Iteris Inc (ITI) 2018 Q1 法說會逐字稿

Good day, and welcome to the Iteris Fiscal First Quarter 2018 Financial Results Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Todd Kehrli. Please go ahead.

Thank you, operator, and good afternoon, everyone, and thank you for participating in today's conference call to discuss Iteris' financial results for its fiscal 2018 first quarter ended June 30, 2017. Joining us today are Iteris' President and CEO, Mr. Joe Bergera; and the company's CFO, Mr. Andy Schmidt. Following their remarks, we'll open the call for your questions.

Before we continue, we'd like to remind all participants that during the course of this call, we may make forward-looking statements regarding future events or the future performance of the company, which statements are based on current information, are subject to change and are not guarantees of future performance.

Iteris is not undertaking an obligation to provide updates to these forward-looking statements in the future. Actual results may differ substantially from what is discussed today, and no one should assume that at a later date, the company's comments from today will still be valid.

Iteris refers you to the documents that the company files from time to time with the SEC, specifically the company's most recent Forms 10-K, 10-Q and 8-K, which contain and identify important risk factors that could cause actual results to differ materially from those that are contained in any of the forward-looking statements.

I'd like to remind everyone that a webcast replay of today's call will be available via the Investors section of the company's website at www.iteris.com.

Now I'd like to turn the call over to Iteris' President and CEO, Mr. Joe Bergera. Please go ahead.

Great. Thank you, Todd, and good afternoon, everyone. Thanks for joining us today. As you saw at the close of the market, we issued a press release announcing the financial results for our fiscal first quarter ended June 30, 2017. In Q1, Iteris recorded $27.2 million in total revenue, representing 14% year-over-year growth. The result was due to continued strong execution across all 3 of our reporting segments: Transportation Systems, Roadway Sensors and Agriculture and Weather Analytics. The result represents record revenue for each reporting segment and for the company as a whole. That said, we did experience some margin compression, notably in our Transportation segment. The compression was largely attributable to revenue mix, which we'll discuss more on today's call.

In Q1, our Transportation Systems segment recognized $14.7 million in revenue versus $12.4 million in the same prior year quarter and $12.6 million in the previous quarter. This represents 19% year-over-year growth and 17% sequential growth for the segment. During Q1, the Transportation Systems segment continued to win new business, securing approximately $13.2 million in new orders. This is a 2.3% sequential increase against the $12.9 million in added backlog in the preceding Q4 and a 24% year-over-year increase against the $10.7 million in added backlog in Q1 of last fiscal year. The segment ended the quarter with $52.8 million in backlog.

Recent notable wins include additional design activity for Phase 1 of the Orange County Transportation Authority I-405 project. As communicated on our last earnings call, we're a subcontractor to a joint venture, OC 405 Partners, which was recently selected to complete the I-405 project. This is one of the largest transportation infrastructure projects in the nation, with a total estimated value of over $1.1 billion. We anticipate a number of task orders over the course of this multiyear project.

In addition to the increased I-405 activity, we received large business process outsourcing contracts from the Virginia Department of Transportation and the state of Montana as well as sizable software-related deals with Caltrans and the San Francisco Bay Area Metropolitan Transportation Commission. Over the course of FY '18, we expect our focus on project mix to continue to benefit the financial performance of the Transportation Systems segment. More specifically, we believe the higher portion of software-related consulting services and business process outsourcing backlog as well as larger average project size, will continue to improve revenue predictability and drive other internal efficiencies. That said, we may encounter project timing issues related to the precise dates of new contract awards and contract renewals which are: one, difficult to forecast; two, beyond our control; and three, could impact results within a specific quarter.

In Q1, the segment's operating income was $2.3 million or flat to prior year on a dollar basis. The segment's operating income margin rate compression was due to a relatively high level of revenue generated by subconsultant and third-party equipment sales, both of which yield lower gross margins than our consulting services. Although we're working hard to manage revenue mix, we could again experience unexpectedly high gross margin variability.

In Q1, the Roadway Sensors segment recorded $11.3 million in revenue versus $10.6 million in the same prior year quarter, which represents 6% year-over-year growth. This growth is almost entirely attributable to continued strong demand for our core product lines as we are only just beginning to realize the effect of the recent introduction of new products. For example, although we've already received several orders for VantageLive!, which just launched in May of this year, we won't begin to recognize any SaaS revenue for this new cloud analytics solution until the second half of this year.

