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Edited Transcript of MTSC earnings conference call or presentation 4-Feb-19 4:00pm GMT

Q1 2019 MTS Systems Corp Earnings Call

EDEN PRAIRIE Feb 8, 2019 (Thomson StreetEvents) -- Edited Transcript of MTS Systems Corp earnings conference call or presentation Monday, February 4, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian T. Ross

MTS Systems Corporation - Senior VP & CFO

* Jeffrey A. Graves

MTS Systems Corporation - President, CEO & Director

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Conference Call Participants

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* John Edward Franzreb

Sidoti & Company, LLC - Senior Equity Analyst

* Richard Michael Kwas

Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Research Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the MTS First Quarter 2019 Earnings Conference Call. Today's conference is being recorded.

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

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Brian T. Ross, MTS Systems Corporation - Senior VP & CFO [2]

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Thank you, Karen. Good morning, and welcome to MTS Systems' Fiscal 2019 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-GAAP 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 GAAP measures. A reconciliation of our non-GAAP measures to the nearest GAAP measure can be found in our earnings release.

I will now turn the call over to Jeff.

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [3]

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Thank you, Brian, and good morning, everyone. We appreciate you joining us for our call this morning.

As usual, on our call today, Brian and I will highlight the performance for the quarter and our view for the rest of the year. But I have to say at the outset, in this quarter, the most significant change is the exceptional growth in our backlog and new business.

At the end of our first quarter of fiscal 2019, our backlog exceeded $500 million for the first time in our company's history, representing a 24% growth in consecutive quarters and a whopping 45% growth year-over-year. These figures are exceptional for us, particularly considering that we ended our fiscal 2018 on a high note, with a record backlog to that point in time, that positioned us well for fiscal 2019.

The sales performance reflects the strength of our technology offerings, our broad geographic exposure and the span of our market verticals in both the Sensors business and our Test and Simulation business.

As many who have followed our company are aware, our focus in recent years has been on executing our growth and diversification strategy, capitalizing on our market-leading Sensors and Test and Simulation equipment, along with a strong focus on providing optimal service to our valuable customers across the globe. In short, we are leveraging the strong core technologies in both of our business units and prioritizing the launch of new products and services in adjacent markets to both accelerate our growth and diversify our market exposure.

While momentum has been building for some time, this quarter, I believe, has become very clear to everyone through the consistent momentum in order rates and the dramatic increase in size and quality of our backlog. We expect to see this momentum continue, translating to sustainable value creation for our customers and our shareholders alike.

While we've been very pleased with our organic orders' performance and backlog growth, another example of our continuing diversification strategy is our acquisition of E2M Technologies last November. As a reminder, E2M complements our existing Simulation business from both a technology perspective and through entry into 2 new high-growth adjacent markets, flight simulation and entertainment, which is commonly referred to as theme parks. Though the acquisition of E2M occurred late in our first quarter, the integration is going well and our expectations for delivering top line growth as well as accretive margins to MTS in fiscal 2019 remains unchanged. This is a model we would expect to continue to executing opportunistically in the future.

With these general comments out of the way, let me share a few more details on our first quarter of fiscal 2019 financial performance, which Brian will add more detail to shortly.

In the first quarter, we generated orders of $125 million in our Test and Simulation business, which is a 15% increase over prior year and orders of $98 million in Sensors, which is a 28% increase over the prior year. These results reflect a continuation of the positive momentum we have established in fiscal '18, when we finished the second half of the year with then record orders of $456 million for the 6-month period.

Test and Simulation orders in the first quarter were again supported by strength in the structures and materials markets, with continued growth in services. Orders in ground vehicles continued to be weaker than historical norms as our customers continued to invest heavily in safety-related testing of new vehicles. However, we did see a slight uptick in orders for the quarter compared to the same prior-year period. Our continued efforts to drive an improved balance of orders across the higher-growth Test and Simulation markets that we serve is paying off.

