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MTS Systems Corporation, (NASDAQ:MTSC)

F3Q08 Earnings Call Transcript

July 24, 2008 10:00 am ET

Executives

Sue Knight - CFO, Vice President

Laura Hamilton - President & CEO

Analysts

John Franzreb - Sidoti & Company

Liam Burke - Janney Montgomery Scott

Mike Hamilton - RBC Capital Markets/Dain Rauscher

Operator

(Operator Instructions) Good day and welcome to the MTS Systems Third Quarter Conference Call. Today's conference is being recorded. At this time I would like to turn the conference over to Ms. Sue Knight. Please go ahead.

Sue Knight

Thank you, Doris. Good morning, and welcome to MTS Systems' Fiscal 2008 Third Quarter Investor's Teleconference. Joining me on the call today is Laura Hamilton, Chief Executive Officer.

I want to remind you that statements made today, which are not of 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.

I am pleased now to turn the teleconference over to Laura who will update you on our third quarter results.

Laura Hamilton

Thanks, Sue. Good morning, and thank you for joining our call today. You know we have had a really active quarter, and we have a lot of good news to talk about today. I am going to do three things with you; I am going to take you through our headlines; our perspective on the quarter's results by segment, which is really the details of orders, and then I am going to talk to you about globalization and the opportunity for our business. Then we will go back to Sue who'll take you through the financial details.

Today we have seven headlines, which seems like quite a few. Three are about the operations of the business, three are about announcements that we have made throughout the quarter, and our fourth headline is about -- or our last headline is about our guidance.

Let us start from the top. With respect to operations, our number one headline is 6% orders growth, which is strong. If you consider the economy, and you consider our first half orders, we are sitting at an 18% year-to-date growth rate and maintaining a strong backlog, and we are really pleased about this.

Our second headline is that Test is improving. We delivered record $92 million in revenue, which is up 8% over last year. With this increased volume and cost containment, this has resulted in a 28% increase in EBIT. At 36.6% gross margin rate, it is still lower than desired, but we are on track to complete these projects by the end of the fiscal year.

Our third headline continues to be about our sensors business and how the momentum continues. Given the economic situation, sensors continue to have outstanding performance. Sensors also booked record revenue of $25 million, which was 24% growth. They also saw a 24% growth in EBIT.

Our next three headlines are around the announcements we have made throughout the quarter. Our first is related to our acquisition of SANS Group. This is about a $25 million Chinese electro-mechanical and static-hydraulic testing company, and we are really excited about the strategic fit.

First, SANS is going to help us accelerate our growth in China. Their extensive sales and service networks will change our footprint overnight in China. Second, the SANS product offering is going to help us accelerate our growth in other emerging geographies. We still expect to close in the fourth quarter, our fiscal fourth quarter, and we will provide more details upon closing.

Our second announcement in the quarter was our announcement of the divestiture of the nano-indentation product line. I think you are all very aware that we are maintaining a focus on our core markets and those opportunities which provide the best opportunity for us, for market leadership, and profitable growth.

Unfortunately, the nano-indentation product line has limited synergies with the rest of our businesses, but we really do believe that Agilent will be a leader in nanoscale imaging, measurement, and manipulation and can leverage our product offerings for their customers. We are excited because we think this is a win all the way around. We received a $13 million purchase price, which resulted in a $0.14 gain per share, net of taxes.

And our third announcement in the quarter was the announcement of our accelerated share purchase program -- an agreement that we entered into with JP Morgan Chase where we purchased 700,000 shares on the open market. This created immediate value for our shareholders at favorable market prices. The cost is about $25 million, which we funded with cash on hand, and has still left us with a healthy cash position of $120 million at quarter end.

Our last headline is about our guidance. We have raised our earnings per share guidance. Our new range is $2.65 to $2.70. This includes $0.14 for the gain on Nano, but it also reflects that operating results are expected to be at or just above the high end of our previous guidance. In addition, we have said that revenue is expected to be in the mid to upper end of our range, which was $455 million to $465 million.

