MTS Systems Corporation F2Q10 (Qtr End 04/03/10) Earnings Call Transcript

May. 8.10 | About: MTS Systems (MTSC)

MTS Systems Corporation (NASDAQ:MTSC)

F2Q10 (Qtr End 04/03/10) Earnings Call Transcript

May 7, 2010 10:00 am ET

Executives

Sue Knight – VP and CFO

Laura Hamilton – Chairman and CFO

Analysts

Liam Burke – Janney

Mike Hamilton – RBC

John Franzreb – Sidoti & Company

Operator

Good day and welcome to the MTS second quarter earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Sue knight. Please go ahead.

Sue Knight

Thank you, Trika. Good morning and welcome to MTS systems fiscal 2010 second quarter investor teleconference. Joining our call today is Laura Hamilton, Chairman and Chief Executive Officer. I'd like to remind you that statements made today which are not historical facts could be considered forward looking statements as defined by the Private Securities Litigation Reform Act of 1995. Future results may defer materially from this statement depending upon risk, some of which are beyond's management's control. A list of such risk can be found in the company's latest SEC form 10-Q and 10-K. This company disclaims any obligation for revise forward statements made today in future events. This presentation may also include reference to financial measures which are not calculated in accordance with Generally Accepted Accounting Principles. These measures may be used by management to prepare the operating performance of the company over time they should not be considered in isolation or substitute for GAAP measures.

Laura will now begin her update in our second quarter results.

Laura Hamilton

Thanks, Sue. Good morning today's call is going to follow our typical format I'll start with key messages. I'll take you through the order summary to provide some idea of what's happening in our market. Sue will walk you through the financial details and turn it back over to me for the long term and short term outlook.

So let's start with our key messages for the second quarter and we have three today. First, we're pleased with the sequential quarter improvements of the second quarter that resulted from both volume leverage and strong cost management. With $10 million in operating margins we were up 65%, on revenue up 6%.

Our effecting key message is that we're participating in the near term improving business conditions and you can see this in the continued positive trend in what we call base order. In our third message is that we believe that we need to maintain a healthy skepticism regarding the long term economic sustainable worldwide whether you're talking about Greece or U.S. unemployment.

Let's shift to orders and provide you some colour on what's happening in our market. From a total company perspective, Q2 orders came in at $93 million. That was within our range of $80 to $110. So as expected. It was down 13% on a sequential basis because there were no large orders in the second quarter. The base was strong or up 6%. Backlog remains stable.

Let's shift to sensors for a moment. Sensors, second quarter orders came in at $21 million, our highest quarterly order in six quarters. On a sequential basis, sensors orders were up 19%, which is pretty impressive and that includes a negative 5 points of currency effect, so without currency it's 24% up.

In total sensors was up about $3.5 million and what's interesting is that $2 million of that was an industrial and $1.5 million was in mobile hydraulics. We like to ask the question and answer, who's buying and the answer is the same as in the first quarter. And industrial side of the business it continues to be broad based global participation.

We've mentioned to you before plastic and rubber worldwide, steel in China and wind power in Europe. Mobile hydraulic is the same we continue to mention construction and materials handling in Europe and the U.S.

So what's driving 20% growth in the quarter? And we think therefore reason and the first is inventory restocking, the second is we think it's because demand is returning from very low levels. When you're at low levels your growth numbers look pretty big. We think the third reason is new customers and new applications for MTS.

And the fourth reason is harder to know for sure, but clearly there are supply availability concerns broadly across the market and it could be prompting some over reaction or over ordering.

Sensors backlog is up $2 million or 14%, which is a little bit unusual and there are three reasons driving this, first and just light quarter bookings, things that were not expected to ship in the quarter. Second, we are seeing a small number of larger or longer term POs being less and the third reason is, we are experiencing supplier delays particularly in electronics and it's manageable. It's something we deal with every week but it does have a slight impact.