From a Sensors perspective, we had another record orders performance in the first quarter of fiscal 2019 after having just set a record for Sensors orders in Q4 of '18. This continued momentum is coming from broad strength across all end markets, including both the industrial and Test markets, which led to another outstanding orders performance and resulted in a book-to-bill ratio of 1.26 in the first quarter. Most importantly, the strength in our orders and increase in our backlog is the underlying reason we have confidence in our ability to achieve double-digit top line growth in Sensors moving forward.

The first quarter orders included the second purchase order associated with our Department of Defense contract, giving us a total of 2 funded orders of roughly $20 million each, which are now included in our backlog. As a reminder, our DoD sensor contract, inclusive of all options, totals approximately $187 million over the next 5 to 7 years.

From an overall company perspective, we're very pleased with our backlog position. Our performance from this perspective in the quarter was very, very strong. We believe this is a significant leading indicator of our ability to deliver on our expectations for growth and expansion and profitability in fiscal 2019. More importantly, we believe the market dynamics, which we're experiencing, will continue to provide momentum and further strengthen this key leading metric.

Moving to our top line performance, revenues from our Test and Simulation business were up 6.2% in the first quarter compared to the same prior-year period, reflecting solid follow-through from our strong orders' performance in the second half of 2018. We believe this is repeatable as we continue to take advantage of opportunities in the non-ground vehicle sectors of our Test and Simulation business, namely materials and structures, as well as Test and Simulation services, which have all been experiencing growth. In addition, E2M will expand its contribution to our revenue base in the Test and Simulation business as we fully integrate it throughout the remainder of the year.

As I mentioned last quarter, we're working hard to diversify our business within the Test and Measurement space, reducing our overall exposure to ground vehicle development markets over the longer term. While this market segment has been a part of our business for decades, it brings with it somewhat higher volatility, which can be disruptive to our workforce planning and our financial performance. Therefore, over time, we'd like to preferentially grow in adjacent markets, where we see increasing demand trends and where we can leverage our world-leading technology expertise in force and motion control.

As a result of these efforts, Test and Simulation equipment sales through our ground vehicle customers was approximately 25% of our total revenue in Q1 of '19, down from its historic levels of 35% to 40%, and we expect our long-term target of 15% to be achievable.

Demand for our Sensors products continues to be steady as industrial markets across key geographies were supported by economic strength and favorable market trends. Sensors revenue growth of 2.6% in the first quarter compared to the same year -- the prior-year period was strictly attributable to the timing of shipments and will increase throughout the year, driven by our strong backlog position and continued robust sales.

Of note, during the quarter, we had minimal shipments on our 2 purchase orders associated with the DoD contract, which were approximately $40 million combined and longer term in nature. We expect these orders to turn to revenue equally in fiscal 2019 and 2020, which is a slight deviation from the normal commercial order-to-revenue cycle for our Sensors business.

Over the next 3 quarters, we expect revenue to increase related to these DoD orders as we have now completed the reconfiguration of our production lines to support higher volumes, and we will be ramped up to full production by the second half of this year.

With the outstanding orders performance in Q4 of fiscal '18 and Q1 of fiscal '19 and continuing broad market strength, we continue to expect fiscal 2019 to be another year of double-digit growth for our Sensors business.

As for our view ahead, for our Test and Simulation business, while we continue to plan for volatility in the ground vehicles sector as we move through '19, the growth in our 12-month opportunity pipeline indicates increasing stability in this market vertical. We expect our Structures market to be stable, with a slight positive trend but as always, lumpy, quarter-to-quarter, due to the size of individual projects that characterize this sector.

Test and Simulation services, again, had an excellent first quarter, and we continue to believe our service business is an underpenetrated and underappreciated part of our core Test and Simulation business. Benefits from this portion of the business will be increasingly impactful through our customers and through our shareholders in the quarters and years ahead.

From a Sensors perspective, I'll repeat what I said last quarter. Our end markets remain healthy and our new product pipeline strong. We simply need to keep doing what we've been doing, that is focusing on execution and providing unparalleled total customer satisfaction. We're positioned very well in Sensors.