So let us talk for minute about MTS' Q3, and I think we have to start by talking about the economy. I am going to start with a quote by Robert Kubarych, Chief US Economist at Unicredit Global Research. Quote: "The US manufacturing sector is split between the haves and the have-nots, with autos in the have-nots, building materials in the have-nots, and exports in the haves."

We have our fair share of tough economic news this quarter. In March, the value of Japanese machinery orders was the lowest since May of 2005. In April, Toyota cut their $10 billion R&D budget by 20%, and essentially froze R&D capital spending. This quarter, the big three fell below 50% combined US market share for the first time ever, and they are working feverishly to respond to a dramatic shift in consumer demand from the gas guzzler to fuel efficient vehicles. But, we have also had a lot of good news in the quarter.

In May, John Deere, the world's largest maker of farm machinery, reported 17% revenue growth and 22% earnings per share growth, the result of high crop prices that drove local equipment demand. In June, CAT announced a $1 billion, two-year US facility expansion to meet mining and infrastructure demand, primarily overseas. In June, the US Steel company said the steel business in the US is holding up very well, in particular, industrial machinery and specialized manufacturing.

Yesterday's news. Three big European passenger car OEMs post higher profits amidst growing economic uncertainty. Volkswagen, PSA Peugeot, and Fiat all forecast higher revenue as record fuel costs spurred sales of small cars and compact SUVs. Also yesterday, Volvo AG, the Swedish truck and bus maker reported 28% rise in second quarter net profits due to higher sales in Eastern Europe, South America and Asia. Volvo maintained its outlook for the year, expecting the European truck market to grow by 10% this year, and the North American truck market to stay on the same level as '07.

Throughout the quarter, investment in new ground vehicle R&D labs continued in Japan, China, India and Romania.

So why has MTS been successful in the face of this economic turmoil? Geographic breadth and market and application breadth; something that we have been building over the last 40 years. Add to this that we are the market leader, which means we are an important player in emerging geographic development.

We are not immune to economic declines, but we are well positioned to withstand much of its impact. We still remain cautious about the future considering the uncertainty, the duration and the extent of the US slowdown, and the potential ripple effect in other regions. But overall, we feel great about our ability to deliver the year, despite the challenges we all face.

So let me take this one level further by walking you through orders. Like you know, orders is both a quarter, as well as, a year to date phenomenon, and I am going to explain that to you both ways.

Let us start with the total company. We have booked $117 million of orders in the quarter, which is up 6 points over last year, 5 points for currency, which means one was organic. But like I said, given the strength of the first half, the lumpy nature of the Test business, we are very pleased that we have had seven straight quarters of year-over-year growth. This is highly unusual for MTS.

We are at 18% year-to-date growth, which is excellent. 12 points of that is organic, 6 is currency, and when we look at this from a geographic perspective, it is 20% in North America, about 20% in Europe and 13% in Asia.

Let us do this now by business. So let us start with Test. In the quarter, Test booked $92 million of orders, which is up 4 points over last year. 5 points of that is currency, which means we are down a point or essentially flat. So, first, we need to look at the large order phenomenon.

So large orders, by that I mean orders that are more than $5 million. That's down year-over-year for the quarter from $17 million last year to $10 million this year. When we strip that out, the rest of the business grew 14%. We did have one large order at $10 million for a friction stir welding contract, which is to be used in the US Space Program. We don't talk a lot about friction stir welding, it's a small niche that we play in, but it really leverages our precise force and motion control technology.

Year-to-date, Test is up 17% year over year. 12 points of that is organic, 5 points is currency. So let me take you through Test by market, and let us start with ground vehicle. We saw a 13% decline for the quarter, but we are still up 8% year to date. For the quarter, we had a tough prior year comparison with $17 million in large orders versus zero this quarter. Again, when you strip that out, we have had 30% growth in the rest of the business for the quarter.

The quarter and the year are really quite similar in terms of what is happening in this market. Global OEMs are buying. Detroit has bought a little, but not much, and not going forward, but this is not new news. We have seen demand in component and full vehicle testing across passenger car, racing, rail, truck and other vehicles including farming and mining. These are some examples of the breadth of our application. In addition, we see demand in emerging markets from regulatory changes and the continued drive to take down development cycle times.