In summary for sensors, we're very pleased with second quarter orders and we believe we will understand the affects of inventory replenishment versus end user demand over time and we remain confident about our ability to find new applications.

Let's shift to test, at $72 million in orders for the second quarter, test orders were down 20% on a sequential basis, two points of that attributable to currency effect. Base orders for test was up 3% because, again, there were no large orders in the test business in the second quarter. So, the results were within our expected range for test.

Very similar to sensors, the external environment is really unchanged from the first quarter. China and renewable energy continue to be very active. Industry continues to selectively buy and government funded projects continue and we're seeing a slightly less effective direct stimulus money. Price pressure does continue.

If we step back for a moment and look at geographic trends over the last several quarters I don't think it's incredibly surprising. On Asia, we continue to see strong because of China, maybe the most surprising piece is that it appears Korea is picking up a bit. The America's base orders have been relatively flat for three consecutive quarters where Europe tends to be more variability in the base. We see strong competition in materials and ground vehicles markets in the Europe. And large opportunities exist across all geographies.

Our opportunity pipeline remains steady, so I just remind you that it includes more large size opportunities and more lower probability opportunities than a year ago. This results in a broader range of possible out comes and more uncertainty in timing continues. The backlog for test has remained stable for the quarter.

So, in summary, we're pleased with the second quarter orders in test and that it was within the expected range. We are maintaining a broad range for quarterly orders given that we have a strong pipeline but capital equipment approvals are harder to predict and there's large order variability.

I'm now going to turn this back over to Sue for the financial details.

Sue Knight

Thanks, Laura. Today my remarks will focus on the sequential comparison of the second quarter to the first quarter of 2010. And I'll begin with revenue. Revenue increased 6% to $94 million from $89 million. The increase was attributable to $2 million of higher volume in sensors and $3 million in tests.

While beginning of quarterback log was $16 million higher than in Q1, the increase was from the addition of $20 million of large tests custom orders received late in the quarter that generated no revenue in the second quarter and as typical will not generate significant revenue in the first couple of quarters after this order has been received based on the timing of engineering and material spending and the associated revenue recognition accounting.

On a segment level, test revenue was up 5% to $75 million due to the reasons just mentioned. We have substantially worked through the lag affect of lower fiscal 2009 order volume from our longer cycle backlog business. Given the short cycle nature of sensors, the 19% increase in Q2 orders both higher shipments and revenue in preferred was up 14% to $19 million.

Moving on to gross profits we had a $3 million increase to $39 million. Q2 was positively impacted by approximately an equal amount from revenue volumes and lower test warranty expense resulting from a claim settlement. The gross profit rate was 40.9%, an increase of 1.4 points.

At the segment level the test gross profit rates increased 1.9 points to 37.8%. The test gross margin rate was favorably impacted by $3 million of higher volume which provided some fixed cost leverage and lower warranty cost as previously mentioned.

The sensors gross profit rate was 53.2%, down 1.6 points compared to 54.8% in the first quarter. Roughly half of the decline was due to an inventory write-off due to an electronic supply issue and the other half was mix related. In any particular quarter, sensors mix can impact the margin rate by as much as one point.

Operating expenses were $28 million in total for the company flat with Q1. We continue to expect our quarterly operating expenses to be in the range of $28 million to $30 million depending on the timing and size of order related selling costs and timing of investment expenditures.

The EBIT rate was a break for the quarter at 10.7% it was up almost 4 points from 6.9% last quarter, it was the highest rate since Q1 of 2009 when revenue volumes was 19% higher. We are delivering higher EBIT rates at lower revenue levels than we did previously based on today's lower cost base.

Moving onto tax, the tax rate in the second quarter of 36% was at the high end of our normal tax rate range compared to 33% in the first quarter. This quarter's rate was impacted by the mix of earnings by country and last quarter's rate was unusually low and rebuilt it favorably from the benefits of fixed tax credits on lower earnings.