One other popular question that I'd like to address is our business in China and trade tariffs. As many of you know, we focus on our China markets for many years, and they represent an area of significant growth for our company. We continue to see strong demand in this region, with an increase in year-over-year orders. In addition, we've experienced only minimal macroeconomic impacts from the tariff enactments, and we feel we're well-positioned to navigate, not only the import and export challenges, but can also minimize any long-term efforts of raw materials inflation.

Now I'd like to turn the call over to Brian to further discuss our financial results and our outlook.

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Brian T. Ross, MTS Systems Corporation - Senior VP & CFO [4]

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Thank you, Jeff. I will move right into our first quarter fiscal 2019 results with focus primarily on year-over-year quarterly comparisons. Jeff already touched upon orders, backlog and revenue performance, so I will start with gross margin.

Our gross margin rate for the quarter declined by 160 basis points compared to the first quarter of fiscal 2018 but held fairly steady with the fourth quarter of fiscal 2018. Test and Simulation gross margin rate decreased by 160 basis points due to the continued investment to improving sustainable long term project execution tools, the E2M acquisition inventory fair value adjustment from purchase accounting valuation, and a slight increase in variable compensation expense.

An important metric to call out for our Test and Simulation business is that income from operations increased from 4.7% to 5.8% of revenue when comparing current quarter results to last year, which shows the concerted effort by our team in improving overall bottom line performance.

The gross margin rate for our Sensors segment declined 140 basis points versus the same quarter results in fiscal 2018 because of production inefficiencies incurred from the introduction of new products and a mix shift from lower revenue in the high-margin energy sector being replaced with revenue from lower-margin markets. Compared to the fourth quarter of 2018, we saw a nice sequential rebound back to near 50% gross margin, which is our target for this business, proving that the unusually low margin in the fourth quarter was temporary in nature. In addition, both segments have ongoing programs that have begun to lower their cost structures and drive productivity improvements.

Operating expenses of $60.3 million decreased by $1.1 million from the prior year quarter, as we continued to manage costs closely to keep our expense leverage aligned with the needs of our business and to be prudent in the investments we undertake to drive profitability. We achieved this decrease despite incurring acquisition-related expenses of $800,000 and an additional intangible amortization of $400,000 from the acquisition of E2M.

Net interest expense of $6.8 million was consistent with the prior year quarter, which is attributable to our significant pay down of debt in fiscal 2018, offset by the additional funding drawn on our revolving credit line for the acquisition. We continue to expect interest expense to be $6.5 million to $7.5 million per quarter for the rest of fiscal 2019.

The effective tax rate of 6.2% for the first quarter includes an additional discrete tax benefit of $1.3 million due to the true-up of and finalization of the measurement period for the Tax Act that was enacted in December of 2017. Without the discrete benefit from the Tax Act, our tax rate would be 17.8%, in line with our guidance for the full fiscal year effective tax rate of 15% to 19%.

Fourth quarter adjusted EBITDA of $30.1 million increased 12% versus the prior year quarter, with improved top line and bottom line performance from our Test and Simulation business.

Our improved performance in Q1 yielded us GAAP diluted earnings per share of $0.54 per share, and our adjusted diluted EPS was $0.59 per share. Our EPS performance for Q1 has us positioned well to achieve our full year diluted EPS guidance, which I will talk about shortly.

We ended the quarter with $70.4 million in cash, which is in line with where we ended fiscal 2018. We ended the quarter with total debt of $466 million, which is up about $78 million from the beginning of the year. We drew approximately $80 million from our newly renegotiated revolving line of credit to pay for the acquisition of E2M. Total acquisition costs are expected to be no more than $1.5 million, of which we recorded $800,000 in Q1 2019. Going forward, we expect strong free cash flow and available cash balances to help us pay down our debt.

As a reminder, before this deal, we had reduced our debt for 8 consecutive quarters, and we currently forecast our leverage ratio to decline to 3.5x or below by the end of fiscal 2019 through a combination of debt paydown and improved adjusted EBITDA performance.

