Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

MTS Systems (NASDAQ:MTSC)

Q4 2013 Earnings Call

November 15, 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

John Franzreb - Sidoti & Company, LLC

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

Adam M. France - 1492 Capital Management, LLC

Daniel Capozzo - Kern Capital Management LLC

Operator

Good day, and welcome to the MTS Systems Fourth Quarter 2013 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Ms. Sue Knight, Senior Vice President and Chief Financial Officer. Please go ahead, ma'am.

Susan E. Knight

Thank you, Aaron. Good morning, and welcome to MTS Systems' fiscal 2013 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.

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

Jeffrey A. Graves

Thank you, Sue. Good morning, everyone, and thank you for joining us for our fourth quarter investor call. We appreciate having the opportunity to discuss our financial results for the quarter. I'll also provide you with a quick recap of fiscal 2013 and our outlook for fiscal 2014, which began in October. 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 briefly summarize highlights of fiscal year 2013 and provide you with our outlook range for fiscal '14. I'll then open the call for your questions.

There are 4 key takeaways for today. First, we had an excellent fourth quarter, delivering the highest levels of orders, revenue, EBIT and EPS in our company's 47-year history. Both our Sensors and Test businesses had year-over-year and sequential quarter financial performance improvements. We're very pleased about the commercial and operational strength we demonstrated in Q4.

Second, we did what we said we'd do, delivering our revenue and EPS results for the full year that were above the midpoint of our guidance range. Revenue was $569 million compared to a forecasted range of $560 million to $575 million. And earnings per share were $3.64, including an unanticipated tax benefit of $0.12 per share compared to the guidance range of $3.30 to $3.60. We feel very good about this performance.

Third, looking ahead, we expect to begin realizing productivity and cost savings benefits from the significant IT capital investments and accompanying business process improvements that we've been making over the last 18 months. These changes are often complex and challenging to implement, but the benefits in productivity and in our ability to grow efficiently our business in the years ahead are substantial. In realizing these improvements, we'll be taking a nonoperating charge of $4 million to $5 million in the first 6 months of fiscal 2014 to adjust the workforce. These changes will provide a current year cost savings of $4 million to $5 million, and save over $6 million annually in fiscal 2015 and beyond. Equally important, they'll create a robust and scalable platform for growth in the years ahead.

Fourth, our outlook for fiscal 2014 considers a continuation of modest global economic growth, which is consistent with the expectations of many other industrial companies. Our opening backlog of $290 million, which is $8 million lower than it was a year ago, driven in part by improved backlog conversion rates and general continuing strength in our end markets. Netting these effects for the full year of fiscal 2014, we are now expecting 3% to 6% revenue growth. From an earnings perspective, we anticipate 2% to 6% EPS growth in fiscal 2014, driven by higher revenues, offset by continued accelerated investments in R&D, sales and service personnel. This EPS guidance excludes the anticipated restructuring charge and the $0.15 favorable impact of the nonrecurring tax benefit from fiscal '13.

Before I discuss the results for the quarter, let me remind you again 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 the automotive, aerospace, energy and infrastructure OEMs worldwide. This business is fueled by our customer's research 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 control systems. These Sensor markets are directly tied to industrial capacity utilization and heavy equipment demand, which have been in a multi-quarter trough, driven by ongoing sluggishness in the global economy, from which we are only now beginning to see modest improvements.

With this as a backdrop, let's now review orders for the quarter. Total company orders of $160 million was a new quarterly record, as both Sensors and Test posted strong growth in the fourth quarter. Total company orders increased 9%, our strongest year-to-date. Adjusted for currency, orders were up 10%. Sensors and Test were 16% and 84% of total orders, respectively.

Backlog of $290 million was down $8 million compared to the prior year, but remains relatively high compared to historical norms. This slight decline was driven in part by a higher backlog conversion rates produced from our investments in upgraded manufacturing processes and systems. We expect these improvements to not only be sustained, but to continue to improve as our system upgrades are completed in the months ahead.