Earnings per share was up $0.23 – excuse me – was up from $0.23 in Q1 to $0.37 in the current quarter. The 61% increase on 6% higher revenue reflects the benefit of volume and a higher gross margin rate while maintaining flat operating expenses.

Moving on to the next topic of cash and cash utilization at $122 million our cash position is robust, cash from operations was $26 million as we collected $20 million of large dollar invoices from a combination of custom advances and milestone payments.

Capital expenditures were $3.2 million consistent with the last few quarters and our dividend pay out on a quarterly basis remained unchanged but timing resulted in two payments this quarter for a total of $4.9 million. Share purchases in the quarter were $4.5 million.

Next I'd like to spend a couple minutes on one last comparison. While the sequential quarter comparison provides financial insight into the company's performance, it doesn't provide a complete understanding due to the revenue lag factor associated with the longer cycle test business. So I'd like to provide you with an additional perspective that shows our positive trend.

I'll compare the first two quarters of 2010, our year-to-date results with the last two quarters of 2009, which is the sequential six months view. Orders are up 14% from $176 million to $201 million and backlog is up 8% from $168 million to $181 million, evidence that the capital equipment constraints have loosened a little.

Revenue is approximately flat at $183 million, which is okay considering our approximate six months lag from orders to revenue. Earnings per share have increased from $0.01 to $0.60. The earnings per share results in the last half of 2009 included a $0.38 negative impact from severance cost. When you exclude these impact earnings per share increased 54% on flat revenue, further indicating the benefit of our 2009 cost reduction actions.

Thus our six month numbers are improving, orders, backlog and earnings per share are up and revenue will increase on a lag basis. We're very pleased about our progress in this six month comparative trend.

In summary, we believe that Q2 was a very good quarter, showing particular strength in base orders, sequential quarter profitability and operating cash-flow.

Now, I'd like to turn the call back to Laura.

Laura Hamilton

Thank you. So, I'd like to move forward in terms of reinforcing our long range outlook and what we have said is that we are positioned for the opportunity ahead. We talk a lot about energy and the environment and how it's driving opportunity for our customers, which in turn creates opportunity for MTS.

I was in Europe two weeks ago and renewable energy was the topic of both customer visits as well the key component of the Hanover Messe 2010 show in Germany. Right now when we talk about renewable energy, we mostly mean wind but we also mean marine energies.

We have focused some of our market development work over the last year on renewable energy and our work is paying off. In the first half of fiscal year 2010, a handful of OEM suppliers and institutes, who are considered among the leaders in renewable energy, have committed to major investments and tests.

Five of them have selected MTS for key portions of these investments. This industry is rapidly evolving and moving toward better integrating testing into their certification and development processes. MTS's emergence as a leader in this new field validates the capabilities of our people to offer the best total value solution.

Therefore, there will be multiple suppliers to the industry, but we are clearly taking a leadership position. And while today this represents about 5% of our year-to-date orders. It's clear that it's one area that's driving test growth.

One of the five leaders is the European government energy center, we've dedicated to accelerating the deployment and integration of renewable energy technology. Their issue was that they lack full understanding of their marine turbine. The opportunity was for MTS to demonstrate our simulation expertise and our project management capabilities to establish ourselves as a key supplier with this new energy customer.

Their conclusion, MTS offered a superior solution with low cost maintenance and less overall risk. MTS offered the best total value. And this resulted in a $4 million order in the second quarter. And this is an example of MTS helping customers build new confidence in new product performance and it's why we believe we're well positioned for the future.

Let me shift to the 2010 outlook. We've talked a lot about orders but just to reiterate, quarterly orders should continue within the range of $80 to $110 million for the remainder of the year. Second half revenue is expected to be flat to up slightly despite the increase in backlog.

