designs for earthquake resistance. And materials testing has been small but consistent for us there. So I -- we don't provide detailed numbers on Japan, but those markets are really very important to us. I think in our K, you can actually dig down to that level of detail.

Susan E. Knight

For revenue. You can see revenue for Japan in our 10-K.

Dan Capozzo

And if you have any number, Sue?

Susan E. Knight

T

I don't know it off the top my head, but...

Jeffrey A. Graves

Between that 10% kind of range for us. And I would caution you. It's probably very lumpy because some of these big seismic systems, when they go in, they can drive a year, yes. But all in all, Japan is a key market for us as is Germany, the Americas and, obviously, the emerging market for future growth. So very important place for us, and we continue to look hard at investments there.

Operator

And next we'll hear from John Franzreb of Sidoti & Company.

John Franzreb - Sidoti & Company, LLC

I apologize if you addressed some of these questions because I've bouncing in between conference calls, and so just give me a one-word answer. But looking at the services revenue, sequentially, June versus March, why the drop in the revenue and also, in the gross margin profile of that business.

Jeffrey A. Graves

Sue, you want to take that one in detail? I can comment directionally on it as well.

Susan E. Knight

Sure. So John, even in our service business, we have differences in the margin rate and the timing depending on how much service contract work we do. Let's say, a 12-month service program versus a break fix, some of these machine quit working. We went out and charged by the hour for labor and part. So we broadly talked about a mix relative to the whole Test business. That is also applicable to service depending on whether it's contract based or whether it's spot service. And it is going to vary from quarter-to-quarter. But roughly, over an annual period, it's about 50% gross margin.

Jeffrey A. Graves

So as a general takeaway, John, we continue to model that businesses about a 10% premium business in terms of gross margin performance. Sue mentioned 50%. We look at that our Test equipment business, it's kind of a 40% business the -- on average, and the services business should be 50% or better. And in terms of overall growth rates, again, I mentioned earlier, John, we expect kind of 10% orders growth this year. So we should be in a double-digit revenue growth range for next year and continuing that momentum and seeing an increase beyond. So some of our investments we made over the last 1 year to 1.5 years were getting traction now. So you'll see an uptick in orders and then -- and again, it's very high-quality business for us.

John Franzreb - Sidoti & Company, LLC

No, I agree. I just -- i was surprised by the 10 point margin differentials. I always assumed it was a 50 point business. I -- we've come before around -- in the mid-40s. I was just curious if there was any thing I needed to know about that.

Jeffrey A. Graves

No.

Susan E. Knight

No.

Jeffrey A. Graves

Yes. Don't change any of your assumptions from history, John. That's the quality of business it is.

John Franzreb - Sidoti & Company, LLC

Okay. Great, Jeff. And you had originally put a targeted take in that business to 15% to 30% of revenue. What's your comfort level with that target, given the macro conditions today?

Jeffrey A. Graves

Yes, it's always a matter of timing, John. But, yes, we should be at that 30% kind of number. I mean, our customers, I've been in, now, several different industries in my life, and this business clamors for service. And it's in the -- it's interesting. In the mature markets, you've got all of the OEMs looking to take cost out of the business, and their -- some of their lab leaders are retiring, things like that. So those are the drivers for growth there. In the emerging markets, you've got a lot of new folks buying equipment, very complex equipment, who are concerned about running it over the next 10 to 20 years. So we -- the way we estimate that market, John, it's -- it continues to be our -- by our definition, bigger and bigger. And we've got -- we sit here today with $3.5 billion worth of installed base. So getting that number to 30% of our overall revenue, well, yes, looking out over the next 5 years is very easily imaginable. And again, it's -- you always hate these investment periods, and we continue to work our way through that, but we're hiring and training a lot of folks in service and we're putting an IT infrastructure to use them efficiently. And you'll really start seeing that stuff get traction somewhat in next year and certainly, in FY '15.