Let us move on to infrastructure. We have seen 31% growth in the quarter, 40% growth year to date. The biggest factor in infrastructure is large orders, which are up $20 million year over year. We have already talked about the $10 million friction stir welding order in the quarter.

We also had two large international earthquake simulation systems for $24 million in the year, and part of building worldwide infrastructure is understanding the effects of earthquakes on structures. And we are seeing that demand. Without large orders, our infrastructure is up 10 points year-over-year, and this is fundamentally about working the base business hard, worldwide.

Finally, we need to talk about aero, but remember, aero tends to be extremely lumpy, and at times, the law of small numbers. We saw a 16% growth in the quarter, but the numbers are really small. And we were overall at a 9% decline year-to-date. We expected to be down this year as aerospace is very program driven, but we say that this is a little bit weaker than we had originally expected.

Let us shift now to a geographic view of Test, and lets tart with North America. We had 1% order growth in the quarter, which still leaves us at 22% growth year to date. For the quarter, the year-over-year comparison from a large order perspective is comparable; both years include a $10 million order. This quarter, it's the $10 million friction stir welding order. Overall, there is really no one trend that can explain North America, but clearly our application breadth is helping. We see demand in government spending, automotive OEM and tier suppliers, a little bit of aero, friction stir welding, racing, and the base business.

In Europe, we have seen 11% growth for the quarter, 17% growth year-to-date. There are no large orders in the current year. We did have one $7 million order in the quarter last year. The quarter, really, was driven by infrastructure and aerospace, but the year is really driven by ground vehicles. And that's broadly defined as you think of passenger car, racing, and truck. It is also the year is being helped by growth in infrastructure, and this is really net of the decline in aerospace. You can't talk about Europe without mentioning that we are clearly benefiting from the weaker dollar.

Finally Asia. We've seen 2% growth in the quarter, and we are at 11% growth year-to-date. We do see strong demand in earthquake simulation. We do see strong demand in ground vehicle in China. Interestingly, Japan is a mixed bag and Korea; we are clearly seeing the effects of the Korean recession.

Let us shift to Sensors for a minute. This is a little bit easier because the Sensor order patterns are definitely smoother. The Sensor order results are another good news story. Sensors booked $25 million in the quarter for 18% growth in the quarter. 7 points of that was organic, 11 points from currency. Clearly, US and European wood markets remain down, but fluid power markets are still growing worldwide. And while mobile hydraulics is relatively small, it is still meeting our expectations.

From a geographic perspective, let us start with North America for Sensors. In North America, we saw a 2% growth in the quarter. This is a little bit misleading because the prior year included two large blanket orders, which is somewhat unusual for the Sensors business. North America's was at 9% growth year to date, the industrial market continues to hold. And mobile hydraulics, while it's small, has really mixed news. With construction equipment down, the agriculture and mining booming.

In Europe, we have seen 36% growth in the quarter and 13% growth year to date. While there is more market concerning Europe, fluid power order books are full, one and half years out. So demand continues strong.

In Asia, 2% growth in the quarter, 34% growth year to date. In general, demand in plastic, machine and the steel industry is driving this. One of the things to remember about Sensors, though, is that the application breadth in Sensors is really large. So it is hard to describe Sensors by explaining any one or two industries. Overall, MTS' strong results are due in part to our geographic and applications breadth.

So while globalization has been part of the discussion all morning, I really want to call it out right now, because it is an opportunity for MTS. I talked about the haves and the have-nots. The haves are going after globalization aggressively. So what are we really talking about? World cross-border trade is growing to 30% of global GDP. US and established countries are importing more from emerging countries, fueling growth in China, India, Eastern Europe and Brazil.

Development of the emerging countries is creating opportunity. It is creating opportunity through significant infrastructure investment. China, Russia and India are in the top five steel producing countries. There is broad investment in communication, transportation, and energy and there is broad investment in manufacturing in steel, plastics and automotive, to name a few.