As we've said, about $20 million of this increase in backlog is the result of custom orders which turn more slowly. Within this custom mix, we are experiencing some specific resource constraints, which is temporarily slowing our progress. We also have a higher number of customer sight readiness delays than normal. To give you a feel for this, typically in the quarter we'd be dealing with two to three site delays.

And in the second quarter we had three times this volume. It's really attributable to orders that are tied to new laboratories. And at the timing of the building is critical to the timing of the receipt of the equipment.

The last factor is really stimulus. And there was a push to commit stimulus money, but there's clearly not as much urgency to finish the projects and take delivery of the equipment. We're disappointed we can't turn the backlog more quickly but we continue to work on ways to accelerate the turn.

These factors are expected to have a greater impact in the third quarter than the fourth; Q3 will be our lowest quarter volume quarter for the year. Second half earnings per share are expected to be flat to up 15%, the range for earnings per share is driven by volume and as we've demonstrated a little incremental volume goes a long way. Volume variability is dependent upon possibility to turn to custom backlog, sensors, short orders – short cycle order volumes and test standard product order volumes.

So in closing, we're pleased with another solid quarter and a relatively strong first half. We're working on the efficient and effective conversion of backlog into revenue and we remain positive about our success in any economic scenario.

At this point, I'd like to turn the meeting back over to Trika for the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question will be from Liam Burke with Janney.

Laura Hamilton

Liam, – try again, Liam.

Liam Burke – Janney

Okay, I'll try again.

Laura Hamilton

Okay. I think we lost Liam.

Operator

Our next question will come from Mike Hamilton with RBC.

Mike Hamilton – RBC

Good morning and congratulations. Thank you.

Laura Hamilton

Hi, Mike.

Mike Hamilton – RBC

Couple of detail questions first, thinking on CapEx the $3 million level for the quarterly run-rate for the back half of the year.

Laura Hamilton

Yes. It could – there could be a slight up tick based on project timing. But it's in the zone of $3 to $3.5 million.

Mike Hamilton – RBC

And then tax rate guidance on the back half of the year, the same range?

Laura Hamilton

Same ranges year-to-date.

Mike Hamilton – RBC

Good. Your verbage suggested that the warranty is all in gross margin in the quarter. The warranty benefit, is that accurate? Anything more that's visible coming Q3?

Laura Hamilton

We don't anticipate any change in warranty in Q3 or Q4.

Mike Hamilton – RBC

Okay. Thanks. Laura, you comment on price pressure and in test and it sounded like particularly in Europe. Can you give any color on what you're seeing there?

Laura Hamilton

Well, we – consistent with what we've talked about in the test business, we talk about that the pie is smaller and that nobody went away in this round of the recession. So, what we do see is that that there is competition, some of it is MTS trying to figure out how to get a bigger piece of the pie and going after things maybe we didn't used to go after and maybe its not the stuff we should be going after. So, some of it is that.

And some of it is everybody trying to figure out the best combination of maintaining price and filling access capacity. I mean that's my perspective. In Europe, we're also much more susceptible to the changing dollar euro currency because our competitors are more European based and we're U.S. based.

So, sometimes it's very much in our favor and other times it's going against us and we have to be much more on top of currency effect on price, much more real time right now because of the volatility in currency.

Mike Hamilton – RBC

That follows into my next question which is if we see Euro stay where it is, what's your thinking on impact over the next two or three quarters?

Laura Hamilton

Are you on pricing or on you on full P&L?

Mike Hamilton – RBC

Full P&L, if you don't mind?

Laura Hamilton

Let's just, start at the top in the quarter. We had low single digit impact negative impact of currency based our global footprint in Europe and I think it's anyone guess whether currency is going to settle as it is or get worse and then bounce back. So, I'm not sure I want to give a forecast about currency. I'm not that smart.

Mike Hamilton – RBC

You're that smart that you won't do it. I don't blame you. I was hoping…

Laura Hamilton

What I'd say is just from a pricing perspective, I think what it is causing, is again, increased commitment to working on our cost. And we believe that we have opportunity to be more cost competitive and to help us mitigate some of the price pressure.