I would like to discuss a few points regarding our E2M acquisition. We are executing nicely on the near-term integration strategy, which is enabling E2M to execute on their 2019 financial performance. We continue to project the E2M business to deliver top line revenue of approximately $30 million for fiscal 2019, with strong operating margins that are accretive to MTS Test and Simulation margins. The results of E2M's operations are included in our Test and Simulation business unit.

E2M hit all our marks in the quarter, indicating progress for the full year, even with having only been included in earnings since the purchase date of November 21, 2018. We have recorded preliminary purchase accounting amounts in our consolidated financial statements and amortization of $400,000 within G&A for intangible assets acquired as part of the acquisition. We expect to record a total of $3 million in amortization expense for fiscal 2019 or approximately $900,000 in each of the remaining 3 quarters.

In addition, we recorded a preliminary $1.7 million inventory fair value adjustment that increased inventory during the quarter. Approximately $400,000 was recognized through cost of sales in the first fiscal quarter of 2019, with approximately $1 million to be recognized in the second quarter and approximately $300,000 in the third quarter, all of which costs are recorded as additional cost of sales.

Beginning in fiscal year 2019, we adopted the new revenue recognition standard under ASC 606 as issued by the governing bodies. While there is a relatively immaterial impact to revenue and earnings, the effort and expense incurred to prepare for and to adopt the standard over the last couple of years should not be overlooked, and I would like to recognize the finance and accounting teams, along with the entire MTS organization, for their work for the adoption of this standard.

Moving on to our guidance, we remain confident in our fiscal 2019 full year guidance of revenue of $830 million to $870 million; GAAP diluted earnings per share of $2.30 to $2.60; and adjusted EBITDA of $122 million to $142 million. These expectations are supported by our outstanding first quarter ending backlog; a return to growth in our Test and Simulation business; continuing strong momentum in our Sensors business; improving business mix; the E2M acquisition; and slightly positive contributions from the revenue recognition standard adoption.

In addition, we are introducing a new guidance metric this quarter: adjusted diluted earnings per share. We believe this metric puts us more in line with other industry players and makes it easier for you to compare us to other companies.

For fiscal 2019, we expect adjusted EPS to be $2.42 to $2.72 per share. The reconciliation to GAAP earnings per share can be found in Exhibit F of our press release. The add-back adjustments include acquisition-related expenses, restructuring charges and the fair value step-up of inventory for the acquisition of E2M.

In summary, we are pleased with our financial performance for the first quarter of fiscal 2019, especially with the phenomenal backlog delivered by both businesses. We were well served by our strategy that includes expanding our portfolio of products in rapidly growing Sensors markets and staying focused on meeting the demands for new Test and Simulation solutions due to evolving technologies and favorable demographics. As part of the diversification piece of our strategy, we are very pleased to add a high-quality business enterprise like E2M at a time when its business model is gaining momentum and size.

I will now turn the call back over to Jeff.

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [5]

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Thanks, Brian. So to reiterate, we're off to a solid start to the year. The clear highlight for Q1 was the significant growth in our backlog during the quarter and the support it provides to our outlook for growth and profitability in the year ahead. While this backlog growth rate may be hard to improve upon, we do expect overall strength to continue in each of our business segments as we move through the year.

As I stated last quarter, when we introduced our thoughts on fiscal 2019, we're strongly focused on 3 key tenets: first, we need to keep executing on Sensors; second, we need to continue taking advantage of the strength in our non-vehicle-related Test and Simulation opportunities; third, we need to successfully integrate our newest acquisition of E2M Technologies without any loss of momentum in their current business, which is on an excellent trajectory. So far, we're executing well on each of these tenets and anticipate continued success moving forward.

With that, Brian and I are happy to take your questions. Karen, I'll turn it to you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from John Franzreb with Sidoti & Company.

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John Edward Franzreb, Sidoti & Company, LLC - Senior Equity Analyst [2]

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Jeff, I'm going to start off where you started off, with the backlog, and [then just] for that matter. Could you just talk a little bit about the strength you see in both materials and structures? And what's driving that demand?