The development of the emerging countries is creating opportunity through the establishment of new brands. The China government has implemented R&D incentives to accelerate the development of Chinese automotive brands. Within a couple of years, Chrysler plans to import vehicles from Cherry Automotive, headquartered in China, to position Chrysler at the lowest end of the automotive market.

And the development of the emerging counties is creating opportunity through their desire to develop and manufacture products that can compete on a global scale. India has established a government industry partnership to develop seven technical centers over the next four years for automotive testing, validation and development. And investments in Brazil are evident from GM, Fiat, Renault and Volkswagen, to name a few.

So what does globalization mean to MTS? First, it means demand for our precise Sensor measurement capabilities as these geographies are developing and manufacturing higher performing products, especially for steel and plastics. It means demand for materials, components, and system level test equipment, our core business.

But it also means increased demand for testing know-how. How do you establish a new lab? Where do you start? How do you quickly rebuild, upgrade or relocate existing capabilities? How do you integrate new capability? How do you optimize testing? Fundamentally, how do you become world competitive in five years, not 25 years?

MTS is well positioned to capitalize on globalization opportunities. We bring more than 40 years experience building confidence through precise measurement and real-life simulation. And with this is combined then with our strong geographic footprints and our investment both organic, acquisition and through business partners to ensure we have the capability to sell, build, service and support our customers wherever they choose to do business.

Geographic expansion is a critical growth opportunity for MTS, today and in the future. We are investing in it and we are capitalizing on this opportunity.

Now I am going to turn this back over to Sue to take you through the financial details.

Sue Knight

Thank you, Laura. Laura has addressed the orders results for the year and the quarter, so I'll start with revenue. Revenue increased to 11% in the quarter to a $117 million, which was driven by an increase in both segments. The growth included 4 points of organic growth and 7 points due to favorable currency as the US dollar continued to weaken relative to the Euro and the Japanese Yen.

Test revenue was $92 million, 8% higher than last year and record volume for the business. The growth included 5 points from currency. North America and Asia were up and Europe was flat based on the timing and mix of projects and backlog.

The quarter also had a higher percentage of revenue from custom projects compared to last year and last quarter. From a market perspective, ground vehicles and infrastructure increased and aero was less than the prior year, which is similar to the results in the second quarter.

Sensors revenue growth was very healthy at 26%. They also had a record revenue this quarter. At $24.5 million, organic growth of 14% and favorable currency contributed 12 points compared to the same period last year. Geographic demand resulted in 15% growth in North America, 26% growth in Europe and 42% growth in Asia, which has our smallest volume of the three locations.

Moving from revenue to gross margins. Margin dollars increased 15% to $47 million, on 11% revenue growth. As a rate-to-revenue, gross margin of 40% was an increase of 1 point compared to 39% last year. Both segments contributed to the year-over-year rate increase.

Test gross margin increased by $3 million or 10% on 8% revenue growth. The margin rate increased 70 basis points, primarily due to increased factory and engineering utilization on higher volume and lower warranty costs. These benefits were partially offset by a higher volume of custom versus standard products compared to last year, which is slightly lower margin rates.

Additional progress was made this quarter on our custom development projects that have suppressed the Test margin rate for the last several quarters. With the possible exception of a couple of projects that have been slowed down due to customer delays, all of the remaining projects are expected to achieve customer acceptance by the end of the fourth quarter. In summary, we are very pleased with the year-over-year improvement in Test, particularly the progress on these custom development projects.

Sensors delivered a 29%, or $3 million increase in gross margin dollars on 26% revenue growth. The margin rate was up more than a point to 56% based on strong volumes.

Moving to earnings from continuing operations. The gross margin increase of $6 million was partially offset by $2 million of additional operating expenses. $1.4 million or 70% of the increase, was due to the negative impact of the US dollar weakness on foreign expenses. Cost containment actions remain in place in Test to offset the lower than expected gross margin rate for the year, while operating expenses in Sensors are as planned.

The net effect of the gross margin contribution and operating expenses in the quarter increased earnings from continuing operations by $3 million or 27%. As a percent of revenue, EBIT from continuing operations increased 1.6 points to 12.3% compared to 10.7% last year.

