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MTS Systems Corp (NASDAQ:MTSC)
Q1 2020 Earnings Call
Feb 4, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the MTS First Quarter 2020 Earnings Conference Call. [Operator Instructions]

At this time, I would like to turn the conference over to Mr. Brian Ross, MTS Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Brian T. Ross -- Executive Vice President and Chief Financial Officer

Thank you, Shelby. Good morning, and welcome to MTS Systems fiscal 2020 First Quarter Investor Teleconference. Joining me on the call today is Jeff Graves, our President and Chief Executive Officer. I want to remind you that we will make forward-looking statements today 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 our latest SEC forms 10-Q and 10-K.

We disclaim any obligation to revise the forward-looking statements made today based on future events. This presentation will also include reference to non gap financial measures. These measures are used by management to evaluate the operating performance of the company over time, they should not be considered in isolation or as a substitute for gap measures. A reconciliation of our non GAAP measures to the nearest gap measure can be found in our earnings release

I will now turn the call over to Jeff.

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Thank you, Brian, and good morning, everyone. We appreciate you joining us on our call this morning. I thought I'd change the format slightly for this call. This quarter, in light of recent events in the world, ranging from the optimism that the companies are signing new trade deals to the fear associated with the outbreak of a new virus. In this context, I'll share our view of the road ahead for MTS, and then I'll ask Brian to review the quarter and our outlook for the full year. As longer-term investors in the company understand our test markets can be very dynamic as our customers adjust the timing, size or short-term priorities of their investments in research and product development.

These changes can be driven by market priorities, such as the launch of autonomous vehicles, by changes in manufacturing technology or the introduction of new materials, such as carbon fiber composites or even economic or environmental factors. Their adjustments are magnified at MTS as the movement addition or cancellation of large orders reverberates particularly forcefully for long lead, highly engineered custom products. In the last two fiscal years, we've seen order levels fly Wait quite quite significantly from the first half of the year to the second, which is why we as a management team stick to providing annual guidance and attempt to supplement with color on the short term market environment that can help investors better anticipate trends on a quarterly basis. considering our first quarter results, this effect was on full display as we met our internal performance expectations, while being short of consensus estimates for the quarter.

As you will hear from Brian shortly, we're holding our full year guidance for fiscal '20, which we expect to be driven by a much stronger revenue performance in the second half than the first half, driven by order trends and mix and backlog. Looking ahead over the next several years, this short-term volatility will be progressively dampened through the growth of our sensors business, which is expanding organically at roughly twice the rate of our Test & Simulation business, as well as the increased scale and market diversity of our Test & Simulation business. Along with decreased, these mix changes will lead to more exciting top line growth, profitability and free cash flow performance in the years ahead. With those comments as a backdrop, let me next take this a step further in detail and describe the current underlying drivers for each business unit. Starting with our Test & Simulation business, our sales process in this case is often very long, sometimes expanding several years and is driven by capital spending plans and our customers laboratories.

Given our current insights, we anticipate that order rates for our ground vehicle sector have now largely stabilized after an extended period of contraction over the last two years. This stabilization reflects the fundamental need for durability and performance testing, attributes that have been deemphasized by our customers in recent times, largely due to the redirection of short-term spending into safety testing for autonomous vehicles. In other words, development of crash avoidance technology has taken precedents over durability and vehicle performance. At some point, vehicle durability and performance, areas in which MTS has been a leader for many years, will be reprioritized due to their ultimate criticality, but we're not forecasting this increase yet. Instead, we're simply saying the decline has largely stopped and spending has stabilized. Moving to the other market sectors for our Test & Simulation business, what we anticipate is continued strength in our materials sector and Test Services moving forward.

Materials testing is largely being driven by the expanded use of lightweight structural materials, such as carbon fiber composites as well as the increased use of additive manufacturing for component fabrication. We expect this trend to continue well into the future. Test Services growth is simply a factor of our increased focus on maintaining and upgrading our installed base of equipment, which now exceeds $6 billion worldwide. While these trends are all positive, the most exciting portion of our Test & Simulation business is now our structure sector, which comprises several distinct markets. The first of these is infrastructure testing, which is basically high force systems that simulate extreme environmental events such as earthquakes and surnames. MTS was a pioneer in this field and has maintained our leadership for decades. These systems allow our customers to develop safer buildings and bridges that are now increasingly needed in high population regions, particularly in the emerging markets, where population densities and GDP growth rates are the highest.

We're seeing increased investment in laboratories that support infrastructure development, and we're very well positioned to support this trend from both the technology and service perspective. Our structure sector also includes aerospace systems, which historically means the testing of airframes and flight engines. And now through the acquisition of E2M in early fiscal 2019, increasingly focuses upon flight simulation for pilot training and the entertainment industry. And finally, we include the energy market in our structure sector, which spans from exploration to generation to transmission markets. Energy and particularly renewable energy generation has become a strong focus for us and is central to our recent acquisition of the energies of the Danish engineering firm, R&D, which I'll speak to in a few moments. So having described the underlying market trends, what does this mean in terms of order rates for our Test & Simulation business? While the timing of individual orders can shift between quarters, we anticipate very strong orders growth beginning in the second quarter and continuing to accelerate throughout the second half of the year.

This growth will be led by exciting trends in our structures sector, which we anticipate becoming the largest of our end markets by year-end for the first time in our company's history, followed by our materials sector and Test Services. Our ground vehicle test sector, which as a reminder includes automotive, truck, bus and rail applications, are anticipated to be roughly 25% of the Test & Simulation business, down from roughly half of the business a year a few years ago. This diversification of end markets has been a priority for us over the last two years, and we're now seeing the fruits of these efforts. In short, by the end of fiscal 2020, and we will achieve the new balance in the Test & Simulation business, that will help ensure a smoother, faster growing, more profitable performance in the years ahead. To give you an idea of the magnitude of these trends, the strongest order performance for our Test & Simulation business in our history was in 2015 with orders of $519 million.