During Q1, the Roadway Sensors segment realized especially strong performance in Texas and the Southeast region. Because our gross margins tend to be lower in Texas, the high degree of revenue contribution from this state created some gross margin compression. Nonetheless, the impact of geographic mix -- apologies, notwithstanding the impact of geographic mix, the segment's operating income dollars increased by $200,000 or 10% on a year-over-year basis and the segment's operating income margins expanded 80 basis points.

In Q1, our Agriculture and Weather Analytics segment recognized approximately $1.2 million in revenue versus $900,000 in the same prior year quarter. This represents a 28% year-over-year increase. The growth was due to strong performance of both ClearPath and ClearAg, our digital agriculture platform. Despite the solid year-over-year performance, some of you may note the Q1 revenue result reflects a 16% sequential decrease. This effect is due to ClearPath's historical seasonality and is consistent with our expectations for this segment.

During the quarter, we closed several net new ClearAg deals with a variety of customers, including allied providers, ag integrators and agronomists. Allied providers and ag integrators represent OEM sales for Iteris as these customers tend to embed ClearAg in their software and other service solutions, whereas agronomists tend to be actual end users of ClearAg. While we continue to add new customers, I'm especially pleased that we saw additional ClearAg penetration at the operating company level of our largest crop science accounts. We believe the single biggest near-term lever for exponential growth will come from converting these accounts to enterprise agreements.

To that end, today, we announced that Jim Chambers will be joining Iteris as Senior Vice President and General Manager of our Agriculture and Weather Analytics segment. Jim is an ag tech veteran with over 20 years in leadership roles with large agribusinesses, including Bayer CropScience, Valent BioSciences, Monsanto and John Deere. Among other responsibilities, Jim will be focused on helping us maximize and accelerate our penetration across science market.

Looking ahead, we remain very enthusiastic about the opportunity for Agricultural and Weather Analytics segment. We continue to see solid pipeline growth and opportunity conversion for both ClearAg and ClearPath weather. As a function of sustained solid bookings, the segment's annualized revenue run rate has increased 47% for the same -- from the same prior year period. Seasonally -- our seasonally adjusted run rate is now $6.2 million for the Ag and Weather Analytics business unit.

Now I'd like to turn the call over to Andy to walk through our financial results.

Thank you, and good afternoon, everyone. Well, as Joe's introduction showcases, we continue to demonstrate strong revenue growth across all our business lines. As we've touched upon in past reports, we're a growing and evolving business, continuing to improve our infrastructure to enable continued business expansion. Before addressing detailed financial metrics, let me update everyone regarding our evolving financial statement presentation.

As previously noted, Iteris is now an accelerated filer with the SEC. Our 10-K report for our fiscal year ended March 31, 2017, was our first accelerated SEC filing. However, the rules permitted certain scale disclosures as a small reporting company during that transition period in our 10-K. Beginning this fiscal year, we are required to meet full regulation S-X disclosure rules with the SEC in our Forms 10-K and 10-Q. Of note, our current 10-Q, which will be filed tomorrow, August 8, will include certain new disclosures. Most obvious is our presentation of revenues on the face of our P&L. From this point forward, we will present Iteris revenues as product revenues and service revenues.

That said, both Joe and I describe the business from a business unit perspective, and we will continue to do so. We will continue with our segment reporting details and our press release as well as our 10-Qs and 10-K. And as you are aware, we did refine our segment reporting last year to create what we feel is the clearest picture of how our 3 businesses performed.

Finally, as you'll see in our segment reporting, we do break out products and service revenue at the segment level, so you can see the components of what constitutes overall Iteris product and service revenue.

As an introduction to our quarterly performance metrics, let me note that there are no pro forma adjustments applicable to our current period or comparative period. As such, all amounts I refer to are GAAP results.

Okay. Reviewing our Q1 detail. As Joe previously noted, Iteris reports revenues of $27.2 million for the quarter, a 14% year-over-year increase. Transportation Systems accounted for $14.7 million in the quarter, a 19% increase year-over-year; Roadway Sensors, $11.3 million, a 6% year-over-year increase; and Ag and Weather, $1.2 million, a 28% year-over-year increase.