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [3]

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Yes, John. It's a few very specific things. Thanks for asking. On the material side, there is an absolute explosion in 2 key areas. One is the use of advanced materials like carbon fiber composites. They are quickly moving from high-end large aircraft application to small aircraft and on now to ground vehicles and many other applications. The carbon fiber composites are just booming. And with that, the need for end customers and developers of the material to test those materials. It requires an awful lot of testing in order to develop the design data. So advanced materials is one of them, and you could lump in there the new aluminum alloys and some other lightweight high-strength materials. But that whole wave of lightweighting of vehicles is really sweeping many industries. The second broad-based driver of our materials test business is additive manufacturing. With the advancement in the equipment technology for making parts through additive manufacturing, the ability to make really exotic geometries is increasing very fast. The unusual part, though, is the material properties you get when you additively manufacture something are often very unique, so they have to be tested. And we've been spending a lot of money on R&D to develop that capability, and we're now fielding equipment that's very targeted toward the additive manufacturing market for testing. So materials, those 2 broad trends are really driving it, and it's very global. I would tell you from U.S., Western Europe, China, India and elsewhere, those 2 trends are very Global. On the structures side, John, there is a fairly clear interest in developing safer, more reliable civil infrastructure, meaning buildings and bridges. And we have a unique, very long-term position in making test equipment to test the impact of earthquakes and others seismic events or even tsunami events on that civil infrastructure. So we're doing very well in that area. They tend to be, as you know, large, lumpy projects, but with the increased storm activity in the world and earthquake events, a lot more countries have a need and the money to invest in basic understanding of how to design and build buildings and bridges that are safe. So we're selling a lot of that equipment around the world, and it's something that we are, I think, very uniquely and well positioned for. So that -- and then you've got the usual, in structures, you've got the usual aircraft expansion. There's new aircraft being launched, and we're very good in that business as well. So you've got the ongoing trends for aircraft manufacturing and other heavy vehicle type applications that require what we would classify as structural testing activities.

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John Edward Franzreb, Sidoti & Company, LLC - Senior Equity Analyst [4]

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Okay. Now did some of those jobs come in earlier than you anticipated in the first quarter? And as a result, there was bigger-than-expected order intake in Q1?

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [5]

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I wouldn't say that, John. The large structural stuff has been unpredictable. So yes, one order did come in. It wasn't abnormally large, so it didn't unduly influence the backlog. But we might have expected it in Q2 it really came in Q1. But we've got other things out in Q3 and Q4, which may shift forward or backward as well. So as you know, structures is just a bit of a lumpy business, but we also had, I would point out, a fairly significant order in Q1 of last year in the structures area as well, so the year-over-year comparison was still very valid. So I wouldn't say it's unusual. I was pleased to get a large order in Q1, but it didn't unduly shift the backlog.

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John Edward Franzreb, Sidoti & Company, LLC - Senior Equity Analyst [6]

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Okay. And then, so can you give us a sense of what Test was in your backlog legacy? If you exclude E2M, what it kind of looked like, I don't know, on an organic basis?

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Brian T. Ross, MTS Systems Corporation - Senior VP & CFO [7]

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Yes. So John, overall, if you look at where we ended the year last year, our backlog was roughly about $415 million. Really strong orders here within in the quarter, and we saw sequential growth, roughly in the 10-plus-percent range. So that's the organic without the acquisition.

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John Edward Franzreb, Sidoti & Company, LLC - Senior Equity Analyst [8]

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That's Test organic or company-wide organic?

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Brian T. Ross, MTS Systems Corporation - Senior VP & CFO [9]

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That's Test -- sorry, company-wide organic, and that's split between both businesses.

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John Edward Franzreb, Sidoti & Company, LLC - Senior Equity Analyst [10]

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So what would Test organic be? Because I know you have a double-upping in the DoD job in the quarter or so.

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Brian T. Ross, MTS Systems Corporation - Senior VP & CFO [11]

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So the growth within the quarter as far as backlog, for Test alone, from year-end, sorry, let me look at the last year.