Now I will provide you with additional context on orders and backlog by business, and I'll begin with Sensors. This quarter marked the third quarter in a row of sequential growth and the second quarter in a row of year-over-year growth, which is a good indication of that our end market conditions are now trending in a favorable direction. Also encouraging were 4 large blanket orders placed in the quarter in excess of $500,000. This is a strong signal of customer confidence and improving market demand.

Sensor orders were $26 million in the quarter, up strongly at 13% year-over-year. Adjusted for currency, orders growth was 15%, with increases in both industrial and mobile hydraulics markets. Orders for industrial markets were up impressively at 11%, driven by demand in all 3 geographic regions. The primary growth markets this quarter were medical, energy, wood, tire manufacturing, steel and fluid power markets. Even more encouraging, at 19%, the growth in mobile hydraulic orders was almost double that of industrial. Strong demand in the Americas and precision agriculture and construction markets more than offset lower volume in European road building machinery and truck mounted cranes.

Backlog in our Sensors business at the end of the quarter was $15.1 million, up 16% year-over-year. Sequentially, backlog grew 2%. In short, we're very pleased with our continued growth in Sensors for the quarter, the strengthening demand from our traditional markets and good progress on new OEM wins, particularly in the growing China market.

Now I'd like to spend a few minutes summarizing Test markets in orders. Our Test business delivered a very strong quarter with 8% growth in orders. Adjusted for currency, the growth rate was 9%. The deferral rate of opportunities in our pipeline dropped to the lowest level of the year to 63%. This follows a 70% rate in the third quarter and a 66% rate in the first half of the year, however, 63% remains above the FY '12 rate of 56%, an indication that customers remain somewhat cautious about spending money on large capital investments.

Test orders in the quarter were $134 million, up $10 million over prior year. Base orders, which are orders less than $5 million were a record $125 million, an increase of 25% year-over-year. This result was attributable to exceptional growth in China ground vehicles.

Large orders, which are highly variable from quarter-to-quarter, were $5 million for 1 order in the fourth quarter compared to $20 million for 1 order in the prior year.

From a market perspective, our ground vehicles segment remained strong, while materials was relatively flat and structures was down year-over-year due to the $20 million seismic order from the prior year that did not repeat.

With that overview, I'll now provide you with additional color in each of the Test markets. Beginning with ground vehicles, 45% growth in the fourth quarter was the largest quarter this year, capping an excellent year of growth at 26%. We continue to capitalize on our technology investments and testing systems for tire and rail products and to create value from our sales force expansion, particularly in China.

From a geographic perspective, Asia increased 52%, while Europe and the Americas delivered growth of 44% and 24%, respectively. Overall, the strong alignment of our differentiated technology is enabling our ground vehicle customers worldwide to solve their development challenges, driven in large part by fuel efficiency and emission requirements.

Moving next to materials testing. Orders were down 3%. Generally speaking, the broad materials market was flat, but rock mechanic testing systems were down year-over-year compared to a peak fourth quarter in fiscal '12, which was driven by oil and gas exploration applications. Despite a modest result in the quarter, we're very encouraged that the mix of products purchased has shifted to our newer Acumen, Criterion and Landmark products, replacing legacy, electromechanical and servohydraulic products from the past. For the full year, material orders were essentially flat.

The 43% decline in structures was entirely large order-driven. There were no large structures orders this year compared to the $20 million last year. Seismic and other large order volume was also down for the full year. On a positive note regarding market trends, we did win a key large pipe connector system -- test system order in the Americas for oil and gas. This win reinforces our belief in the growing opportunity for testing of oil and gas products, ranging from deep sea oil drilling to fracking on the production side, to refining and transmission on the delivery into the market. These very demanding applications and environmentally sensitive industries play to the strength of MTS testing technologies and know-how built over the last 5 decades.