Looking at gross margins. Total company saw gross margins up 36.4%. That compares to 39.3% for the prior year period. Considering gross margins by segment. Sensors posted 44.7%, which is down from 46.7% in the prior year period. The current period performance is on the lower side of our expected margin performance. That's due to core product mix as well as rebalancing warranty and reserves, given their significant product transitions over the last couple of quarters.

In regard to Transportation Systems, current period gross margin of 29.6% compares to 32.4% at the previous year period. The unfavorable variance is primarily related job mix, in particular, higher-than-usual subcontract and third-party equipment components at our current period revenue numbers which carry very low margins.

Looking at Ag and Weather Analytics. We posted gross margins of 43.3% as compared to 47.5% last year. The current period gross margin figure is consistent with previous quarters, which also fell under SaaS accounting treatment which require us to defer certain revenues related to upfront SaaS deployments over future periods as well as capitalize certain software development costs for new functionality or enhancements to our SaaS software engine.

Joe touched on our segment operating margin results, which was $2.5 million for sensors, which is up from $2.3 million last year, $2.3 million for systems, which is flat with our last year performance; and our Ag and Weather businesses reported an operating loss of $1.8 million, which is flat with our last sequential quarter but is unfavorable compared to $1.6 million loss in their last year comparative period.

In terms of our corporate expenses, which include corporate IT, HR, accounting, legal, administration, executive and public company costs, we saw expenses of $3.56 million for the current quarter, which is down from $4 million at Q4 fiscal 2017. Our prior year first quarter corporate expenses were $3.05 million. The year-over-year increase was due to planned headcount additions and subcontract expense associated with overall strengthening of our infrastructure, which includes Sarbanes-Oxley compliance and accelerated filer costs.

As we've discussed every period, our G&A expenses have and will continue to be a key management focus, and we are on plan in terms of normalization of these costs as demonstrated by the $400,000 sequential quarter cost improvement. Looking forward, we feel that $3.5 million to $3.7 million quarterly corporate expense range may be appropriate, given the seasonal nature of audits, proxy filings, new accounting rule changes and so forth.

At the current level of corporate spend, we feel that we can attend to what will be yet another year of building and improving our business models. As noted earlier, we are now filing our 10-Qs and 10-K under full reg S-X accelerated filer status. We continue to improve upon our internal management reporting capabilities to support what Joe notes are newly introduced business models. Unlike the rest of the industry, we'll be migrating our revenue recognition models and processes to take into account the new rules under ASC 606, which becomes effective for Iteris at the beginning of our next fiscal year, April 1, 2018, and we will continue to look at other housekeeping items that are due for a refresh, such as our proxy filing process, S-3 registrations, internal processes and so on and so forth.

Regarding earnings, our first quarter fiscal 2018 loss was $0.01 per share as compared to $0.00 per share or breakeven last year. From a balance sheet perspective, we ended the quarter with cash at $17.6 million, a slight use of cash which approximates our operating loss.

Finally, deferred revenue increased slightly to $4.3 million at June 30, 2017, versus $4 million at the beginning of the year. In all, this is the start to a new year of continued growth and development aimed at creating increasing leverage in our business model. This concludes my prepared remarks. And again, a reminder that we will be filing our 10-Q tomorrow. At this point, I'll turn the call back to Joe.

Great. Thanks, Andy. So Iteris continues to benefit from improved execution and also from favorable trends in both transportation and agriculture. And simultaneously, our team continues to deliver business and technology innovations in our transportation segments while also developing a highly meaningful, high-margin subscription model in the agriculture market. With continued strong execution, we'd expect to realize solid organic growth through FY '18, although we continue to anticipate some shifts in the mix and timing of future growth, which I'll discuss in more detail momentarily.

Our Transportation Systems business continues to experience an increase in demand for programs related to smart cities, data analytics and enhanced safety and mobility. We also continue to experience growing demand for connected vehicle advisory services and vehicles infrastructure planning and design projects. At this time, we have 6 active projects related to connected vehicle advisory services and vehicle infrastructure planning and design. We believe this segment will continue to benefit from a favorable shift in transportation infrastructure spending through FY '18.