Mike Hamilton – RBC

Thanks. One last one. I thought you were fairly clear, but I want to make sure that I didn't confuse it. That your comments on flat to 15% growth is back half over front half EPS, correct?

Laura Hamilton

Correct.

Mike Hamilton – RBC

Okay. Yes, that's the way it read but I wanted to make sure I hadn't missed anything. That's it for me and I thank you for the help.

Laura Hamilton

Thank you.

Operator

And our next question will come from Liam Burke with Janney.

Liam Burke – Janney

I guess I made it this time.

Laura Hamilton

Well done.

Liam Burke – Janney

Good morning, Laurie. Good morning, Sue.

Sue Knight

Hi.

Liam Burke – Janney

With the backlog mix of fewer larger orders in the second half of the year, I know there are some puts and takes on gross margin and tests. But would – could you imply, sort of firm the better test margins in the second half of the year with the less custom and more standard orders?

Laura Hamilton

Well, orders – remember the mix of custom orders in the second half is less about the margin in the second half. The backlog in the second half is more about the margin. The first half – so the backlog drives the near term, so you said less custom orders in the second half and I don't think we said that.

Liam Burke – Janney

Okay. So the product mix, well, I'm trying to get at, Laura is, the product mix for the second half test of would be more heavily weighted towards custom projects rather than the standard; is that right?

Laura Hamilton

What we're trying to say is – so, from a revenue perspective we're saying that the backlog, if you took those starting backlogs from six months ago and said, how fast did it turn and you took the current and opening second half backlog and turned it the same rate, we're telling you, don't use the same rate because there's more custom in there. So, you're saying, okay, then, how do I figure out that affect on margins?

Liam Burke – Janney

Gross margin.

Laura Hamilton

There's so many affects on margin right now in terms of capacity, we started the year with some excess that I don't think we're saying it's direct – use that directly for a margin. I think we'd say stick with first half, second half, kind of plus or minus two points typical variability.

Liam Burke – Janney

Okay.

Laura Hamilton

Don't take this one comment and change your margin rate because there's too many factors going into the gross margin.

Liam Burke – Janney

Okay. Thank you. And on the census side, it looks like you're getting a little traction on mobile hydraulics. Is that the building some momentum in that application?

Laura Hamilton

So, at a higher level it's exciting. I was at a show two years ago in Las Vegas and then I was at this show in Germany just two weeks ago. And what was – so while you have clear, you could see the economic difference because one was boom and the other is post recession, you could – unfortunately, see the volcanos impact because lots of people couldn't make it. But then the really exciting thing was how far this intelligent machine had really permeated the entire show.

So in the first show, we had to go looking for the examples where the sensors group would point out for me, see it's here. And it was everywhere. So, while volumes are still off because of construction and that sort of thing, we're clearly picking up on the technology adoption side.

For us, first half from orders revenue perspective mobile hydraulics has crossed into – just passed the 10% of the sensors business mark. We've said it's always been 10. And we're pushing up a couple points at this point. So, we're optimistic about where that could keep going.

Liam Burke – Janney

Great. Thank you.

Operator

And our next question is from John Franzreb with Sidoti & Company.

John Franzreb – Sidoti & Company

Good morning Laura and Sue.

Laura Hamilton

Hi, John.

John Franzreb – Sidoti & Company

I guess, Laura, I'd like you to go back and just help me by redefining or defining what you consider your base business in both test and sensor.

Laura Hamilton

Okay. So, base for sensors is sensors. And they are all base.

John Franzreb – Sidoti & Company

Okay.

Laura Hamilton

Okay. And what we do – what we've been trying to do this year, to help explain was what we did is we took the $5 million orders out and called – everything else is base. So, anything under a $5 million order is base MTS. And the reason we did that is because, for example, in Q1 when we had $20 million of orders but it was only two orders, it's hard to say, is that signifying growth or is that – did we shrink this quarter because we didn't book $20 million in large orders.