We're also pleased that our Test service orders were up 38% in the quarter. This increase was driven by multiple large annuity service orders globally, including 1 lab management contract in Europe. Our investments in service staff and new offerings are beginning to pay off, and we're excited about this growing part of our Test business.

My last comment in the Test order section of my remarks is about the order pipeline, which is our 12-month look ahead on orders opportunities. At $833 million, the pipeline is healthy, up 9% year-over-year and up 6% sequentially despite a very strong orders result in the quarter. This bodes well for continued growth in the year ahead.

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

Susan E. Knight

Thank you, Jeff. My remarks today will summarize our fourth quarter results based primarily on a year-over-year comparison basis. As Jeff noted, fourth quarter revenue of $155 million was a record high, exceeding our previous high of $143 million in the first quarter of this year by a significant margin. Revenue growth in the quarter was 12%. And adjusted for currency, revenue was up 13%.

Both Sensors and Test delivered double-digit growth as new order rates accelerated and the Test backlog was processed to meet customer requirements for shipments and make progress on longer-term projects. In short, we did what we said we would do in last quarter's call.

Summarizing the results by segment. Sensors revenue of $26 million increased 10% year-over-year. Adjusting for currency, revenue was up 13%. It was also the third sequential quarter of growth, up 6% compared to the third quarter.

Revenue in the quarter for Sensors was driven by short cycle orders, which were up 10% year-over-year. At 23%, growth in the Americas led the way, followed by 6% growth in Europe and 3% growth in Asia.

Test revenue of $129 million was up strongly with growth of 13%. Adjusting for currency, revenue was up 14%. The backlog term rate accelerated in the quarter from operational process improvements, strong evidence that our capital Investments are delivering results.

Geographically, Asia revenue growth of 30% was great. The Americas grew 5% and Europe declined 6%. These geographic growth rate differences are most reflective of the backlog mix and the specific projects that are currently in process and are not an indication of the more recent order trend. We expected record revenue in Test, and it was accomplished.

The next topic is gross margin. At $67 million, gross margin was up impressively at 16% from leverage on 13% higher revenue. It was our strongest quarter year-to-date on both a dollar basis and a rate basis. The consolidated gross margin rate of 43.2% was the highest quarterly rate in fiscal 2013, and up 1.5 points year-over-year.

In Sensors, gross margin was up 17% to $15 million. Approximately 2/3 of the increase was attributable to higher volume and 1/3 from a higher gross margin rate. The 57.2% rate in the quarter was excellent, up sharply compared to 54% in the prior year.

In Test, gross margin of $52 million increased 16% on 13% revenue growth. Approximately 75% of the increase was volume-related and 25% from a higher gross margin rate. Test had the strongest gross margin rate year-to-date of 40.3%, a 1.2% increase over the prior year.

My next topic is operating expenses. At $39 million, expenses were up 9% on 12% revenue growth and in line with our expectations for the quarter. Essentially all of the increase was in selling and marketing, reflecting our year-over-year growth investments in both Sensors and Test. As a percent of revenue, operating expenses were 25%, which was 1 percentage point lower than the previous year. It was also below our typical rate to revenue of 26% to 27% driven by volume leverage.

Moving on to EBIT and EBIT rate. At $27.6 million, EBIT increased significantly by $6.1 million or 28%. This result was driven by the higher gross margin and net of $3 million of higher operating expenses. Sensors and Test EBIT were up 14% and 33%, respectively. As a percent of revenue, EBIT also increased significantly, up over 2 points to 17.8%. This was a postrecession quarterly high.

Both Sensors and Test delivered strong, higher year-over-year EBIT rates; Sensors at 23.5% and Test at 16.7%.

Transitioning next to taxes. The quarterly rate was approximately 22% compared to 29% last year. The rate is lower, primarily due to recently issued guidance related to the U.S. R&D tax credit. This resulted in a tax benefit of $2 million, which reduced the rate by approximately 7 points compared to the prior year.

