Q1 2020 Earnings Call
Good day and welcome to the NPS first quarter 2020 earnings Conference call. Today's conference is being recorded at this time I would like to turn the conference over to Mr., Brian Ross and T.S. Executive Vice President and Chief Financial Officer. Please go ahead Sir.
Thank you Shelby good morning, and welcome to MTS systems fiscal 2021st quarter Investor teleconference.
Joining me on the call today is just Braves, 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.
Sure results may differ materially on these statements depending upon risk some of which are beyond management's control.
Just as such risks can be found in our latest STC forms 10-Q, one 10-K.
We disclaim any obligation to revise the forward looking statements made today based on future events.
This presentation will also include references to non-GAAP financial measures. These measures are used by management to evaluate the operating performance of the company overtime.
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 I'll turn the call over to John.
Thank you, Brian and good morning, everyone.
We appreciate you joining us on or call. This morning.
I thought I'd change the format of slightly for this call. This quarter in light of recent events in the world ranging from the optimism that accompanies the signing of new trade deals to the fear associated with the outbreak of a new virus.
In this context I'll share our view as a way to held for MTS and then I'll ask Brian to review the quarter and our outlook for the four year.
As longer term investors and the company understands our test markets can be very dynamic as our customers. The just the timing size or short term priorities of their investments in research and product development.
These changes can be driven by market priorities such as the launch of autonomous vehicles by changes in manufacturing technology or the introduction of new materials, such as carbon fiber composites.
Even economic or environmental factors.
They're adjustments are magnified MTS has the movement additional cancellation of large orders with liberates, particularly forcefully for a long lead highly engineered custom products.
In the last two fiscal years, we've seen order levels fluctuate quite quite significantly from the first half of the year to the second.
Which is why we as a management team stick to providing annual guidance and attempt to supplement with color on the short term market environment that can help investors better anticipate trends on a quarterly basis.
Considering or first quarter results. This effect was on full display as we met our internal performance expectations, while being shortest consensus estimates for the core.
As you will hear from Brian shortly we're holding or for your guidance for fiscal 2008, which we expect to be driven by a much stronger revenue performance in the second Hell in the first half.
Driven by order trends and mix in backlog.
Looking ahead over the next several years the short term volatility will be progressively dampened through the growth of our sensors business, which is expanding organically or roughly twice the rate of our test and simulation business as well as the increased scale, one market diversity of war chest and simulation business.
Along with decreased volatility. These mixed changes will lead to more exciting topline growth profitability and free cash flow performance in the years ahead.
With those comments as a backdrop, let me next take this I step further in detail in describes a client underlying drivers for each business unit.
Starting with our tests and simulation business our sales process. In this case is often very long, sometimes spanning several years and it's driven by capital spending plans and our customers laboratories.
Given our current insights, we anticipate that order rates for our ground vehicle sector have now largely stabilized after an extended period of contraction over the last two years.
The stabilization reflects the fundamental need for durability and performance testing.
Attributes that have been deemphasized by our customers in recent times largely due to the redirection of short term spending into safety testing for autonomous vehicles.
Other words development of crash avoidance technology has taken precedence over durability and vehicle performance.
At some point vehicle durability and performance areas in which MTS has been a leader for many years will be reprioritize due to their ultimate criticality, but we're not forecasting this increase yet instead, we're simply saying the decline has largely stopped and spending has stabilized.
Moving to the other market sectors for a test and simulation business well. We anticipate has continued strengthen our material sector and test services moving forward materials testing is largely being driven by the expanded use of light weight structural materials, such as carbon fiber composites as well as the increased use of as.
Factoring for component fabrication.
We expect this trend to continue well into the future.
Test services growth is simply a factor of our increased focus on maintaining in upgrading our installed base of equipment, which now exceeds $6 billion worldwide.
While these trends are all positive the most exciting portion of our test and simulation business is now restructure sector.
Which comprises several distinct markets.
First of these infrastructure testing, which is basically high four systems, the simulate extreme environmental events, such as earthquake and tsunami.
MTS was a pioneer in this field is maintained our leadership for decades.
These systems allow our customers develop safer buildings and bridges that are now increasingly needed in high population regions, particularly in the emerging market, we're population densities and GDP growth rates for the highest.
We're seeing increased investment in laboratories, the support infrastructure development and we're very.
Well positioned to support this trend from both the technology and service perspective.
Our structure sector also includes aerospace systems, which historically mean, the testing of airframes and flight engines and now through the acquisition of each to have in early fiscal 2019 increasingly focus is a four upon flight simulation for pilot training and the entertainment industry.
And finally, we include the energy market in or structure sector, which spans from exploration to generation to transmission markets.
The energy in particular, we particularly renewable energy generation has become a strong focus for us and is central to our recent acquisition of the entities of the Danish engineering from R&D, which I'll speak to in a few moments.
So having describe the underlying market trends what does this mean in terms of order rates for our test and simulation business.