As we continue to pursue large strategic projects, we anticipate the length and timing of these complex procurement cycles will cause the segment's revenue line to move in step functions. In other words, we would anticipate the growth rate for the Transportation Systems segment to average in the mid-single digits for the fiscal year followed by periods of step function growth as we convert these large procurements. However, the specific timing of contract renewals and new contract awards is highly unpredictable.

In FY '18, the Roadway Sensors segment will continue to execute against our strategy of providing the industry's most complete portfolio of detection sensors, increasing the number and value of data elements our sensors collect and developing a recurring revenue stream for monetizing that data.

As I mentioned a few minutes ago, this segment recently launched its first SaaS solution, a data analytics service branded as VantageLive!. It is our intent to evolve VantageLive! into a robust analytical platform with the potential to unlock both a strategic and economic value of the data that can be collected by 130,000 sensors we've installed at intersections across the country. Given the level of market interest for VantageLive!, we're proceeding with some limited investments in the segment sales and customer success organizations. These investments, which will start in Q2 and reach steady state in Q3 will support channel and sales enablement as well as customer onboarding. Based on the introduction of new products in FY '17 and the recent release of VantageLive!, we expect the rate of revenue growth for our Roadway Sensors segment to increase year-over-year with our annual growth rate anticipated to exceed the market's historical growth rate of about 7%. This higher level of revenue will increase the segment's operating income dollars. However, the anticipated modest investment to capitalize on the high demand for VantageLive! may put some near-term pressure on the segment's operating income margin rate. Still, we continue to believe the VantageLive! product line will realize substantially higher gross margins than we realize on our sensors as the new SaaS product reaches maturity.

Now let's discuss our Agriculture and Weather Analytics business. We remain confident that the structural challenges faced by the agricultural sector present a substantial long-term market opportunity for ClearAg. Indeed, the continued growth and adoption of ClearAg, particularly at the operating company level of some of the world's largest seed and crop protection companies, validate our market assumptions. Nonetheless, as I mentioned, last quarter, the combination of historically low prices for agricultural commodities compounded by the industry consolidation among the largest crop science companies is delaying the enterprise-wide adoption of digital agriculture in several of our largest accounts.

We continue to anticipate enterprise agreements at our largest crop science customers to average $5 million in annual recurring revenue. However, our near-term pipeline tends to be comprised of operating company level opportunities rather than enterprise-wide deals because most of our crop science accounts are distracted with industry consolidation and other short-term sectoral challenges. Therefore, through FY '18, we'll continue to focus our commercial activities to secure additional orders at the operating company level of existing accounts as well as to penetrate new accounts but again do that at the operating company level. We expect this activity to continue to generate solid segment level revenue growth similar to our FY '17 growth rates. Additionally, we continue to anticipate considerable future revenue acceleration as we transition our crop science customers to enterprise agreements. However, again, we expect to begin to realize that impact in FY '19 rather than FY '18 due to current market conditions.

While we will maintain our strategic focus on the crop science market, we will, of course, continue to develop our OEM business with allied providers and ag integrators who embed ClearAg into their solutions, and of course, we'll continue to respond opportunistically to demand in other segments.

We believe our scientific and engineering capacity remains sufficient to meet current product road map requirements, and likewise, we believe our current total sales and marketing resource level is sufficient to support our FY '18 revenue targets. Therefore with the exception of the segment's new General Manager, we expect the Ag and Weather Analytics cost base to remain relatively flat through FY '18.

In summary, in Q1, Iteris realized solid sales execution across all of our segments despite some mix challenges in the Transportation Systems segment. We believe the market conditions will remain generally favorable in all of our end markets, and therefore, we continue to anticipate full year organic revenue growth from each of our reporting segments while at the same time we continue to work to contain expense growth. Further, we'll continue to implement business model innovations, such as the introduction and development of high gross margin recurring revenue streams, which we believe will continue to create long-term shareholder value. Now with that, we'd be delighted to respond to your questions and comments. Operator?

(Operator Instructions) And will go to Jeff Van Sinderen, B. Riley.

Let me say congratulations on the record revenues for the quarter and great to see Jim Chambers on board for the Ag segment. I know it's early and you mentioned a couple of things in your prepared comments, but maybe you can give us a little bit more of a sense of what Jim's sort of early primary objectives will be? And anything, I guess, along the lines of his approach to those objectives?