Next comment is relative to discontinued operations. The sale this quarter of the net assets of the Nano Instruments product line were just over $13 million, and the operating loss is recorded as the discontinued operation. The operating loss net of tax for the quarter was up 700,000, or $0.04 of earnings per share. And the after-tax gain on the sale was $2.5 million or $0.14 earnings per share as Laura previously mentioned. Together, they contributed positive earnings in the quarter.

Tax expense for the quarter was $4.3 million or 28% of revenue, compared to $2.4 million or 20% last year. The year-over-year increase in the rate was driven by the impact of having more significant tax benefits in 2007, primarily from R&D credits and the impact of export transactions. On a full-year basis, we continue to expect the tax rate to be in the 29% to 30% range.

Earnings per share from continuing operations increased 23% to $0.64, compared to $0.52 last year. The $0.12 increase was a combination of improved business performance, a little bit on the net interest line and $0.03 from a lower share count, which was partially offset by a higher tax rate which had a negative impact of about $0.06.

Net income increased 28% including the discontinued operations impact, and the associated earnings per share increased 35%, including the one-time benefit of the Nano Instruments product line sale.

The last topic for today is cash. We ended the quarter with $120 million in cash, a decrease of $9 million from last quarter. Operating cash flow was $9 million, net of the $6 million or 7% increase in working capital, associated with the higher revenue this quarter.

Capital expenditures were $1.9 million. We also funded the accelerated share repurchase program for about $25 million. And the net proceeds from the Nano sales were also reflected in the cash balance, which was $12 million.

Our global cash continues to be conservatively invested in bank deposits, treasuries and money market funds, which is a comment that I'll continue to reinforce on a quarterly basis.

That is the end of our prepared comments. I will now turn the meeting back over to the moderator for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from John Franzreb from Sidoti & Company.

John Franzreb - Sidoti & Company

Good morning Laura and Sue.

Laura Hamilton

Good morning.

Sue Knight

Hi, John.

John Franzreb - Sidoti & Company

My first question is the Nano business. The operating loss, I think you said it was $0.04. That is for the first three quarters -- is that correct?

Sue Knight

Just let me double-check the year-to-date, John, versus the quarter. The impact in the quarter was $0.04, and the nine-month impact was $0.02.

John Franzreb - Sidoti & Company

-- was $0.02. Great. Okay. And the acquisition of SANS, can you talk a little bit about what your margin expectations are for the business? Will it be a contributor to EPS or not, once complete?

Sue Knight

John, we really haven't provided any financial details associated with the transaction at this point, but we will do so as soon as we close the deal.

Laura Hamilton

This is Laura. The one thing we have said is it is a healthy business.

John Franzreb - Sidoti & Company

I am just wondering if it is going to be accretive to margins? Is your expectations of it will be, will this be a drag on margins? What should I be thinking about once it is rolled in?

Laura Hamilton

We are going to do detail at that level once we close.

John Franzreb - Sidoti & Company

As far as you are raising your numbers, how much of that is the exclusion of the Nano business built into increasing your EPS estimates?

Laura Hamilton

Not really. Well the $0.14 is -- $0.14 we have added, and then the rest of it is operating results. And you are saying is it really getting rid of a loss?

John Franzreb - Sidoti & Company

Exactly.

Laura Hamilton

I know that -- that not really is. No, it is really about the business at a net income level.

John Franzreb - Sidoti & Company

Okay. The gross margin -- I mean, it sounds to me that the cost overruns in the custom projects due to customer delays, is what I think I heard you say, Sue, will spill into 1Q '09. Did I hear that properly or no?

Sue Knight

We do have two projects that could delay final acceptance. Not because we are not ready, but we just need the customer to provide us a final acceptance, and they have had some site delays. So I do not expect there to be material cost issues associated with that. I think our cost estimates currently reflect it. It is just a matter of us being able to say we have passed ownership final ownership from MTS to the customer.