This year, we should exceed this level, either by a small or a wide margin, depending upon macroeconomic risks, which I'll describe shortly. We expect this to translate to year-over-year organic growth in orders of greater than 9%. Importantly, this does not include our most recent acquisition of R&D, which will contribute meaningful growth beyond this level. I'll comment more on R&D as well as risk factors in a few moments. Now let us turn to our outlook for our sensor business, which started the year on a strong note of near double-digit top line performance. As you know, our three largest sectors for this business are the test sector, which includes laboratories to test new products as well as our department of defense contracts; Our industrial sector, which is primarily targeted toward machine automation; and our physician sector, which comprises both industrial automation and the heavy equipment applications, such as earthmovers, construction and farming equipment. In short, the test sector in sensors is very strong. The industrial sector is stable to positive, and the physician sector is soft. With the macroeconomic factors improving, we expect demand trends in each of these markets to be stable to positive from current levels.

In addition, the ramp-up of our newly acquired Endevco product lines, which primarily support the test sector, will add to this momentum increasingly throughout the year. We believe these trends will translate to double-digit order growth for our sensor business for the full year, building substantially upon the record orders booked in fiscal 2019. So to summarize, our outlook for the full year in terms of order rates is very positive. For the full company, we anticipate topping the $1 billion mark in orders for the first time ever, which alone would translate to over 20% growth from the prior year record that was set in 2018. Given the timing variation and conversion of orders into revenue, driven by mixed details, we'll update revenue projections as the orders are booked into backlog each quarter. And that will reflect the timing and any changes we make to our forward annual guidance.

So what could influence this very positive outlook for orders this year? On the positive side, we believe risk stemming from trade tensions have reduced since the signing of the Phase I trade deal with China and the U.S. MTA in recent weeks. This has lowered the tension level with our long-term customers in China, particularly those that are government owned, such as university laboratories, enabling continued positive planning for the future. In addition, we believe the initiatives to stimulate economic growth in China and Europe are beginning to gain some traction with increased spending on new products, new services and efficiency initiatives. This is all positive for MTS. We do, however, see the potential for downside risk because the unknown economic impact of the coronavirus, which is now spread to many population centers in China into a growing number of countries around the world. Our primary concern is, first and foremost, on the health and well-being of our employees, particularly those located in China. We have and will continue to take whatever steps are necessary to assist them in this time of uncertainty and to comply with the guidance issued by the governments and health experts around the world.

As we now see the holiday shutdown being extended in China and the increasing barriers to normal commercial activities, we anticipate some degree of new headwinds from these measures. We're hopeful that the duration and impact will be small. We'll provide updates as needed going forward until the situation is resolved. On a final note, before I turn the call over to Brian, we're very pleased to announce the execution of the agreements to acquire certain entities of the Danish engineering firm R&D, which provides MTS with another strategic technology portfolio and expands our access to important markets for our Test & Simulation business. With the execution of this agreement on January 24, 2020, which is near the beginning of our second quarter, no financial results for R&D were included in the first quarter results.

Our M&A activity has served us very well over the last two years in finding high-quality test and measurement companies that have an outstanding fit with our overall strategy to expand our technology reach, and again, a strong foothold into new adjacent markets that have significant barriers to entry. The combination of these strategic factors provide for accelerated, sustainable and profitable growth. In addition, with the R&D acquisition, we expect to have minimal execution and integration risks similar to what we have experienced with previous acquisitions. As a brief reminder, let me give you some additional insight into the R&D company. The core strength and value of R&D is that the company comprises exceptional engineers, who are experts in the design, development and manufacturing of precision, high force test machines that can simulate in a laboratory, even the most extreme operating environments for rotating systems. The manufacturers of wind turbines, R&D's test systems can simulate the extreme wind, land and sea forces that are encountered over the 20-year design life of a modern wind turbine in operation. Their systems are so accurate and powerful that they can compress these life tests into months or even weeks in the laboratory, allowing dramatic reductions in the time it takes for the introduction of new turbine designs.

The result is that new and even larger, more efficient wind turbines can be confidently introduced into the electric utilities worldwide, accelerating the adoption of these modern clean renewable sources of energy. Having had great success with wind turbine test systems, R&D and Max expanded their focus more recently into aerospace, where they've quickly become a recognized leader in the testing of aero engine systems. This puts them on the critical path to the introduction of new aircraft propulsion systems that are more fuel efficient, reliable and cost-effective for airlines around the world. With MTS's rich history in the testing of high-performance materials and status structures in both wind and aerospace, the addition of R&D technologies to the MTS portfolio will greatly enhance the value we can bring to these markets worldwide. R&D's operating entities bring within a strong backlog of projects in excess of $35 million, which -- with contract duration stretching into 2021. Like MTS, they also have an exciting pipeline of new wind and aero opportunities that will help ensure exciting and growth and profitability for years to come. Over the last few weeks, we've already begun integrating R&D into our Test & Simulation business with a particular focus on identifying new opportunities in the energy and aerospace markets.