At $1.36, this was the first quarter in our history that we've achieved earnings per share in excess of $1, and we came in significantly above this milestone. Earnings per share was up 45% on essentially a flat share count.

And finally, I'd like to close with some comments on cash. The cash balance remains healthy at $48 million, and we ended the quarter with net cash of $13 million. While the fourth quarter is typically a strong operating cash flow quarter for us, the timing of our revenue growth in the quarter was heavily skewed to August and September, negatively impacted our cash conversion cycle. Thus, we used $4 million of operating cash flow, driven by $30 million of working capital increases.

$20 million of the $30 million is from higher receivables, which should convert to cash in the first quarter. The remainder is from the normal drawdown on advanced payments as a result of progress on projects. Typically, the advances are replenished with cash flow from new large custom orders, but the orders booked in the last couple of quarters have been smaller orders, which typically don't have advanced payment terms as attractive as the large orders. Our current business mix is requiring a higher level of working capital -- capital than we've had in some time.

Additionally, capital expenditures were $7 million, and we paid $5 million in dividends. We purchased approximately 350,000 shares or $21.7 million in the quarter as well.

In summary, we had an excellent quarter and I'm very pleased with our overall performance. That concludes my prepared remarks for today. I'll now turn the call back to Jeff for his final remarks. Thank you.

Jeffrey A. Graves

Thanks, Sue. Next, I'd like to provide you with some summary level context about fiscal '13, both as a reflection of our results and as a backdrop to consider our outlook range for fiscal '14.

Overall, we delivered a solid year performance in a global economy that seemed to go 1 step backward for every 3 steps of forward momentum. While our Test order pipeline remained strong and Sensors orders started to grow again in the second half of the year, orders of $567 million was essentially flat year-over-year as Test customer order deferrals escalated in the middle of the year. Despite low orders growth, revenue was up 5%, driven by a higher backlog conversion rate in Test. A testament to the operational improvements that are underway at MTS.

Thus, we'll begin fiscal '14 with $8 million less in backlog than we had at the beginning of fiscal '13. Our earnings per share of $3.64 was very healthy, but less than we expected when we began the year. Orders pushed out some revenue, we reduced discretionary spending, but we continued on with critical productivity and growth initiative investments that will enable us to accelerate innovation, capture the rich opportunities in the emerging markets and realize the potential of our services business. Even with an accelerated level of investment, EPS still grew at 13% as reported, but down 1% adjusted for the fiscal 2012 government settlement cost. We're proud of our progress on our initiatives, including the launch of our new Echo product and the Exceed materials testing product line.

Our backlog term [ph] acceleration and our fourth quarter orders momentum as we begin a new fiscal year. So let's now transition to our outlook for fiscal 2014. I'll also provide you with some quarterly insight, as the backlog mix will result in first half, second half year lumpiness that is somewhat greater than we had in fiscal '13.

There are 4 aspects to our fiscal '14 outlook that I want to walk you through today. The full year guidance ranges for revenue and EPS, the profile of first and second half growth, the Q1 restructuring charge and, finally, our growth plans relative to our $1 billion revenue goal.

The first topic is the outlook for the full year. From a global economic perspective, while we expect continued volatility throughout the coming year, for the full year, we're anticipating a modestly stronger European outlook, while the rest of the world strengthened slightly faster compared to fiscal '13. This should result in mid-single digit orders growth, a marked increase compared to fiscal '13. Depending on the order timing, the majority of the orders will convert to revenue and the remainder will replenish backlog.

As I mentioned previously, our opportunity pipeline is very strong as our customers remain committed to their R&D investments. These investments are essential to their businesses in that they enable continuing competitiveness in meeting their rapidly changing customer needs for new products and higher efficiency equipment. We're confident about the value that our Sensors and Test solutions bring to our customers, even though the timing of their purchase decisions is less clear on a quarter-by-quarter basis in the continuing volatile regional markets in which they increasingly operate. Given all of these factors, our full year revenue growth for fiscal '14 is expected to be in the 3% to 6% range, equating to $585 million to $605 million.