While the timing of individual orders can shift between quarters, we anticipate very strong orders Glenn beginning in the second quarter and continuing to accelerate throughout the second half of the year.
This growth will be led by exciting trends in our structure sector, which we anticipate becoming the largest of our end markets by year end for the first time and our company's history.
Followed by our material sector and test services.
Our ground vehicle test sector, which as a reminder includes automotive truck bus and rail applications are anticipated to be roughly 25% of the testing simulation business down from roughly half of the business a year a few years ago.
This diversification in markets has been a priority for us over the last two years and we're now seeing the fruits of these efforts.
In short by the end of fiscal 2020, we will achieve the new balance in the test and simulation business that will help ensure a smoother faster growing more profitable performance in the years ahead.
To give you an idea of the magnitude of these trends.
The strongest order performance for a test and simulation business in our history was in 2015 with orders of $519 million.
This year, we should exceed this level either by a small or a wide margin depending upon macroeconomic risks, which I'll describe shortly.
We expect this to translate to year over year organic growth in orders of greater than 9%.
Importantly, this does not include our most recent acquisition of R&D, which will contribute meaningful growth beyond this level.
Comment more on R&D as well as risk factors in a few moments.
Now, let's turn to our outlook for our sensor business, which started the year on a strong note of near double digit top line performance.
As you know our three largest sectors for this business or the test sector, which includes laboratories, the test new products as well as our department of defense contracts.
Our industrial sector, which is primarily targeted toward machine automation.
And our position sector, which comprises both industrial automation and the heavy equipment applications, such as earthmovers construction in forming equipment.
In short the test sector and sensors is very strong the industrial sector is stable to positive and the position sector soft.
With the macroeconomic factors, improving we expect demand trends in each of these markets to be stable to positive from current levels.
In addition, the ramp up of our newly acquired Endevco product lines, which primarily support the test sector.
I will add to this momentum increasingly throughout the year.
We believe these trends will translate to double digit order growth for our sensor business for the full year building substantially upon the record orders booked in fiscal 2019.
So to summarize our outlook for the full year in terms of order rates is very positive.
For the full company, we anticipate topping the billion dollar Mark in orders for the first time ever which alone would translate to over 20% growth from the prior year Records. There was set in 2018.
Given the timing variation in conversion of orders into revenue driven by mix details will update revenue projections as the orders are booked into backlog each quarter and that will reflect the timing and any changes we made to our Ford annual guidance.
So one could influence this very positive outlook for orders this year.
On the positive side, we believe risks stemming from trade sensitive reduce since the signing of the phase one trade deal with China and the U_s_m_c a in recent weeks.
This is lowered the attention level with our long term customers in China, particularly those that our government owned such as University laboratories, enabling continued positive planning for the future.
In addition, we believe the initiatives to stimulate economic growth in China, and Europe are beginning to gain some traction with increased spending on new products, New services and efficiency initiatives. This is all positive for MTS.
We do however, see the potential for downside risk because of the unknown economic impacted the Corona virus, which has now spread to many population centers in China into a growing number of countries around the world.
Our primary concern is first and foremost on the health and wellbeing of our employees, particularly those located in China.
We have and will continue to take whatever steps are necessary to assist them in this time of uncertainty and to comply with guidance issued by the governments and health experts around the world.
As we now see the holiday shutdown being extended in China, and the increasing barriers to normal commercial activities.
Anticipates some degree of new headwinds from these measures, we're hopeful that the duration and impact will be small will provide updates as needed going forward until the situations resolved.
On a final note before I turn the call over to Brian We're very pleased to announce the execution of the agreement to acquire certain entities of the Danish engineering from R&D, which provides MTS with another strategic technology portfolio and expands our access to important markets for our test and simulation business.
With the execution of this agreement on January 24th of 2020, which is near the beginning of our second quarter No financial results for R&D were included in the first quarter results.
Great M&A activity has served us very well over the last two years and finding high quality test and measurement companies that have an outstanding fit with our overall strategy to expand our technology reach and again, a strong foothold into new adjacent markets that have significant barriers to entry.
A combination of these strategic factors provide for accelerated sustainable and profitable growth.
In addition, with the R&D acquisition, we expect to have minimal execution and integration risks similar to what we've experienced with previous acquisitions.
As a brief reminder, let me give you some additional insight into the R&D company.
The core strength in value of R&D as a company comprises exceptional engineers, who are experts in the design development and manufacturing a precision Hi force test machines that can simulate in laboratory, even the most extreme operating environments for rotating systems the manufacturers of wind turbines.
R&D is test systems can simulate the extreme wind land and see forces that are encountered over the 20 year design life of a modern wind turbine and operation.
Their systems are so accurate and powerful they can compress these life tests into months or even weeks in laboratory, allowing dramatic reductions and the time. It takes for the introduction of new turban designs.