As I described previously, with our exciting organic growth projections and the addition of R&D from the second quarter onward, we expect our structures sector to surpass our ground vehicle sector to become the largest sector in the Test & Simulation business from this year forward. From a financial standpoint, the purchase price of R&D was structured as a combination of an initial upfront cash payment of approximately $57 million, with expected payments of up to an additional $26 million being earned over the next 18 months. R&D currently delivers $50 million to $60 million in annualized revenue and have strong operating margins, which generate excellent free cash performance as new investments in working capital and capital expenditures are minimal. We anticipate the acquired R&D entities will contribute over $40 million in incremental revenue in fiscal '20, but be neutral to earnings, excluding transaction costs, most of which occurred in our first fiscal quarter. However, we expect R&D will immediately be accretive to Test & Simulation operating margins.

Now I'll turn the call over to Brian to discuss our first quarter results and our outlook for the full year. Brian?

Brian T. Ross -- Executive Vice President and Chief Financial Officer

Thank you, Jeff. I will start with our first quarter results with comparisons on a year-over-year quarterly comparison, unless otherwise described. Our first quarter consolidated revenue was $205.8 million, providing growth of just over 1%. Our sensors business grew revenue at near double digits in the first quarter and provided the 10th consecutive quarter with quarter-over-quarter growth, delivering $85.5 million or 9.7% growth compared to the same quarter last year. Given the timing of the Endevco acquisition very late in our fiscal year 2019 and rapid integration of the Endevco product line into MTS sensors production facilities, the growth in sensors for the first quarter was predominantly organic, driven by a ramp-up of our DoD business and continuing strength in the sensors test sector. As we had expected at the beginning of fiscal 2020, Test & Simulation revenue declined 3.8% in the first quarter to $120.7 million, mainly attributable to a slower orders profile in the last half of fiscal 2019, prominently led by a decline in the automotive portion of our ground vehicle sector and continued weakness in the European market served.

It is not unusual for the order levels in Test & Simulation to fluctuate between the first and second half of the fiscal year, which ultimately impacts revenue levels six to 12 months later. This pattern is indicative of a large project that we occasionally take into backlog and the volatility of the automotive market. From a growth perspective, we continue to gain momentum on great opportunities in our structures and materials markets, as Jeff just discussed. While we experienced a slower consolidated sales performance in the first quarter of the year, our full year 2020 expectations remain intact as we expect to have continued orders and revenue growth each quarter as we progress throughout the fiscal year with a very strong second half of the year. We are on track to see our Endevco and R&D acquisitions add $65 million to $75 million of revenue in fiscal 2020. Our Department of Defense business continues to grow, and we will benefit from investments that we have made to broaden and strengthen our technology offerings and support our broad geographic presence. Moving next to gross margins. Gross margin rate was 37.2%, a decline from the comparable rate of 38.5% in the prior year, mainly attributable to product mix changes in our Test & Simulation business, and an expected decrease in our sensors gross margins.

The decline in sensors was due to mix shift, production inefficiencies described in the second half of 2019 that are improving and the start-up of Endevco production recently transferred into our sensors production facility. As we exited the fourth quarter of fiscal year 2019 with historically low margins, we expected our overall gross margin rate to show marked improvement in the first quarter. We delivered on that improvement in the first quarter, yielding an additional 230 basis points in gross margin from the fourth quarter of fiscal year 2019. This improvement was headlined by our Test & Simulation business, going from 27.1% gross margin in the fourth quarter of fiscal year 2019 to 30.6% in the first quarter of fiscal year 2020, as we experienced better revenue mix from our improved backlog position and less revenue from the larger, lower margin jobs produced in the fourth quarter. Gross margins included $540,000 of inventory fair value step up charges in the first quarter relating to the Endevco acquisition compared to $445,000 of inventory fair value step up charges in the first quarter of last year relating to E2M acquisition.

Operating expenses of $61.5 million increased by $1.1 million from the prior year quarter, primarily driven by the inclusion of operating expenses from the acquisitions of E2M and Endevco, but were offset by cost containment programs, increased capitalization of investments in research and development projects, focused on developing new technology that will enable Test & Simulation to continue as a leader in our respective markets. We continue to manage our operating cost structure to increase bottom line performance and selectively use some of these savings to make prudent investments that are required for future growth and stability as a company. During the first quarter, we incurred $1.7 million of acquisition-related expenses related to the Endevco and R&D acquisitions, compared to $761,000 of acquisition-related expenses in the first quarter of last year, relating to the E2M acquisition.

Net interest expense of $8.3 million increased by $1.5 million compared to the prior year quarter primarily due to the increase in debt utilized to acquire E2M in November of 2018 and Endevco in August of 2019. Interest expense for the first quarter was slightly below our guidance range on a quarterly basis. However, with the acquisition of R&D closing in January 24, 2020, we continue to expect interest expense to be within the range previously announced of approximately $8.7 million to $9.3 million per quarter for the remaining fiscal 2020 quarters. The effective tax rate of 17.8% for the first quarter was in line with our expectations and guidance range for the full fiscal year with no discrete benefits being recognized during the quarter.

After a few years of unusually low tax expense due to tax reform and discrete tax benefits, it is important to note the following tax rate in calculating earnings per share comparisons as we experienced a consolidated tax benefit of 9% in fiscal 2017 and a benefit of 38.7% in fiscal 2018. Furthermore, we had consolidated tax expense of 11.4% in fiscal 2019, and we are now expecting a more normalized rate of 15% to 19% for full year fiscal 2020. First quarter adjusted EBITDA of $29.6 million was essentially flat versus the prior year quarter. This metric includes adjustments for $2.2 million of stock-based compensation expense, which we do not exclude from our adjusted EPS of $1.7 million of acquisition-related expenses and $540,000 of acquisition inventory fair value adjustment. Adjusted EBITDA was 14.4%, as a percent of revenue for the first quarter compared to 14.8% last year and quarter. We ended the quarter with $64.1 million in cash, a slight increase from the end of fiscal year 2019.