So, we're saying, no, large orders are episodic, but the base trend, which can still vary across – from quarter to quarter, but if we watch the trend of the base, that's the most indicative and then we analyze large on top. And we said base is plus or minus $85 million.

John Franzreb – Sidoti & Company

Okay. Because you confused me when you said base orders for text were down 3% and you went on to say because of the lack of large orders.

Laura Hamilton

So, base orders were up 3% total test was down because of the large orders.

John Franzreb – Sidoti & Company

Okay. I likely misunderstood. Okay. And next the sensor business, could you help me understand, if you think that inventory restocking is done or do you think that because the backlog is so relatively healthy your visibility has improved and customer confidence has improved?

Laura Hamilton

So, we talk to our customers all the time. Our customer's confidence is improving and it may be improving because we all feel good about inventory restocking. It's too difficult. Nobody knows exactly. So, and in sensors we've got to look through about three layers. You have us, you have sometimes the cylinder makers, you could have the OEM, the machine builder.

Then you've got the machine builders OEM. And because we are so many layers away that it's everybody's opinion. So, that's where we say we're going to know this more over time and we're going to learn this more from the look-back analysis of GDP and PMI and things like that. But we continue to ask, clearly there's a lot of activity going on. I think there's concern that a piece of it is over reacting, which is not atypical when you start picking back up and people get nervous about supply issues.

But to be able to say which is which – is too difficult right now. So, that's where we say we're participating but we're going to maintain this healthy skepticism because if we just respond and say, this is a 100% rebound, we might make the wrong investment decision.

John Franzreb – Sidoti & Company

Okay. Now, in your answer to question earlier, you clearly kind of voiced concerns about the euro dollar rate, is there some sort of mental number that you that well, you anticompetitive at EUR110 or whatever?

Laura Hamilton

No, I think our comments are it is – so, this is the hard part any time we comment on any one piece of our business. I mean, sometimes we quote in dollars, sometimes we quote in euro. I think what we're more trying to say is, about the long term fundamentals than about the short term euro rate. And so we just use that as an example, Greece, Spain, that is more about our healthy skepticism than it is more about competitiveness. And yes, it's pretty volatile right now but within a manageable business situation.

John Franzreb – Sidoti & Company

Okay. You also went on to say that you – that competitive disadvantage or swing, if you will, due to the exchange rates is going to make you be more cost conscious and take more cost out of the business. Could you provide some color where you see that opportunity?

Laura Hamilton

Okay. But first what I said is price pressure is going to make us take more cost out of the business. And price pressure a piece of that is exchange rate, but that's not really driver of price pressure.

So, how do we take cost out, we continue to do the things we've been doing. We have been working on leads, manufacturing techniques. We've been – I mean, we're taking tried and true methods and applying them to our business. A big portion of our cost is procured. We think that we have a lot of opportunity to partner with suppliers in different ways we think there's opportunity to look at local supplies because we supply – we're delivering around the world.

We believe that there's still opportunity to look at efficiencies in how we do our work and then there's I guess those would be the main three, operating methods, procurement and efficiency in how we do our work.

John Franzreb – Sidoti & Company

Okay. And Sue, when does it the debt get repaid?

Sue Knight

Let's see. I think that we have two traunches borrowing, but roughly speaking 2012.

John Franzreb – Sidoti & Company

Okay. Thank you very much.

Sue Knight

Thanks, John.

Laura Hamilton

Thanks, John.

Operator

(Operator Instructions) And Ms. Hamilton, there are no further questions.

Laura Hamilton

Terrific. So, I will just close this out and really I think to close I would just really stress, we are participating in the near term improving conditions. We're going to take advantage of everything out there while we maintain this healthy skepticism about the long term as we decide on investments. Thank you for your participation today.

Operator

That concludes today's conference call. We thank you for your participation.

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