Considering both the quarterly revenue profile and the continuation of our growth and productivity investments, earnings per share, excluding restructuring costs, which I'll talk about in more detail in a moment, is expected to be $3.55 to $3.70, as it will be another year of investment for growth. This represents a negative 2 to positive 2 growth range on an as reported basis. Adjusting for fiscal '13 results for the $0.15 benefit of the non-recurring R&D tax credit, earnings per share year-over-year will be 2% to 6%, up over prior year, similar to the revenue growth range.

The second topic is the first and second half year profile. In addition to the order timing variability by quarter, we'll begin fiscal '14 with $8 million less in Test backlog than a year ago, and several custom projects in backlog. Our business by quarter is always lumpy and fiscal '14 is not an exception. On a quarterly basis, we expect Q1 to be the smallest revenue quarter of the year as our backlog in Test is being replenished, followed by sequential growth in each of the subsequent 3 quarters. First quarter revenue is expected to be in the range of $139 million to $144 million, and EPS is expected to be $0.65 to $0.75 before the impact of the restructuring cost.

Similar to revenue, EPS is expected to grow sequentially beginning in Q2. Combined, these conditions will result in a Q1, Q2 revenue growth that is flat to up 2%. The growth in the second half of the year will be 6% to 8%. We believe this is solid performance given the global economic environment and represents a balanced view of risks in our end markets.

The third topic is restructuring. Over the last two years, we have made significant capital investments in the Test operations to optimize existing business processes and tools in order to more efficiently meet our customer's requirements for processing quotes and orders, designing and manufacturing products and providing aftermarket support. In short, we've now automated several global processes that were previously done manually. This reduces the need for approximately 60 positions in the U.S. and Europe, so we're taking a $4 million to $6 million restructuring charge in the first quarter, reflecting this adjustment. The partial year savings in fiscal '14 will be roughly $4 million to $5 million.

Annually, the savings will be over $6 million. This restructuring will allow us to shift resources to R&D, sales and service to fuel growth, as we strive to meet our customer's increasing demands around the world. We're excited that we'll begin to realize the planned return on these infrastructure investments.

And finally, I want to comment on our outlook for growth over the longer-term. A year ago, when I introduced the goal of becoming a $1 billion company, I stated that it will take some time to build up to the double-digit compounded annual growth rate that's inherent in this goal, with the target of reaching it in 2018. That's because we needed to build the necessary infrastructure of people, processes and systems, which are key to being able to grow reliably to this scale. Combined, these initiatives will drive higher order growth rates in our service and short cycle businesses, reducing our historical quarterly lumpiness, shortening our cycle times from order to delivery and reducing our operating costs. Given the macro trends of a rapidly growing consumer base in China and across emerging markets, the scarcity of energy globally and the increasing environmental regulations required to deal with rising pollution levels in the emerging markets, as well as the changing demographics in our specific marketplace, we have sustainable, long-term tailwinds to our business.

In addition, we have some of the strongest customers in the world that we've served for decades, and that are spending ever more money on R&D and product development to meet these global challenges. Therefore, we continue to believe strongly that double-digit growth rates are highly attainable in our business. This belief is what drives our investment strategy and our pace. However, while the positive macro trends are undeniable, the near term economy is more volatile than we would have expected a year ago as our customers generally have grown more cautious over the last year, and deferred many large capital equipment purchases into the future. The FY '14 revenue growth rate of 3% to 6% is an example of the net effect of these short and long range pressures. Therefore, looking to the longer-range forecast, while the economy will ultimately be a key determinant of the exact timing when we reach $1 billion in revenue, our most important underlying objective remains to realize double-digit growth in meeting our increasing customer demand on a sustainable year-over-year basis. We are fully committed to achieving this goal as soon as possible, along with the margin expansion, strong cash flow and a continuing strong return on invested capital performance. This profile for MTS will make us a more valuable company to our customers as we can better serve them around the world, a more attractive company to our global employees as they have expanded career growth potential and able to deliver increasing value to our shareholders on a reliable basis. This is an exciting future, and our plans for the new fiscal year will provide another key step to making it a reality. That concludes my remarks. Erin [ph], I'll turn the call back to you for initiation of the Q&A period.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go first to John Franzreb with Sidoti & Company.