We used $5.7 million of operating cash in the first quarter, which was an anomaly for us with higher acquisition-related costs, the temporary inefficiencies for moving one of the Endevco production facilities into our existing centers facility. The investment in working capital for inventory stocking and lower advanced payments received from customers. During the first quarter, we had capital investments of $10.6 million to meet the growing demand in our sensors business and to address the long-term needs of our facilities, ultimately generating negative free cash flow of $16.3 million in the quarter. Moving forward, we expect a marked improvement in free cash flow coming from a return to more optimal working capital profile, higher revenue and improved bottom line performance. We ended the quarter with total debt of $540 million, a slight increase from the end of fiscal year 2019 for positioning of the R&D acquisition and general operating needs. Our outlook for generating cash and managing debt is driven by expectations that each of the recent additions to the MTS portfolio will generate strong incremental free cash flow to pay down the existing debt balance.

We ended the first quarter with a gross debt leverage ratio of 4.08x and a net debt leverage ratio near 3.6x. With the completion of the R&D acquisition, the leverage will increase slightly. However, we have confidence that our financial profile of both our existing and combined businesses will decrease gross leverage to below 4x by the end of fiscal 2020. Now I'd like to provide a quick update on the Endevco acquisition. The integration is on an aggressive time line, and we have already completed the move of one manufacturing facility into our sensors production facility within a span of only four months. Our integration teams has done an outstanding job overcoming the inherent challenges present in a move of this magnitude over a short time span. The second and final production facility migration is scheduled to be completed by the end of fiscal 2020, and I have full confidence that we will integrate the business successfully and build on the strategic opportunities we envision with this acquisition. Due to this rapid production migration, first quarter results were slightly muted for Endevco compared to our anticipated results. However, we continue to expect the business to deliver approximately $30 million of revenue in fiscal year 2020, as previously stated. Customer reception to this combination remains extremely positive.

The markets served by this product line continue to be solid and our execution to our plan is progressing as expected. That concludes my comments on the first quarter results. Next, I would like to add a few remarks on our full year guidance. We are reiterating our full year guidance for the fiscal year as we continue to manage and expect fluctuations in performance by our businesses on a quarterly basis. The results for the first quarter were anticipated and included in our full year guidance projections after the end of fiscal year 2019. For reference, the range for full year revenue is $955 million to $995 million, the range for GAAP diluted earnings per share is $2.05 to $2.35, the adjusted earnings per share range of $2.20 to $2.55, which includes adjustments for acquisition-related expenses, and the range for adjusted EBITDA is $138 million to $158 million. It is important to note that our adjusted earnings per share does not adjust our amortization expense for acquired intangible assets related to our multiple M&A transactions, nor does it adjust for stock-based compensation costs.

The amortization of purchased intangible assets decreased our earnings per share by $0.20 per share for the first quarter and is expected to impact earnings per share in the range of $0.80 to $1 per share for the full year. The quarterly increase in amortization expense going forward will be attributable to the acquisition of R&D, any changes made in the purchase price allocation of Endevco and minor roll-off of amortization expense from our M&A activity. In summary, we are continuing to execute on our growth and diversification strategy, making prudent investments across MTS to deliver sustained long-term revenue and profitability growth, along with the efficiency and productivity improvements that create shareholder value long term.

We believe that over time, this consistent focus will prove successful in building upon our legacy as a technology and customer-focused test and measurement company and one that is more diversified and resilient to changes in the external environment and is better positioned to sustain a higher level of financial performance. Finally, I would like to welcome the entire team from our newly acquired R&D company to the MTS family. We envision a great future together in combination with our legacy MTS team and other newly acquired businesses in E2M and Endevco, and we are excited for a great future ahead of us delivering excellent customer-focused technology.

I will now turn the call back over to Jeff.

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Thanks, Brian. So as Brian just mentioned, we expect fiscal 2020 to be a benchmark year for us. The one in which we see the development of a very strong backlog, exciting sustainable growth prospects and expanding margins. By year-end, we're confident that the transformation of MTS into a larger, more robust test and measurement company, comprising two strong and complementary business units that have global scale and outstanding customer base and world-class technology, all delivered with a passion for total customer satisfaction will become fully appreciated by all of our stakeholders. With a slow start to the fiscal year now behind us, we will increasingly see progression in our metrics that we laid out for you in our full year guidance. Let me conclude with what we believe are the keys to our success. MTS is a complex business that employs some of the smartest, most insightful engineers in the industry. Our story is a simple one to understand at a high level, and it remains consistent.

First, we need to keep executing on sensors. It's a great business with a strong leadership team that we believe will generate significant value for our customers, employees and shareholders alike. Second, we need to take full advantage of the strength in our non-vehicle related Test & Simulation equipment and service opportunities to drive growth and margin expansion. This strategy has been consistent and is showing positive results. Third, we need to continue with the same disciplined integration methodology that we've employed in the past with our more recent acquisitions. We have the experience and focus needed to ensure success. Executing well in these three ways will help ensure that we achieve strong financial performance in the year ahead, delivering solid growth with expansion of our margins and free cash flow performance successfully creating value for our customers, employees and shareholders alike.

With that, Brian and I are happy to take questions and Shelby, you can open up the line.

Questions and Answers:

Operator

[Operator Instructions] We'll take our first question from John Franzreb with Sidoti.

John Franzreb -- Sidoti -- Analyst

Good morning, Jeff and Brian.