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John Edward Franzreb, Sidoti & Company, LLC - Senior Equity Analyst [12]

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You finished around $346 million, I believe. I'll just ask one more question.

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [13]

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It's okay, go ahead. And Brian will be checking the numbers for you, John. Go ahead.

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John Edward Franzreb, Sidoti & Company, LLC - Senior Equity Analyst [14]

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Right. I guess, one more question around if material is doing so well and structure is doing so well, it sounds like ground vehicle is the offset here. Can you talk a little bit about what's going on in ground vehicles, especially in light of what we're seeing in lower production rates and sales expectations in calendar 2019?

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [15]

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Well, John, we've seen -- well, I would tell you factually. We had a slight uptick in ground vehicle test orders, it's still well below historic norms, but we did actually have a small uptick in orders. So I would interpret that to mean that people are starting to spend money again on durability and performance testing for ground vehicles, primarily cars. There are a lot of new products being launched and they had -- our customers had the preference to spend their money on safety. But we see some of that coming back now. I still anticipate it to be choppy, but it was nice to see a little uptick. It didn't contribute substantially to orders and backlog, but it was nice to see an uptick and not a drawdown on vehicles. So it was certainly on the lower end of performance, but it was at least stable and growing a little bit. So Brian, do you want to come back to that question?

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Brian T. Ross, MTS Systems Corporation - Senior VP & CFO [16]

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It's about 10% growth from the year-end, so roughly if we're at $346 million, you have that same amount (inaudible)

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [17]

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So it's the Test growth -- the Test growth rate that John asked about?

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Brian T. Ross, MTS Systems Corporation - Senior VP & CFO [18]

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Yes.

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Operator [19]

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(Operator Instructions) Our next question is from Rich Kwas with Wells Fargo Securities.

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Richard Michael Kwas, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Research Analyst [20]

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Just a few questions here. With regards to the DoD business, the $20 million, the 2 contracts. I think Jeff, you mentioned something about -- or maybe it was Brian, talking about them contributing equally. What do you mean by that in terms of -- is that the dollar amount equally over the next 3 quarters? And then what's the cadence of that full $40 million? How does that roll into the numbers here? What's the time frame?

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [21]

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So Rich, in Q1, we had very little, very minimal contribution in revenue from the bookings on that. So if you remember, we got $20 million PO in Q4 and another $20 million here in Q1. We have virtually no revenue in Q1 from that. And quite frankly, we spent the end of our fiscal '18 and early '19 reconfiguring the production line for this anticipated volume that's coming. So we landed the 2 POs, 1 in Q4 and 1 in Q1 here. We got virtually none of the revenue in Q1. We will ramp through Q2, but we really won't hit full production stride on those purchase orders until the second half of the year, Q3 and Q4. And that comment about splitting it, what that will really translate to is we'll realize about half of the revenue from that $40 million here in Q, and correct me, Brian, if it's -- in fiscal '19 and about half in '20.

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Richard Michael Kwas, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Research Analyst [22]

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Okay, okay. So equal. So it sounds like this is going to be within the $20 million for the year for '19, the majority of that should be booked in FQ3 -- FQ4, right? Is that the right way to think about it?

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [23]

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Yes, it should turn to revenue. Yes, the POs are firm. It's in the backlog. It should turn to revenue in the second half of the year, Rich.

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Richard Michael Kwas, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Research Analyst [24]

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And then as we think about '20, that run rate continues over the balance of the 4 quarters of '20, it should be relatively even contribution over the course of '20?

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [25]

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Yes, correct. I would expect, given the run rate in the second half of the year, that PO would be primarily fulfilled, I'm thinking, Brian, at first half of '20. And then we're -- again, Rich, we're very optimistic. That full contract is $187 million. So we've now booked $40 million of it. With all the options on it, it's worth $187 million. So if this military funding continues this way, we would expect that to live into its potential, looking out into '20 and beyond.