Yes, sure. Jeff, those are great questions. So given the market landscape that we see in the crop science segment, I think it's really important that we take a very, very focused approach to each of our accounts. One of the things that I see customers asking for is a better understanding of how our solutions can be immediately plugged into their business operation to create near-term value. And that's because, right now, I feel like a lot of these big crop science companies are having a hard time thinking over an extended time frame, given the degree of industry consolidation and then some of -- just the sectoral challenges that they are facing. So what does Jim give us? He has substantial experience working in a number of the largest crop science companies. He understands their internal operations. He actually was involved in the evaluation of ClearAg app Bayer CropScience. And so based on that experience, I think he's going to be able to help us better articulate our value proposition, our return on investment in these accounts and make sure that we're introducing those accounts in a way that it's clear how we can provide immediate value to these customers.

Okay, good. And then if we could shift a little bit, maybe you can just tell us kind of, I guess, more about what you're factoring into your system segment outlook or guidance. And are there other things we should consider timing-wise and mix-wise as we think about revenues by segment for Q2 and beyond? And I guess also, is there anything else we should be aware of around gross margins and operating expenses for Q2?

This is Andy. Given that very, very broad question, I'll take the start and then have Joe finish. First and foremost, with any of our BUs, it's really important to consider them from a full year perspective. All 3 of them are going to be subject to different timing issues from a quarter-to-quarter basis. In context of the systems business, that business from a statutory perspective is going to run between 31% and 32% gross margin. As you've heard from us in the past from both Joe and I, the leverage in that business tends to come from the operating income side, the operating margin side. But in context of gross margins, that business traditionally runs about 25% to 30% subcontract content, sometimes we're the prime contractor sometimes we're a sub. We run up to 400 concurrent projects, so there's quite a bit of variation and complexity in our mix. So from time to time, we're going to have some variations from a quarter-to-quarter perspective. When you consider our last quarter, we did have a fairly high content of subcontract and also equipment pass-through revenue and, hence, costs associated with that. If you take out the part that's considered to be atypical for a given quarter, we still grew that business, let's say, in the mid- to high single percentage points. So if you consider a $2.3 million year-over-year growth, about, just thumb in the air, $1.3 million of it was basically a typical subcontract component cost. Again, that just happened to hit this 1 quarter and you're talking about the timing between 1 or 2 weeks as that moves. So all things go well in that business. We're growing, again, where we expect to grow. In some cases, we did have this up spurt in terms of subcontract content. But on a total year basis, that business is going to perform within our expectations, and I think within the basis of the way people are modeling that business from a gross margin and OI perspective. Joe, would you like to add a little bit more about forward-looking side of it?

Yes, sure. So Jeff, just to put context here, there -- we do have one particularly large project that's coming up for renewal at the end of this calendar year. We are certainly going to compete to -- for the renewal of that contract. And in addition, we are pursuing a number of additional very large new projects. But for purposes of forecasting, we're trying to be as conservative as possible, and the current description that we're providing to you guys under is -- reflect the most conservative scenario where we would not win the re-compete for that project. So depending on the outcome of that procurement process, the timing of that decision and then also when and if we win some of these other large projects that are expected to be announced at the end or the very beginning of our next fiscal year, then you could end up with some dramatically different timing scenarios. So again, we're trying to be as conservative as possible in setting expectations with you and others who are following the stock.

Okay. Well, that's a good strategy. I could take the rest offline. I appreciate you guys answering my questions.

We'll go next to Mike Latimore, Northland Capital Markets.

This is [Lucian] for Mike Latimore. I have a couple of questions. Do you see most of the digital ag growth coming from current or new customers?

Say it again.

Do you see most of the digital ag growth for next year coming from the current customers or the new customers?

Is that most of the ag revenue, is that the question?

Yes.

Yes, so good question. Yes. Most of the revenue we would expect for the balance of FY '18 to come from additional penetration in our existing crop science accounts. Now that being said, we continue to win a number of new accounts. And as I mentioned in my prepared remarks just a few minutes ago, we secured an additional several new allied provider and ag integrator customers last quarter, quarter 1 of this fiscal year. We'll continue to do that. But just because of the size of the relationship and the overall size of the enterprise of our crop science accounts, that's where most of the revenue growth will come in FY '18.

And how are the insurance and irrigation categories shaping up as prospects for digital Ag?

For ClearAg?