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Morning, John.

John Franzreb -- Sidoti -- Analyst

I guess I want to start with the order trends, surprisingly weak now for three quarters. Jeff, you're signaling nearly a hockey stick kind of recovery this year. I just want you to maybe talk us through why you get confident to that kind of recovery, especially considering the weakness you've been seeing in Europe, and I suspect the continued weakness you can see at least in bookings coming out of China, given the coronavirus. Now what gives you that confidence level that going to see a sharp recovery in order trends?

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Yes, John, it just gets Well, I'd tell you two things. Number one, as you know, things can vary quarter-to-quarter. We've seen a few light quarters now in terms of actual order placements, but continuing growth in our opportunity pipeline. And at some point, that just has to be relieved. At some point, just the fundamentals there -- these -- the launch of new products in the world continues. The spending on those new products continues. And at some point, the pipeline builds up to a point where customers just need to place orders, so they're not going to launch new products on time. So there's that underlying fundamental. But beyond that, we are just deeply embedded with our customers, and we see the time orders. Now their capital investments, especially in our Test & Simulation business. So the management can always make a decision in one quarter or another to postpone an order. They're rarely canceled.

They're rarely taken out of their planning as what usually happens is they're pushed off, but we've seen that for a few quarters now and our day-to-day feedback from customers is they're running out of time. They've got to get orders placed and they got to get moving. So as I said, I try to be very clear in the commentary, we expect that to start happening in the second quarter and continue to accelerate in the second half. Now your point about the coronavirus is a good one. We're tracking it very closely. We do have a wonderful customer base in China, which we expect to be out of the holiday. Now they've extended the holiday. The world had delay ordering? Will it delay normal commercial activity? Undoubtedly, it's a headwind, John. What I don't know is how rapidly this risk may decline and how rapidly they'll move back to normal operations. I can tell you, I don't expect that demand to go away.

And if this runs its course and it goes down, I expect to have minimal impact. But it's all in the future. We just have to see how it plays out. I can tell you we're monitoring it daily. We have six business sales and service guys in China. We get great feedback from the ground on what's happening. And I can just tell you, I feel very good about the overall order trajectory for the year. That is certainly of an unknown headwind to us off going forward?

John Franzreb -- Sidoti -- Analyst

Well, just maybe sticking with the geographic mix here, is the opportunity pipeline is the best growth you're seeing here in North America? Does that give you some sort of confidence?

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Yes, it's...

John Franzreb -- Sidoti -- Analyst

Go ahead.

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Well, no, I'm sorry to cut you off. John, you go ahead and finish your question.

John Franzreb -- Sidoti -- Analyst

And I was just saying -- and just on the coronavirus, I mean, we've seen in the past numerous times, we've had deferral jobs for numerous reasons. This one don't seem to me like a legitimate reason that the second quarter might be weaker than expected. Just on that basis alone, should we be factoring that in? Are you just thinking about that? What are your thoughts about that in general? Both those questions.

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Yes, it's certainly the -- from an ordering standpoint, you could see orders pushed out. Now those orders would not have turned into revenue in the second quarter largely anyway. So I wouldn't have expected a lot of that's impacted revenue and slowdown performance there. But in terms of order rates, you could certainly see a push out there. Before that -- before this virus emerged, I would have been even more bullish about the second quarter in orders. Now I just think it's an unknown headwind. Back to the first part of your question, in terms of geography, yes. Certainly, the demand in China is terrific. We love seeing that. But I would tell you, worldwide, I mean, we've either -- they've been trying, I think, kind of quietly to increased liquidity and the investment environment in Europe. We're starting to see the flow-through of that now and increasing opportunities in our pipeline. And that's broad-based. And I would expect in energy and renewable energies to be a big factor there.

I think that's really, really going with Gusto now, and you're going to see a lot more of that in our structures area. And I think at some point, automotive at least has stabilized, and we're encouraged to see that. And I think it will hang in there for the rest of the year. So Europe's coming back a little bit. I don't want to oversell that, but it's doing a little bit better. And North America remains a very good environment for us across the board. I -- North America, our installed base is biggest. So we have a big services opportunity. And the companies are relatively cash-rich right now and able to make the investments. Now will they depends on their outlook for their new products and things, and that can change. But right now, all signs are green in terms of basically worldwide demand. Even places, John, like India, I'm very pleased with the prospects in India.

Now it's a small part of our business today, but you'll see us increasingly talk about that. The populations density is very high, and they need infrastructure. They need to build out their infrastructure, and they want to make it safe. So you'll see our equipment that goes into building a bridge design, you'll see renewable energies, all of that stuff growing there, too. So it's what gives me encouragement is it's broad-based strengthening, some areas more than others, but broad-based stabilization is strengthening. And in the emerging markets, strong demand growing, which we're bullish about the risk factor we see on the horizon here is the coronavirus, obviously, and we just have to see how that plays out.

John Franzreb -- Sidoti -- Analyst

Okay, fair enough. And then just switching over, Brian, you touched on in your prepared remarks kind of a rarity of the free cash outflow for MTS in the quarter. You suggested that part of it was moving of facilities of Endevco. Could you talk a little bit about what the capex is expected to be for the full year this year? You mentioned the debt repayment, you're going to get down to under 4x by the end of this fiscal year. Maybe a little bit more on your debt repayments thoughts going beyond fiscal 2020 into 2021. A little bit of color behind cash flow, debt repayment, capex would be helpful?