John Franzreb - Sidoti & Company, LLC

Okay. And again, if you touched on this, I would withdraw the question. But I've heard a lot about deferrals in large project businesses across multiple industries. It seems to be a seeping phenomena. One concern I always have when that happens is that the pricing environment becomes more aggressive. Have you noticed any change in pricing on new jobs?

Jeffrey A. Graves

No, I would tell you, John. Our margin rate on -- our ships margin rates continue to be very strong. We've -- because of our level of technology, and again, these are areas where customers don't want to take a risk when they buy stuff. Generally, that really helps us in terms of pricing support and encouraging us to embed a lot of engineering content and the best technology every day. It's -- everything's competitive in the world. But truly, our technology is pretty compelling. So they may change their mind on exactly when they want to place a purchase order. But in terms of bringing in additional competitors and trying to broaden the base, it is there, but it's not -- I wouldn't categorize this as severe or increasing. It's just is what it has been historically.

Operator

Dasari Nadaqui [ph] of Schroders.

Unknown Analyst

So I want to check in with you on the outlook for the Test orders. I mean, you still seem to have 2 quarters of large orders ahead of you. So wondering if you can kind of parse out your visibility for the next 2 quarters on how you see the large orders versus base orders, how we should think about it if you have -- if you do have that level of visibility.

Jeffrey A. Graves

Well, we certainly see them in the pipeline, and there's a lot of large orders in our future pipeline out there. The problem is it's most highly variable in terms of timing quarter-by-quarter because, again, these are generally large capital investments for our customers. And they can easily juggle. Well, I shouldn't say, easily. But they can juggle them from one quarter to the next. So our opportunity pipeline continues to be very strong and growing. We did see an increase in deferral rate, primarily from big project sales, with some small ones, too. But primarily from big projects, we see -- we saw an uptick again in Q3 of deferral rates. So it means the opportunity stays in the pipeline, but gets pushed out in time. So I -- it's almost impossible for me to comment looking out in like 1 quarter or 2 quarters to say, "Yes, this is what I expect." But I can tell you over the next 2 to 3 years, the pipeline remains very strong, and I've been there and physically seen the level of investment and the preparation customers are doing for to expand their product development and its substantial. So I believe our numbers, I believe the pipeline opportunities.

Unknown Analyst

So when we think about the next quarter, you kind of talked about a little bit better outlook for the fourth quarter. That's more driven by the base orders, your expectation for the base order growth?

Jeffrey A. Graves

Well, in terms of -- well, our comments around the fourth quarter were primarily in terms of revenue. Because Test is a backlog-driven business. Coming into the quarter, a lot of it is sitting in backlog and ready to turn through. So we can still have some small surprises, which manifest themselves, maybe, in volume or a little product mix. But when we talk about the fourth quarter, our revenue and earnings outlook for the full year, which is really down to the fourth quarter now, we have some level of confidence because a lot of it's sitting in backlog.

Unknown Analyst

But I was surprised because your book-to-bill came, I think below 1 for that business, so that -- I was trying to put that together, your comment on revenue outlook versus slightly weaker bookings.

Jeffrey A. Graves

Well, yes. So remember it's a backlog business. So what we'll turn in Q4 was largely booked. Well, it's almost all booked in prior quarters, all right? So even if the book-to-bill really affects next year more than this year, and again, it's highly volatile quarter-by-quarter. So we -- I'd love to see that deferral rate drop. It ticked up again Q2 to Q3, so I don't want to see customers to, say, push out orders. But it's -- it really is, when we talk about orders in our Test business, we're really talking about next year now in terms of that.

Operator

And it appears there are no further questions at this time. I'll turn the conference back over to our presenters for additional or closing comments.

Jeffrey A. Graves

Thanks, April. Thank you, all, for joining us on our call today. While Test orders in the third quarter were softer than we wanted, revenue and earnings were in line with our expectations, and we are positioned to deliver a strong finish to the year in the fourth quarter. We look forward to updating you again next quarter on our performance. Thanks, and have a great day.

Operator

And that does conclude today's conference. Thank you, all, for your participation.

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