John Franzreb - Sidoti & Company

Okay. One last question, and I will get back into queue. The Sensor business is posting some stellar results. Laura, I think you kind of referenced steel several times in your prepared remarks as a primary driver. I am wondering what the exposure is to the paper market? We had two companies here last night pre-announce on the paper equipment side and actually the paper providing side, what the Sensor exposure is a) to that market, and b) what kind of growth expectations, if I am reading you properly, that you expect Sensors to get from the steel market?

Laura Hamilton

So this is the part at the end where I said it is really hard to use application examples in Sensors because there are so many. So, what I am really trying to do is everybody knows that wood is down because construction is down. So I am just trying to say, but don't forget that steel is up and plastics is still strong. So overall, we felt -- we've already felt the effects of wood; wood being related to paper, and so I don't think that that's going to -- and it is a small segment for Sensors. But all of these segments are relatively small, and you add them all up and we have a great business. It is part of why we have a great business is because we are really good at these niches. So no one segment is going to drive Sensors up or down.

John Franzreb - Sidoti & Company

But hopefully drive them up.

Laura Hamilton

Well, a lot them drive them up, but it takes them all to drive them up.

John Franzreb - Sidoti & Company

Okay, thanks. I will get back into the queue.

Operator

We will go next from Liam Burke from Janney Montgomery Scott.

Liam Burke - Janney Montgomery Scott

Laura, Sue, how are you today?

Sue Knight

Good, Liam.

Laura Hamilton

Hi, Liam.

Liam Burke - Janney Montgomery Scott

Sue, in terms of the tax rate, you gave us for the full year what you expect it to be. Now you have a lot of overseas activity. If I am looking on an ongoing basis, what's the amount of overseas activity? Could we expect a lower than normal tax rate, and I define that in the 30% or below?

Sue Knight

No, less than a 30% tax rate is not what you can expect going forward. I think, as we have talked in the past, if you look at US Statutory rate, we would have about 35% tax rate, but when you adjust for the German tax rate at 30%, you consider the permanent re-investment status change that we made in the second quarter associated with Japan. And our increasing contents in China, we would expect to be a couple of points less than 35%, but not consistently below 30%. The rate that we are experiencing this year had a tremendous amount of benefit from the one-time cash repatriation impact in Japan in the second quarter.

Liam Burke - Janney Montgomery Scott

Great, thank you. And in terms of overseas, you mentioned the tax benefit from repatriating the cash. Do you still have a significant balance overseas?

Sue Knight

Yes. The majority of our cash is still overseas. It is in Europe, and we are looking at whether we have opportunities to bring some of that cash back on a cost effective way, but I haven't concluded that yet.

Liam Burke - Janney Montgomery Scott

Thank you.

Operator

(Operator Instructions) We will go next to Mike Hamilton from RBC.

Mike Hamilton - RBC Capital Markets/Dain Rauscher

Good morning.

Laura Hamilton

Good morning.

Mike Hamilton - RBC Capital Markets/Dain Rauscher

Laura, could you take a couple of minutes giving your assessment of anything you are seeing over global economies in terms of changes in the sales cycle, knowing that that covers an awful lot of ground, but just kind of from a high level, if you are seeing anything -- any changes in your…?

Laura Hamilton

Yes. I think what we definitely see -- what we can see sometimes is that activity, which would mean our pipeline of opportunity, continues, but it is slower to close. So we do see those delays. Toyota is a great example. They freeze capital, and it doesn't mean that absolutely nothing gets approved, but it means that it takes a lot longer to get approval, and that they are a little bit more in a wait-and-see as opposed to driving ahead on their original project schedule.

And what is interesting, Korea is probably the other good example of, clearly there is a recession, and it stopped capital spending. One of the other changes then in the order pattern is that you stop buying capital equipment, and you try to do more with what you have, which means then you make -- we go after the business in service and upgrades.

We have done some rebuilds instead of new equipment sales. And that is what I keep calling, "Working the base business hard." If they are not buying big pieces of equipment, they need help somehow, and we need to be able to do that. So I would say Korea and Japan, and Detroit we felt for so long, we don't rely on the big three to buy a lot in the US.