Brian T. Ross -- Executive Vice President and Chief Financial Officer

Yes, sure. So this -- last year was a higher capex year for us than what we had projected was that it would be at an elevated level for the current year kind of been around that 3x to 3.5x -- 3%, 3.5% of revenue for the full fiscal year. As we just complete some investments that we're making. So that's one item. As far as debt repayment, we talked about a slower year of debt repayment on the actual leverage ratio, a much improved -- continued improvement in the EBITDA side of the world in performance for the full fiscal year, which would help reduce leverage. And then in fiscal 2021 is when we expected more rapid payment to our debt on the deleveraging side of it.

Operator

[Operator Instructions] We'll take our next question from Deepa Raghavan with Wells Fargo Securities.

Brian T. Ross -- Executive Vice President and Chief Financial Officer

Good morning, Deepa.

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Your Live Please speak.

Operator

He's not speaking. So we will move on to our next question. We have, again, John Franzreb with Sidoti.

John Franzreb -- Sidoti -- Analyst

I'll ask a quick follow-up and maybe Deepa can chime in again. If not, I'll chime in here for a third time. Okay. I guess, I wanted to ask a little bit about the structures business. You implied that it's going to be bigger than the ground vehicle by the end of the year. I guess, just three buckets to that, that I want to talk about. Bucket one, how much is that in the inclusion of R&D? Bucket 2, how much is it ground vehicles weakening or on a year-over-year basis, I know you implied it stabilizing. How much of that business is being down on a year-over-year basis? And bucket 3, how much of that is -- organic growth within structures? And just to tie the knot around it. I'm sorry guys, I got one question, and I want it to be easier. Is the structure business, the legacy structures business, a higher-margin business than the ground vehicles legacy business?

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

So I'll tell you what, I'll let Brian take that margin question at the end. But let me just comment, John, on the rationale for being the largest. There's a couple of factors. I think you touched on them. Number one, certainly, ground vehicles, and the biggest piece of that is automotive, it has come down in the last couple of years, and it had really peaked out a few years ago at half of the business. And it was driven by our success there. We were pulled in by customers around the world as the automotive market invested a lot of money in new products. Then that investment has largely continued in total, but it shifted more to safety-related items right now for autonomy. So we've seen the durability and performance test needs that we satisfy come down. So part of it is that percentage has come down, and as we saw that happening, we invested preferentially in materials testing and then in structures testing.

And we've been in those businesses for many, many years. And fortunately, for us, those markets are really strong. And what's driving them is what I mentioned, carbon fiber composites are going everywhere, and you see additive manufacturing really taken off for materials testing. Our installed base is at record levels. We have a big service opportunity there for growth. And then in structures, John, the emerging market is really a fabulous story. It's overshadowed a lot by all the other stuff. But when you look at the emerging market spend, their GDP growth and their spend on infrastructure, it is really profound. And so they're investing in a lot of new building and bridge designs, but we've been in that business for decades, and we're absolutely the recognized leader. So they continue to build our laboratories to design new buildings and bridges, but on top of that now, energy as a part of that structure element is really growing.

And we've always been involved in energy testing for drilling and even rock cracking for fracking, things like that, that are very basic to the industry. But it's always been a small part of our business. Now with renewables coming up, we anticipate wind energy being a very large industry in the future. And the issue there, John, is those turbines need to last 20 years. And the evolution of the technology is really fast. So they have to have a way to test them very quickly. And you can't afford to build a whole acres acres of a wind farm, and then have all the turbines fail in a limited amount of years. So you have to do this accelerated testing in a lab, which we've been in and around for a while, but R&D now, the R&D acquisition gives us a chance to really grow that business and may be the leader in the world in testing wind turbines. So -- and we see that moving. It started in Denmark and largely has expanded from there and is now really growing fast, in China, and then we expect India in the United States.

So we love that growth aspect of that business. And then what I'm missing -- Oh I'm missing aircraft, of course. So we've always been in the aircraft -- airframe testing business and components that go into engines. What we can test now with the R&D add-on is we can test the actual rotating structure like the rotating hardware in the engine and the gearboxes, things that go into modern aircraft engines that really determine the fuel efficiency and the performance of that engine. So now we're a holistic provider to the aircraft industry. And then with the E2M acquisition, of course, we've added on flight simulation. So I would tell you, John, you'll hear us -- I mean, like I said, for the first time in 53 years, the structures business is going to be the biggest one for MTS by the end of the year, and I expect that to continue to grow. I think we've got to -- gotten the business back in proportion now to where it's much more balanced, and we've added on a services element. All of those areas are going to grow.

Now periodically, John, I would expect automotive to go through spending periods worth what's higher. But all in all, we want to keep it -- like Brian and I said, we want to keep that percentage down, we'll get it down to 25% this year. But we want to keep it down by growing the overall -- by having higher growth rates in the other markets. So the dollars can climb, but we want to have niches where we can really be successful and make money in that business. So we've got a bit big a few years ago. We balanced the business out this year, and I expect that balance to be retained going forward. So Brian, do you want to end with a comment on margin performance?

Brian T. Ross -- Executive Vice President and Chief Financial Officer

Yes, sure. Just real quickly, I think what our expectations are is that the R&D company will add about $40 million of revenue to our existing business. So that adds about 5% to 10% of -- as we broke out the sectors within structures. As far as the structural side of the world on gross margins, we generally see those about five to 10 points higher and execution on those projects even better. So original budgets that completion of the project within budget. I line all of that is usually very successful for us.

John Franzreb -- Sidoti -- Analyst

Great. So that's a mix benefit. That's what I was looking to hear. That's fantastic. And I'm going to get back in the queue. Let other questions be asked -- chimed in. But if not, I still have two more follow-ups. Alright guys, thank you.