Yes, yes.

Yes. So you're probably thinking about the QBE NAU deal that we announced a couple of quarters ago. As a matter of fact, we have continued to expand our relationship with that account. We've had some follow-on orders. I would expect that there'll continue to be additional orders. And also as I mentioned, at the time that we announced -- that we won that deal, we were starting to see inbound interest from other crop insurance companies, and we continue to do that. We do have some dialogue going on with some prospective crop insurers. Now that being said, we tried to be clear that we -- at this time, anyway, we don't view the crop insurance market as a strategic market. So we're not proactively marketing to that segment. But when we have qualified inbound interest, we're certainly responding, and we, also, of course, are going to continue to develop our relationship with QBE NAU.

What about the irrigation category?

Yes, so that's interesting. So you're probably thinking about the announcement that we recently put out regarding our irrigation advisory. We do continue to see irrigation as being an interesting opportunity for us. We would expect to partner with irrigation providers, although we do think we can provide valuable irrigation advisories direct to growers. So we'll -- I guess what I'd say is, I think it'sinteresting area for us, and I'd recommend that you guys stay tuned.

We'll next go to Steve Dyer, Craig-Hallum.

I appreciate the conservatism just around the remainder of the year, but just as it relates to Q2, and I know there's some variability that's typically run somewhat close to Q1, is that a conservative way to think about it? Or is that kind of going out on a limb at this point?

We wouldn't want you to go out on a limb.

Q2 is a good quarter for us. Q3 is typically our seasonal quarter. The typical variations, again, can be across all sectors, is very strong. In our systems business, in particular, we do get some August vacations, which does put a little bit more cost down in the G&A side and the OI. But in terms of just the variations and gross margins, again, they're more likely to bounce back to the norm than be where they are. Again as -- there will be a little bit of extra cost down in G&A due to vacations, hence utilization. The Sensors business has a very predictable in terms of their business, strong quarter and they're doing quite well. In terms of gross margin, they're a little bit lighter than they typically are seasonally, but not -- certainly within the point of expectation and that could probably improve a little bit. And I think what's probably -- at least for me, one of the most interesting aspects of Ag and Weather is, as we're getting into our second and third years of really going out to market with these and now with having Jim Chambers onboard partnering with Tom Blair, we're just entering all the big planning periods for the big agribusinesses in terms of planning for the next cropping season. So a lot of interesting activity going on, a lot of very important strategic discussions. So at that point, hopefully, we'll have more to report on that as we look at the next 2 quarters. Joe?

Got it. And then finally from me, wondering your thoughts on acquisitions. I know it's been sort of out there, but you have sort of enough things internally to keep you busy and probably still do. But is that still something that's kind of out there and new on that development?

Yes, that's exactly right. We have a lot to keep us busy internally. As I've had some people ask me about that from time to time, and just to be totally transparent, the first few quarters that I was here anyway, I just felt like we have a lot of internal work that needed to get done to really capitalize on the intellectual property that we already had as a company. And so that's what we've really been focused on. I do think over the course of the last couple of quarters, we've managed to demonstrate our ability to scale the operation. As Andy said in his remarks today and previously, we've made some investment in our infrastructure, and I do think we're getting to a place where we could successfully plug another, like a tuck-in, into our operation. If the right opportunity came along, we would certainly look at it, assuming it would create shareholder value. But now that being said, I think we have a lot of opportunity in front of us. It's not -- there's no requirement for us to do an acquisition, but I do think it's something that we're in a position we could at least consider now.

(Operator Instructions) We'll next go to Jon Fisher, Dougherty & Company.

First, I wanted to start with Roadway Sensors. Given kind of the early stages of the new product cycle you're in, that was a pretty significant deceleration in growth from Q4. I guess, I was surprised at that steep of a drop off. So was just wondering kind of what your outlook would be for a new product cycle this year for growth for that segment.