Mike Hamilton - RBC Capital Markets/Dain Rauscher

Thanks. My other question, any products in the pipeline worth noting? New products or adjustments to products?

Laura Hamilton

I would say, we talked a little bit about that we are capitalizing software. And this is a significant investment for us. It is not a new product, but it is going to be a very different capability when we finish this software platform. And that is going to be coming out over time, so that won't be a big bang, which is a part of the approach. But it is really leveraging -- we have this applications breadth, and what we are also doing is pulling it together and leveraging it like only MTS can in this investment.

This year, we launched the beginning parts of our landmark load frame platform, and have had very positive response. And we will continue to introduce the remaining product families in that. And then we talked a little bit about we are in the pilot stage, and we are completing three pilots this year on basically this integration of physical testing -- or the optimization of physical testing and modeling. And we will continue to invest in that.

The other part is that some of these projects that we are working on are moving forward -- our capability and some of our high-end offerings. The custom project issues are really investment in performance in some of these platforms.

Mike Hamilton - RBC Capital Markets/Dain Rauscher

Thanks, and thanks for the detail of the discussion today.

Laura Hamilton

Great.

Operator

(Operator Instructions) We will now take a follow-up question from John Franzreb from Sidoti & Company.

John Franzreb - Sidoti & Company

Hi. It has been a year now since the custom projects has kind of weighed on the margins. Is your expectation that the Test margin can return to what it was in -- I guess it was the March of '07 timeframe when we had a 43% gross margin for the business, once these projects are gone?

Laura Hamilton

No, I don't think we think we are going to get back to that -- that was a peak. And so, a couple of things we would say, we think that Test can get back to more of the average that we had been running at before, but you have to average Test margins because quarterly margins are so variable and mix is big. Mix will always move our margins a few points. So that is a hard thing to model, but that is what we are working to return to.

Mike Hamilton - RBC Capital Markets/Dain Rauscher

And what was -- remind me, Sue, was the average then of Test, would you recall the average?

Sue Knight

Well if you look over the last several years, the average would be in the 39% to 40% range.

Mike Hamilton - RBC Capital Markets/Dain Rauscher

39% to 40%. Okay, compared to the current 36%?

Sue Knight

Yes.

Mike Hamilton - RBC Capital Markets/Dain Rauscher

And you touched on that the mix is a big issue. Can you give us a sense at how much, what you call standard products, as a percentage of sales?

Sue Knight

Let us see. We talk about the business in terms of 50% customs and then 50% everything else which is standards and service. So, I would say that the margins for standards and service are comparable and then custom is lower.

Mike Hamilton - RBC Capital Markets/Dain Rauscher

Okay. Okay. And one last question. Can you give me a breakdown in Test for the quarter? What was ground vehicle, what was infrastructure, and what was aerospace? Just on a percentage basis would be fine.

Sue Knight

Are you looking at orders?

Laura Hamilton

On what line?

Mike Hamilton - RBC Capital Markets/Dain Rauscher

Revenue, please?

Sue Knight

Alright, just a little math.

Mike Hamilton - RBC Capital Markets/Dain Rauscher

Okay.

Sue Knight

The ground vehicle was just over 50%; aero was about 10%. And be careful, because aero can swing with the programs.

Mike Hamilton - RBC Capital Markets/Dain Rauscher

Right. So the balance would be…?

Sue Knight

So the balance would be infrastructure. Yes.

Mike Hamilton - RBC Capital Markets/Dain Rauscher

Great. Thanks a lot.

Sue Knight

You are welcome.

Operator

And it appears we have no further questions. Ms. Hamilton, I will turn the call back over to you for any additional or closing remarks.

Laura Hamilton

Okay. No, I would say once again, we are pleased with the quarter. We are pleased with our progress, and we think we are well positioned as we move forward. Thanks for participating today.

Operator

Ladies and gentlemen, that does conclude today's conference. We thank you for your participation, and hope you have a great day.

Laura Hamilton

Thank you

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Source: MTS Systems Corporation, F3Q08 (Qtr End 09/27/07) Earnings Call Transcript
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