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Thanks.

Operator

[Operator Instructions]We'll take our next question from Deepa Raghavan with Wells Fargo Securities.

Deepa Raghavan -- Wells Fargo Securities -- Analyst

Good morning. Happy 2020, since this is the first time we're chatting this year. But can you -- this is something you've discussed extensively, but I just have something to give us a little bit more comfort. Just any commentary, you do anticipate order pick up in the second half. There's a backlog replenishment that you'll have in the second half, it all seems to be on track. But we don't see that. It's not a captures in order growth trends. So is that like a soft commitment from clients that gives you the visibility and the confidence to say that there's a pickup coming. And where I think I struggle with that is also another thing I struggle with, your Q2 and Q3 comps start to stiffen a little bit. So how do you triangulate all of these and say, "Hey, we will still grow in the second half orders or backlog wise?

Brian T. Ross -- Executive Vice President and Chief Financial Officer

Yes, Deepa. So with comps, just be sure and stay straight on order comps versus revenue comps because the -- in the test, the Test & simulation business, particularly is a backlog-driven business. So orders come in and then they flow through over time into revenue. So that can be a little disconnected there. But in terms of order growth, I would tell you, Deepa, Q1 was clearly light and Q3 and four last year were clearly light. But with our customer base, and this is why we -- this is why I really wanted to take time on the call to go through our orders outlook because I don't like surprises in the future. And what we're seeing right now is a very strong demand profile coming. And yes, there are risk factors, the coronavirus certainly throws a new risk factor out there. But what we see is a very strong demand profile coming, which will first translate into orders growth, and that I would have told you before the virus, that would have clearly started here, I believe, in the second quarter that we're in right now.

With the virus, it's an unknown risk. And we'll push out in time or not. But we saw it starting in Q2 and then going strongly through the second half of the year, that order growth replenishes backlog and as some piece of it will actually translate into revenue for the year. And then that revenue, obviously, that revenue growth will follow through in fiscal '21. So most of my contrary was on the orders outlook from demand. And I would tell you the same thing I said to John a few moments ago, that's from being embedded in our customer base around the world very deeply. And so what I'm telling -- what I'm passing on to you is the feedback we get from our customers broadly around the world. And nicely, as I said before, it's fairly geographically evenly distributed. You see some strength coming back in Europe. You see the Americas, North America being strong. And you see the growing demand in China and the emerging markets and with the caveat again of the virus. But -- and the impact there. But fundamental demand is growing. Order placement has been weak the last few quarters.

Our pipeline is much bigger than ever. And we expect those orders to break through and start being placed. And that's the best intelligence we have today. And clearly, there are always risk factors that could change the outlook. Once those orders are placed, we will continue to give you updates on revenue and EBIT flow-through from those -- from our operations. Right now, we're holding guidance, assuming that our initial revenue outlook and even EBITDA flow through, whereas model at the beginning of the year within that range. So that's -- we're holding to that. We're pinning it really on our outlook for orders for the remainder of the year, which we believe is very strong organically. And then you add on the acquisition of R&D, which will be on top of that, I believe it will end up being a very good year from an order standpoint and backlog.

Deepa Raghavan -- Wells Fargo Securities -- Analyst

Okay, got it. I apologize if this was asked earlier, John, a little late, but your DoD sensors business, how is the pace of auto release been with them? I mean you should be looking to backfill some pretty soon. I'm just curious how the next tranche of autos been released from them is looking at this point?

Brian T. Ross -- Executive Vice President and Chief Financial Officer

Yes, we'll update you every quarter on that. We landed, as you know, from what we described previously, we landed the big contract. It's funded incrementally in discrete purchase orders from the OEM that we support. The system that goes into. So I can tell you, the budget that was passed from Congress to fund the DoD I'm really tracking time now a month ago or so, six weeks ago, clearly, that opened the spicket for the OEMs to receive their funding on contracts. And largely, if I look at the broad industry, those contracts have been placed. I would expect that flow through to suppliers to continue, and we're obviously a key supplier for the platforms that we're on.

So I would expect that to continue. Timing of the government is an imprecise science. And I want to throw that out as a caveat. I can't guarantee when the purchase orders are going to come through. We still have enormous confidence that, that contract will be funded. The technology is really rock-solid and it's going into a great platform. So we feel really good about the contract. The exact timing on purchase order placement from the government I -- well, really, from the OEM and via the government funding, I can never be precise on it. We will update you quarter-by-quarter. And all in all, it's going to be a great program for us.

Deepa Raghavan -- Wells Fargo Securities -- Analyst

Got it. Sorry, can you -- is there a way -- my last question is, is there a way you could size out -- size of your China exposure as it relates to maybe just a specific region within China that your revenues are driven from more or is there a way to just ring fence, just the export area within China?

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Sure. Sure. Let me make a general comment, and then I'll hand it off to Brian to give you some numbers, Deepa. But China has been a really great market for us for 30 years. And it's driven by the same factors. In the beginning, they were -- it was university work, basic research, they were trying to ramp up, infrastructure testing, as they become more affluent now in the world. Their GDP has gone up. They do a lot more research on building designs and bridge designs for their population as their cities have grown and now you see the emergence of an automotive industry and an aircraft industry, a domestic one for them, that every large economy wants to have, and that flows through the supply chain. So we've been in laboratories for 30 years very broadly. Materials, things that go into structures, things that go into automotive.