John Franzreb - Sidoti & Company, LLC

Jeff, I guess, I really want to address the first half guidance. Because if I look at the pieces of the business that go into that, we're looking at an improved Sensor business, we're looking at an improved gross margin profile in the Test business, we're looking at improved conversion rates. I don't quite understand why the margin profile to get those guidance numbers is so low. Is it the gross margin or are you significantly adding to SG&A? What's the biggest impact there?

Jeffrey A. Graves

John, it's back to basics. Test is very much a backlog business, right? So we -- while we expect orders rates to continue, much of those orders in the Test business go right in the backlog, and will be shipped in the second half of the year. Then we have to look at product mix all the time as well. So it's -- looking at these net effects of what volume flows through the revenue within the quarter and even within the second quarter, it's a volume and mix effect.

John Franzreb - Sidoti & Company, LLC

So on the mix side, you said base order growth has been impressive. I would imagine that would be a net beneficiary or am I just reading that improperly.

Jeffrey A. Graves

Yes, it certainly helps, John. I mean, those orders turn faster. They still often don't hit within the quarter. So I was thrilled with our smaller orders rate in the fourth quarter, it was a record level and up substantially. And that's where we've got a lot of our new products. They just don't turn in the quarter. I mean, a lot of them came in very late in Q4, and they just don't end up impacting until you get into Q2 and beyond. So again, it's just an orders flow-through timing situation, John.

John Franzreb - Sidoti & Company, LLC

Okay. So when I'm looking for modeling purposes at the margin profile, is it the gross margin that's going to take a bigger hit in the first half or is it the higher SG&A level in the first half that's a bigger hit?

Susan E. Knight

Yes, the bigger hit is on the expense side, because we invested last year, you've got a run rate effect coming into the first half of fiscal '14 that we didn't really have last year.

John Franzreb - Sidoti & Company, LLC

All right. Okay. And one last question. In the -- Sue, I guess, this would be for you. On the balance sheet, you borrowed in order to repurchase stock. How much cash do you have left in the Americas? And Sue, you also mentioned in your prepared remarks that conversion rates are a little bit slower than anticipated. Are you going to continue to be adding debt to the balance sheet in order to fund the business in the near term?

Susan E. Knight

John, our belief today is that the higher receivables that we ended Q4 with, we could monetize that in the first quarter, and we see our debt levels remaining relatively constant with where we are today. Your question about how much cash we have in the U.S., about $6 million of the total. So we use that U.S. cash balance for funding the working capital increases. The majority of the capital investments that Jeff referred to are certainly financed from that geographic location. And then there's dividend and share repurchase. So we bring the cash back if we can, tax effectively, but you understand how that works, you just can't bring it back for free.

Operator

[Operator Instructions] And we'll go next to Liam Burke with Janney Capital Markets.

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

Jeff, on the service business, you mentioned the order growth was there. Sue mentioned that there are some expenses coming into 2014 that weren't in 2013, I'm presuming a lot of that is your investment in engineers to support the service for the aftermarket business. Are you satisfied with the ramp there and do you think you can get operating leverage off that business in a reasonable amount of time?