Well, I'm thinking that the reason you felt that there was a deceleration because we had such strong growth in Q4 of last year. And just as a reminder for everybody, we did have some pickup in Q4, which I think we talked about last quarter, and that was due to the fact that we had some supply chain issues and inventory issues that prevented us from fulfilling product for which we'd receive orders in previous periods. And so there was that catch-up effect in Q4. Now that being said, the 6% growth rate I will say is below the 7-plus percent growth rate, which we're expecting to average over the course of the year. But that being said, we do see a fair amount of variability from quarter to quarter. It's not -- I certainly don't think it represents an overall trend, although it is a little bit on the low side of the range, I think, for the year. We continue to see strong demand in all regions. We have a tremendous amount of opportunity flow in Q2. And as I look ahead through the end of Q2 and beyond, I feel very confident that we'll manage to come in above that 7% historical average growth rate.

Okay. And then just taking a couple of bigger picture questions for the year, good start to the year from a backlog standpoint. Would you expect this year based on what your pipeline looks like to grow backlog versus what you ended fiscal year out last year at $54.5 million?

Yes, so this is Andy. I'll take a start on this. I think what's a real positive story in backlog and just kind of backing up first, I should just kind of remind everyone, backlog is just one measurement that we look at as far as forward-looking indicators. And to put it in a funny way, if the backlog keeps growing and growing, that means we're not executing against it. So there's a specific size we think is relevant, and certainly, we're operating at that level. But as Joe said earlier on, we do take a conservative approach in terms of how we look forward as far as some of these very large jobs that we're re-competing for or bidding for in a normal roll off of contracts quarter-to-quarter and year-to-year. When you look at the current number Joe referred to, which is the $52.8 million in systems, he talked about the business we booked. But this also takes into account looking at these large contracts that just naturally going to re-compete. We don't book backlog, assuming a win or a possible win. We basically wind that backlog down in terms of what's left on the contract. So despite kind of our cautious or conservative nature, that backlog is still maintaining at a very strong level. So again, very healthy business, but I think both of us will always caution that it's just one particular number. And in any period, it can move, let's say, $5 million to $10 million up or down. That's not necessarily indicative of a big change in the business. It's just basically timing of some very large contracts.

Okay. And then final question, just on the margin outlook for the year, both gross margins and operating margins. Is it your expectations to increase gross margins year-over-year? And from an operating margin standpoint, is it your expectation for OpEx spending to be at a slower rate of growth than revenue growth will be this year?

Sure. This is Andy. I will start on the gross margin and then kind of hand to Joe a little bit on the op margin because op margin does actually bring into very strategic investing concepts. But the -- again, if you look at the different businesses, systems, as I said earlier, 31% to 32%, somewhat statutory driven in that a fair amount of that business still is hourly driven, and hourly driven in terms of a statutory overhead rate. So that becomes somewhat programmed. That business leverages down on the OI level. And again, that's going to be subject to where we choose to do some investing. So for instance, in the software or software-type applications that we're pursuing and feel actually can provide a much better leverage opportunity in the future, you'll see basically R&D spend or it might be some sales and marketing related to actually sell into different type of product down there. So that's something that we choose to manage specifically. On the sensor side, that business runs actually very strong for being an agency-based business at 47% to 50% for core business. There's about 10% of that business again, as a reminder, that is distribution, a third-party product that runs 10 to 15 point margin. So you end up at a blended 45%. That's very strong, and we think that's sustainable, and -- but it'll move, let's say, depending on that mix between distribution and product. It's going to move between the 44% and 48% quarter-to-quarter, but very strong and likewise leverages down pretty consistently what you see right now in terms of our operating expenses, our G&A-type expenses, our R&D expenses, we're building ever so slightly there for the new products but it's fairly representative of what to expect in the future. So as that business grows, you continue to see more margin. And Joe did comment that in Ag and Weather, we basically stabilized the spend in that business, so incremental revenue is going to drive incremental OI. But let me just pause a second to let Joe talk a little bit about some of the key investments that we're looking at and -- actually both sides, but probably more so in Transportation as far as enabling some of these new product opportunities.