That has really ramped up in the last several years, and we see great long-term potential for us over there. It is very broad-based. We basically have followed the development of the Chinese economy. So we started off in the big cities of Beijing, Shanghai, and down south in Guangzhou province, where the first joint ventures went in and laboratories were built, and we've spread from there basically throughout the country. So we're very -- we sell all over the country. We sell to laboratories and OEM laboratories all over the country and universities all over that country. We have a very broad and deep sales and service team around their. And we do most of the fulfillment out of the states here primarily. So that's been our model. It's worked very well for us. Brian, do you want to -- and we have about -- we have roughly 400 employees in -- throughout China. But there's no one significant geographic region. It's mainly the big coastal cities and then spreading from there across the country. Brian, do you want to add anything?

Brian T. Ross -- Executive Vice President and Chief Financial Officer

Yes, overall, our business is about 35% or 36% in Asia and about 20% to 25% of that is specifically in China. So you can think about that as a ring-fence around what revenue we sell into China and a complete shutdown of the economy, China, everything, obviously, we put a ring fence on below, which I don't believe is the case or this thing irons itself out, and we've seen maybe a little blip here in the -- our second quarter, the first calendar quarter here, and it irons itself out through the rest of the year. It's somewhere in between that. I wouldn't state that it is at the drastic level at this point based upon the way that we monitor that.

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Yes, specific to that, Deepa, we have a handful of employees actually stationed in Wohan. And in that province there. And clearly, we've taken all the precautions that the government recommends and beyond in terms of protection of those employees. But it gives you a sense out of 400 people, we've got a handful that located in that region. Now unfortunately, for China and the rest of the world, this virus came up at their holiday period where there was a lot of travel.

So we're taking extended precautions as every company, I'm sure is, and the government to make sure that people, either don't travel or travel safely, that they stay in their home, if they've been to that region and don't contribute to the risk of spreading the disease. So all of those precautions we're taking. We get daily reports, and it looks very rational right now to us in terms of the actions being taken. But no one knows the future, and our hope is this subsides like past issues have. But I think Brian put the ultimate ring-fence around it, and I'm sure every company is doing the same. Does that answer your question?

Deepa Raghavan -- Wells Fargo Securities -- Analyst

Yes, it does. One small clarification. Is -- Brian, is this considered -- then -- are you considering any impact at all within your guide at this point in time? I know you have a pretty good range within the guide, but is there any impact from this Coronavirus actually is your guidance?

Brian T. Ross -- Executive Vice President and Chief Financial Officer

Well, what I would say is that there's been a swap in -- within that range. And before we had tried to encompass in our original guidance what could happen in the trade discussions, and that's largely starting to iron itself out. And now it's being kind of swapped with the current virus issue that's out there. So I think it is still encompasses our existing range for the full fiscal year.

Deepa Raghavan -- Wells Fargo Securities -- Analyst

Alright, that's cool. Thanks so much.

Brian T. Ross -- Executive Vice President and Chief Financial Officer

Thanks, Deepa.

Operator

We'll take our next question from John Franzreb with Sitodi.

John Franzreb -- Sidoti -- Analyst

Hi, guys, All right. So in the interest of time, you can make this as short as you want. Two questions. One, the service business was down both sequentially and year-over-year. Jeff, you suggested, that business is going to do well for the balance of the year, could you briefly discuss why? And two, E2M, you purchased it before the 737 MAX issue. Anecdotally, we're hearing more simulates being put out there, could you talk about how that business is performing relative to your expectations from then to now? How much is it performed better-than-expected or not as well as expected, given the Boeings issue. Both those two topics and how many words we can fit in?

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Yes. So again, let me give you a couple of general comments, I'll ask Brian to add any numbers on top of it. So in service, in general, John, is a great business for us. We have over $60 installed base now. And so what we're doing, as you know, is we're calling on customers to service that base and we're embedding our service people wherever we can create business. It does have a little bit of seasonality to it. Fourth quarter is generally a little bit lighter as people -- as customers watch their spend because a lot of that spending comes out of expense, Customers expense line rather than capex. So there's always a little bit of shading at the end of the year on that. But all in all, I expect our service business to grow strongly going forward. We've been delivering kind of high single-digit growth, occasionally into the doubles. I expect that kind of trajectory to continue. E2M, I just love the acquisition.

We're using their electric technology now in a lot of our platforms. So technology -- the technology synergy is excellent. The demand profile, I believe, for flight simulation is excellent. But actually, the incremental impact of any 737 MAX issue, we've not really seen. But I would -- John, frankly, I wouldn't have expected to see it right now. It flows through to our customers, they factored into their capital planning and build out. I don't expect a spike. And I -- the demand profile there has been significant. So I don't know that we'll even really notice it. But it can't be a negative. It has to be a positive for us. So we're very, very encouraged about that. We love those guys. We love the business. And I wouldn't underestimate the amusement business, all right? As more and more amusement parks are gearing their high-end attractions toward flight simulation. And I think it's a marvelous business to be in. So we'll be growing in all those. Brian, do you want to add any numbers on it?

John Franzreb -- Sidoti -- Analyst

Okay, guys, thanks for taking all my points in the room.

Brian T. Ross -- Executive Vice President and Chief Financial Officer

Of course. Thank you.

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

Thank you, john, for the interest of time. Shelby, I know we're at 10:00. So maybe I'll just say thank you all for participating in the call today and the interest in the company. We'll look forward to giving you an update again next quarter. Have a good day, guys.

Operator

[Operator Closing Remarks]

Duration: 59 minutes

Call participants:

Brian T. Ross -- Executive Vice President and Chief Financial Officer

Dr. Jeffrey A. Graves -- President and Chief Executive Officer

John Franzreb -- Sidoti -- Analyst

Deepa Raghavan -- Wells Fargo Securities -- Analyst

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