Jeffrey A. Graves

Yes, John, I think overall -- Liam, I'm sorry, I think, Liam, overall, we've been pleased. We kind of modeled it a year ago with saying we were going to have to hire a lot of field service folks and train them for about a year before they would be productive. That's probably more like a 6 to 9-month period now as we look at it. But fundamentally, you're correct. I mean, a lot of the additional expenses coming into the year are literally feet on the street in services that are calling on customers and servicing them, in addition to a few more sales folks out in the emerging market. So am I pleased? You always push to do it faster, reality is, we have very complicated equipment in the field and you've got to make sure you're ready to deliver the right value to the customer for these folks. So you've got to get them fully trained. So we're pushing that cycle time beyond as small as we can. We're carrying more expense into the new year because we've hired those folks and they're still undergoing training. We did see, for the first wave that we had added from the -- at the beginning of the year, we saw them actually make a real impact in the fourth quarter. We were up 34% in terms of order rates for services in the fourth quarter, 10% for the full year, and a lot of that is the impact of these new people. So while it will -- again, like everything, we're penetrating -- largely penetrating a new market for us, if you will, in services. Though I expect again there to be fits and starts quarter-by-quarter, but I was quite pleased in Q4, and I expect this we'll continue right on the strategy that we've been following on hiring and training people, and it will be another big hiring year in services this year, which is again why you see EPS growing basically at the same rate of revenue, where we're going to continue to add folks in that into the business because it's a great margin business for us and there's an enormous revenue opportunity out there.

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

Great. And then you just touched on hirings, feet on the street for emerging markets. Are you seeing the Test business in some of the India's and Russia's of the world taking root?

Jeffrey A. Graves

Absolutely. It's a little frustrating, Liam, because the gist of the regional economic effects, like India went through a slowdown in the middle of the year. So you see, this enormous construction going on, for example in the Indian automotive industry, and then suddenly, they have an economic issue in the middle of the year and currency changes and it slows down. And we see that picking up again. Certainly, it's very hard to model in a quarter and a year, but you look at the macro trends, Liam, and they're enormous. The bottom line is we already see it in China, we've seen it for several years now, and it's continuing to just gain momentum. This emerging consumer base in China that's consuming cars and riding on high speed rail and flying on airplanes is an enormous trend. Governments and local economic conditions can impact it in any given year, but it's an enormous macro trend, and I believe, India is right behind it. And we're excited about Russia. They have -- they're -- driven off their oil and gas industry, they've got a massive way of reinvestment going on in their indigenous businesses, and we're right there supporting them in automotive and aerospace and infrastructure testing, just like we've done in China. So, yes, I'm very excited. We're investing in new offices. You'll see us announcing this year offices in Russian and India as we continue to put feet on the street for sales support and services growth.

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

Good. Sue, for 2014, is a 29% tax rate accurate or in the ballpark?

Susan E. Knight

No. I expect that in fiscal '14, our tax rate would look like our -- more of our historical average which is typically in the low to mid 30s. We did get a lot of benefit from the R&D credit, and it's going to expire for '14. So from a legislative point of view, that's actually going to be a drag on the rate.

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

Okay. And you did announce a cash flow from operations for the quarter. Do you have one for the full year handy?

Susan E. Knight

I don't have it handy. If you have another question for Jeff, I can look it up quickly.

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

No, that's okay, we can go offline. You can go to somebody else.

Operator

We'll go next to Adam France with 1492 Capital.

Adam M. France - 1492 Capital Management, LLC

Can I ask you all this fairly simple question? You may or may not be able to answer it at this time, but in terms of -- you've got some good service order momentum here. How much is this business costing us at this moment or for fiscal '14? Is this costing us on a operating income basis $2 million, $4 million, and when do you expect a breakeven, I guess?

Susan E. Knight

So, can you repeat your question? I'm not sure I followed.

Adam M. France - 1492 Capital Management, LLC

I just want to -- the invest and the expenses in the service business, when you take the revenue it's bringing in minus the expenses, what is it costing us and when does it become breakeven?

Susan E. Knight

So in fiscal '13, we added approximately 35 people in the service business over the course of the year. And to Jeff's earlier comment, when you think about 6 to 9 months to have those people really be fully effective on a billable or chargeable hour rate, and we're going to add more people in '14. So I think for the people that were added in '13, they should be fully profitable by the second half of '14. And then you've got the next wave and that cycle is going to repeat. So you can think about service being our highest margin business, but will likely take 6 to 9 months to individual profitability, but that will make money this year.