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Richard Michael Kwas, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Research Analyst [26]

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Okay. And then, I guess, on the ground vehicle side, if we -- some of the other industrial players and automation companies have talked about weakness in project activity, weakness in MRO, inclusive in the U.S., North American market. When you look at that business, I know you -- I realize you have an uptick in orders here on a year-over-year business, a slight uptick. But when you look at the business regionally speaking, are you seeing any sort of meaningful weakness when you look at China, Europe, North America? And China has been weak in terms of underlying retail sales for a period of time at this point. Europe has started to soften up recently. Just curious in terms of what you're seeing around that activity, particularly on the auto side within the ground vehicle.

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [27]

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Yes, it's interesting, Rich. From our perspective, the overall spending levels have been down, but from a geographic perspective, it's very uniform across Europe, the States and in China. And the frustrating thing for us has been our orders are derived from their spending on new product testing. And they have been developing a lot of new products. They just haven't been doing the type of testing that requires our equipment. It's been more safety testing. So again, we anticipate at some point, that trend will shift back, but what we're seeing right now is pretty uniform performance around the world and at a historically low level but stabilizing. Okay. So we did see a slight uptick in orders. I don't want to oversell that. It wasn't glamorous, but it was nice to see at least the arrow pointing upward and not downward. And it's pretty uniform around the world. So that's what I can tell you about it. They do have a wonderful array of new products they're developing. They're spending a lot of money on it. But unfortunately, a lot of it is going into safety. From our perspective, it doesn't fuel our business much.

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Richard Michael Kwas, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Research Analyst [28]

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So it's pretty uniform. Nothing significant across the various geographies?

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [29]

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Correct.

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Richard Michael Kwas, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Research Analyst [30]

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Okay. And then just a housekeeping question for Brian. With regard to restructuring here that was taken in the quarter, was that for the core business? And was that in costs of goods sold?

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Brian T. Ross, MTS Systems Corporation - Senior VP & CFO [31]

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Oh, no. So for the restructuring, it was just kind of the ending piece of what we took action on in China over a year ago. So that program rolled out and it's -- there's some sitting in cost of sales, yes, and a little bit in the operating line.

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Richard Michael Kwas, Wells Fargo Securities, LLC, Research Division - MD & Senior Equity Research Analyst [32]

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Okay, so it covers both. Okay. Great.

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Operator [33]

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And we'll take another follow-up question from John Franzreb with Sidoti & Company.

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John Edward Franzreb, Sidoti & Company, LLC - Senior Equity Analyst [34]

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Yes, Jeff, could you just help me understand why you can't participate more in the safety side of the business in ground vehicle? Especially since you mentioned earlier, the safety side is what you're benefiting from in the structures market. And I mean, I'm also curious if E2M brings something you could also leverage into the ground vehicle market. Could you just talk a little bit about that -- the greater dynamic there?

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [35]

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Yes. Sure, John. Very specifically, the safety -- done now, the safety testing they've done now in automotive is for crash avoidance, so it's related to these new, more autonomous cars avoiding a crash. Historically, it's been survival of the crash. And you know, that's very specific crash-led kind of equipment and stuff. We were in that market very early but this is many -- it's a couple of decades ago. We're in that market early. We didn't participate broadly and don't now. But the money they're spending now, John, is on crash avoidance and it's really track testing, so getting out in real-world environments and trying to avoid a crash. So that equipment is not mature. The equipment that's used for that is very OEM-specific and it's a very fluid market. So we've not found the right entry point in crash avoidance testing, and we can't really, at this point, identify what a good return the investments would be. So we haven't participated largely. The OEMs have mainly been a do-it-yourself shop in that arena and doing a lot of track testing. So that's the story on safety. Eventually, the durability of the car, the aerodynamic performance of the car, the equipment that we make to support that will come back as a need, but right now, it's been predominantly safety and testing. You asked a good question about E2M. With the E2M technology and expertise, we have a broadened capability for simulating driving environments, so doing driving simulators. And that does open an opportunity because those are used much more extensively in autonomous vehicle developments to look at the interface between the car and the driver during autonomous driving. So we do have an opportunity there. And it's -- but we also have some marvelous other opportunities in flight simulation and in entertainment that we're clearly going to exploit. So what we continue to do in ground vehicle simulation, we will do activities there on a very focused way, but it will compete with what we do in other market adjacencies.