Yes, sure. So thanks a lot, Andy. So yes, I appreciate that. We are making some investments and we tried to talk to those on our last call. In the systems business, they're modest but some of you may remember that last year, we talked about the fact we're re-factoring our various applications to deliver them on a SaaS basis. We started to increase our R&D headcount in that segment throughout FY '17. So while we're not adding a lot of additional R&D resources in FY '18, there is headcount annualization that is showing up in our FY '18 figures. Also, we have made a decision to hire a couple of sales resources that have experienced sale -- selling SaaS solutions in particular in software in general, which is a different model from what we've done in the past because, typically, we've had our consultants sell our software, which is one of the reasons, I think, we ended up delivering it on more of a job shop kind of basis or a managed services basis. But as we start to focus more on delivering our software solutions on a SaaS basis, we think we need to have a couple dedicated salespeople with experience in selling enterprise software and SaaS solutions. In this segment -- in the Sensor segment, also as I mentioned, we are making some modest investments to channel and sales enablement as well as the customer onboarding. Again, it's kind of in a similar vein. We've had tremendous success in generating demand and closing a surprisingly good number of VantageLive! deals with our existing sales staff. But we think having people with software experience selling VantageLive! will be beneficial. It can help us get even additional acceleration. So again, there are some very modest increases in spending there. With respect to Ag and Weather analytics, there is no additional expense other than we've added the General Manager, as I've just mentioned. So anyway, what does that look like? Our OpEx, as a percentage of sales, I think would stay in this generally the same range as it was, and I'd expect our segment level OI to remain generally in the same range. So these aren't big investments, but there are some investments this year which we think will create leverage going forward.

And we'll go to Joseph Osha, JMP Securities.

A couple of questions. First, acknowledging that you said that sort of expense run rate for Ag and Weather has stabilized. At the point at which one of these really big subscription deals potentially shows up a couple of million dollar run rate, would that potentially still be coverable with the existing organizational run rate that you've got? Or would there be additional expense associated with that? And I do have one other question.

Sure. This is Andy. Yes, we think we have a very robust infrastructure built out at this point and you bring up a good kind of good factor, which is the strategy has been to go after this very large seed and crop protection folks, the large enterprises because this is where we can get our leverage. It's a high leverage sales play. And it's also highly leveraged in terms of when you look at deployment, these aren't super custom deployments. These are basically on extension of the service that we have in place. Again, incrementally, it would take quite a few very large customers to actually drive our cost of sales from that perspective. We feel again that we have a very big strong engine built and this is what we're looking forward to in the future is actually taking on these larger customers and executing.

So we'd see at that point that if some of these materialize, the fall-through from that revenue should be pretty high, right?

Well, absolutely. And this is what we've talked to in the past in terms of -- basically, how does this business drive its way up to 70-plus gross margin, and it's exactly this way. You start to get this business up from, like Joe said, a $6 million run rate. You get it to 10, it's going to look different, and you get it to 15 to 20, and it's profitable and it's running 70 point gross margin. So essentially each $500,000 revenue basically incrementally improves all our metrics.

Okay. And second question and full warning here, Joe, I'm really headed off the range. I've had a number of companies that I've met here recently doing drones as a service. I had one in here the other day that was doing it for sort of mining facilities. I'm wondering whether as part of your business maybe in the context of the acquisition question earlier, have you thought about trying to integrate some drone services for some of these Ag information products you're offering?

Yes. So we've had some drone companies approach us. To some -- I don't mean to cast aspersions, Joe, I think it's a really exciting analogy...

Okay. Go ahead. Go ahead, please.

Well, but in my experience, I think sometimes it's a solution looking for a problem, right? And so we've had interest by some drone companies in working with us because using the drone we're able to collect information that then provides the insights and helps to kind of close the value loop there if you will. So anyway, we're certainly open to it. But right now, we've just got so many other opportunities in front of us. We're kind of staying focused on those. But I'm not ruling that out. I think it's an interesting idea.

And that concludes today's question-and-answer session. I will now turn the conference back over to management for any closing remarks.

All right, great. Well, thank you, operator. So we appreciate everybody's support and all the thoughtful questions, even though some of them were a little bit tough today. But that's okay, we're up to it. On the Investor Relations front, I just wanted to let everybody know that we'll be presenting at several upcoming conferences. We hope you look for us at the Canaccord Genuity 37th annual growth conference. That takes place in Boston this week, August 9 through 10. And then we'll be at the Dougherty & Company institutional investor conference in Minneapolis on September 18 through 20. And we'll also be at the Benchmark Micro Cap Discovery Conference in Chicago on December 14. So if you're attending any of these conferences, we'd love to see you. We encourage you to come see our presentation. In the meantime, we look forward to updating you again on our continued progress when we report our results for the second quarter of FY '18. So thanks again, and this concludes today's call.

And that does conclude today's conference. We thank you all for joining us.