Jeffrey A. Graves

Yes, and Adam, recognize services is our highest margin business. It's clearly roughly 10 points better than the equipment business for us. And our penetration rate is extremely low. I mean, the benchmark we throw out, most industrial companies that sell heavy capital equipment this complicated anyway, they're doing 30% of their revenue off services on that equipment, we're doing 15% today. So we view it as a very nice growth opportunity over the next several years. It is a very profitable business for us today. As Sue said, the incremental resources take a good year or more to actually pay for themselves. But once they're up and running, it gives us not only great top line growth, but an improving margin mix, and a much smoother revenue profile once it becomes big enough. So I think we win on all fronts on this.

Adam M. France - 1492 Capital Management, LLC

So, Jeff, you're saying this business is profitable currently?

Jeffrey A. Graves

Yes. Yes.

Adam M. France - 1492 Capital Management, LLC

Okay. Fantastic.

Jeffrey A. Graves

You remember, we have a...

Susan E. Knight

Service business in total?

Jeffrey A. Graves

Yes, yes, exactly.

Susan E. Knight

Yes, it's a 50% gross margin business.

Jeffrey A. Graves

And remember, we're coming off a run rate of $70 million to $80 million in services, right?.

Susan E. Knight

Correct.

Jeffrey A. Graves

In total. So we have a nice existing business, Adam, that we're adding these incremental resources to, so even with the dilution of these new folks that aren't productive for a year or so, it's still a nicely profitable business for us today. So it's not like we have to live through a loss period until it becomes profit. It already is.

Adam M. France - 1492 Capital Management, LLC

Very good. And then, Sue, do you have an estimate for depreciation in fiscal 2014?

Susan E. Knight

It will be similar to '13.

Adam M. France - 1492 Capital Management, LLC

Okay. And what was that in the fourth quarter? It looks like you were at $12 million through the 9 months.

Susan E. Knight

I've got to look that up for you. $18 million on an annualized basis as we think about '14.

Operator

And we'll go next to Dan Capozzo with Invicta.

Daniel Capozzo - Kern Capital Management LLC

A couple of questions. I guess, first, again, looking at the guidance for Q1. Kind of going back to what John was trying to get at. Can you help me understand, it looks like revenue is going to be roughly flat for last December quarter, but the earnings will be down about 20%. So even if I keep kind of the OpEx the same, is the gross margin going to be down year-over-year?

Susan E. Knight

In the Sensors business, the gross margin should be relatively the same. In the Test business, there is some margin shift given what we're working on in backlog. But the primary story is in the operating expense, differential year-over-year.

Daniel Capozzo - Kern Capital Management LLC

Okay. So it sounds like a little bit of movement in both the gross margin and the OpEx?

Susan E. Knight

Yes. If you look at our historical quarterly differences in Test gross margin rate, they vary between 36% and 40%, and it's driven by the mix in backlog, custom and standard. A lot of projects with a lot of concrete versus technical engineering content, and that really drives variability in the margin rate and it's all based on which projects we're working on.

Daniel Capozzo - Kern Capital Management LLC

Okay. Great. And for your full year EPS guidance, does that include the $4 million to $5 million in savings from the restructuring?

Jeffrey A. Graves

Yes, it's all in. Yes, that's -- it's an all in number.

Operator

And it appears there are no further questions at this time. I'd like to turn the conference back to Dr. Jeffrey Graves for closing remarks.

Jeffrey A. Graves

Well, thank you for participating in our call today. We're proud that we delivered a record fourth quarter and made meaningful progress toward our objective of becoming a growth company. I look forward to updating you on first quarter results in February. Thank you, and goodbye.

Operator

This does conclude today's conference. We thank you for your participation.

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!

This Transcript
All Transcripts