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John Edward Franzreb, Sidoti & Company, LLC - Senior Equity Analyst [36]

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Got it, got it. And you touched on China in your prepared remarks. And so were China orders up for you in the quarter?

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Brian T. Ross, MTS Systems Corporation - Senior VP & CFO [37]

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Yes, overall China, we -- I would say that it's a little bit flat for us right now, but we did have a slight uptick in the orders, so if you think of revenue on orders. But we're still seeing kind of our same type of business. In 2018, we talked about really nice growth there. It's moderated slightly but we're still in pretty good position for it.

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [38]

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And John, the way to think about that continuing demand is we sell equipment, as you know, into new product labs and R&D labs. And China is spending a boatload of money in that area to develop an automotive industry, an aircraft industry, that expand basic research. So there is a continuing demand for testing equipment in those areas that we see as fairly robust.

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John Edward Franzreb, Sidoti & Company, LLC - Senior Equity Analyst [39]

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Okay. And I guess, 2 more questions. Jeff, it seems like you are optimistic about your service revenue as it unfolds in 2019. Is there any particular reason? Are you having more success with customers? Can you just talk a little bit about that?

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [40]

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Yes, John, services is being very well received. And we continue to grow at high single digits, occasionally, double-digit level of services orders and revenue. And the margins have improved now. They're nicely accretive to the overall Test and Simulation business. So we love that business. Customers love that business. We are really limited by how many people we can hire and train. We went through a wave of retirements. A lot of people that do that work are career-long people. We went through kind of a wave of retirements over the last few years now that we had to replace, plus we had to grow. So we've been doing a lot of hiring and training of service techs around the world. We have about 350 today roughly, spread around all of the major continents we do business on. And they do a tremendous job. Customers are very happy with them. So we continue to hire and train about 10% gradually -- about 30 to 40 people, say, a year. And we continue to grow that business organically. There's not much we can do in the vein of an acquisition to accelerate it, but we will continue to hire and train and grow. Customers love it. They can source this very high-tech maintenance kind of work and service work to someone else instead of doing it themselves. So it's a good deal for them, it's a great deal for us. And we love that business. I think it remains kind of underappreciated in the market, but we are right at that $100 million mark now. And it's an over $1 billion kind of opportunity for us out there, and well, at least half of which is very strong margin business. So we continue to invest heavily in it, and even from an R&D perspective, for software upgrades, spare parts, things like this to keep our equipment running, which is designed to run for decades. So we view it as a great part of the business. We expect it to continue to grow high single-digit kind of levels, maybe occasionally a double-digit level, going forward. So it will make more and more contribution to the business.

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John Edward Franzreb, Sidoti & Company, LLC - Senior Equity Analyst [41]

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And one final thing. In the R&D line, maybe this is for Brian. I know in the past that you can shift personnel from R&D to COGS or whatever, depending on the job cycle. But it's gone down meaningfully in the last 2 quarters. I'm wondering if there's any reimbursements there. And if you can go on that line, what do you think about total R&D spend for fiscal 2019?

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Brian T. Ross, MTS Systems Corporation - Senior VP & CFO [42]

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Yes, so it should be relatively in line with where it is for Q1, give or take, a couple of percent. But as far as reimbursement, there's none. But I would say that we're pretty solid on the ground with our R&D expense as we see it now.

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Operator [43]

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And with no further questions in the queue, I'd like to turn the conference over to Dr. Graves.

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Jeffrey A. Graves, MTS Systems Corporation - President, CEO & Director [44]

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Thanks, Karen. So thank you all very much for participating in our call today and for your interest in the company. We look forward to updating you on our progress again next quarter. Thank you, and have a great day.

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Operator [45]

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This concludes today's call. Thank you for your participation. You may now disconnect.