The result is that new and even larger more efficient wind turbines can be confidently introduced into the electric utilities worldwide.
Already the adoption of these modern clean renewable sources of energy.
Having had great success with wind turbine test systems R&D next expanded their focus more recently at the aerospace where theyre quickly become a recognized leader in the testing of Arrow engine systems.
This puts them on the critical path to the introduction of new aircraft propulsion systems that are more fuel efficient reliable and cost effective for airlines around the world.
With MTS is rich history, and the testing of high performance materials and static structures in both wins in aerospace. The addition of R&D East technologies to him to the MTS portfolio will greatly enhance the value we can bring to these markets worldwide.
R&D is operating entities bring with them a strong backlog of projects in excess of $35 billion, which with contract duration stretching into 2021.
Like MTS. They also have an exciting pipeline of new wind in Aero opportunities that will help ensure exciting a growth and profitability for years to come.
Over the last few weeks, we've already begun integrating R&D into our test and simulation business with a particular focused on identifying new opportunities in the energy in aerospace markets.
As I described previously with our exciting organic growth projections and the addition of R&D from the second quarter onward, we expect our structure sector to surpass our ground vehicle sector to become the largest sector in the tested simulation business from this year forward.
From a financial standpoint, the purchase price of R&D was structured as a combination of an initial upfront cash payment of approximately $57 million with expected payments of up to an additional $26 million being earned over the next 18 months.
R&D currently delivers 50 to 60 million an annualized revenue and has strong operating margins, which generate excellent free cash performance.
New investments in working capital and capital expenditures are minimal.
We anticipate the acquired R&D entities will contribute over $40 million, an incremental revenue in fiscal 20, but be neutral to earnings excluding transaction costs, most of which occurred in our first fiscal quarter.
However, we expect R&D will immediately be accretive to test and simulation operating margins.
Now I'll turn the call over to Brian to discuss our first quarter results and our outlook for the full year Brian.
Thank you, Jeff I will start with our first quarter results with comparisons on a year over year quarterly comparison, unless otherwise described.
Our first quarter consolidated revenue was $205.8 million, providing growth of just over 1%.
Sensors business grew revenue at near double digits in the first quarter and provided the 10th consecutive quarter with quarter over quarter growth delivering $85.5 million or 9.7% growth compared to the same quarter last year.
Given the timing of the Indepth go acquisition very late in our fiscal year 2019, and rapid integration of the industrial product line into MTS sensors and production facilities the growth in sensors for the first quarter was predominantly organic driven by a ramp up of our DSD business and continuing strength in sensors test sector.
As we had expected at the beginning in fiscal 2020 test and simulation revenue declined to 3.8% in the first quarter, two $120.7 million, mainly attributable to a slower orders profile in the last half the fiscal 2019.
Predominantly led by a decline in the automotive portion of our ground vehicle sector and continued weakness in the European markets served.
It is not unusual for the order levels intestine stimulation to fluctuate between the first and second half of the fiscal year, which ultimately impacts revenue levels six to 12 months later.
This pattern is indicative of a large projects that we occasionally take into backlog and the volatility of the automotive market.
From a growth perspective, we continue to gain momentum on great opportunities and our structures and materials markets as Jeff just discussed.
While we experienced a slower consolidated sales performance in the first quarter the year, our full year 2020 expectations remain intact. As we expect to have continued orders and revenue growth each quarter as we progressed throughout the fiscal year with a very strong second half of the year.
We're on track to see our Endevco and R&D acquisitions add 65 million to $75 million of revenue in fiscal 2020.
Our department of Defense business continues to grow and we will benefit from investments that we have made to broaden and strengthen our technology offerings and support our broad geographic presence.
Moving next to gross margins gross margin rate was 37.2% a decline from the comparable rate of 38.5% in the prior year, mainly attributable to product mix changes in our test and simulation business and it expected decrease in our sensors gross margins.
The decline in sensors. The duty was due to mix shift production inefficiencies described in the second half of 2019 that are improving.
And the startup of Endevco production recently transferred into our sensors production facility.
As we exited the fourth quarter of fiscal year 2019, with historically low margins, we expected our overall gross margin rate to show marked improvement in the first quarter.
We delivered on that improvement in the first quarter, yielding an additional 230 basis points in gross margin from the fourth quarter fiscal year 2019.
This improvement was headlined by our test in simulation business going from 27.1% gross margin in the fourth quarter fiscal year, 2019% to 30.6% in the first quarter fiscal year 2020, as we experienced better revenue mix from our improved backlog position and less revenue from the larger lower margin.
ABS produced in the fourth quarter.
Gross margins included $540000 of inventory fair value step up charges in the first quarter relating to the in Devco acquisition.
Compared to $445000 of inventory fair value step up charges in the first quarter of last year relating to each one acquisition.
Operating expenses of $61.5 million increased by $1.1 million from the prior year quarter, primarily driven by the inclusion of operating expenses from the acquisitions of each of them and endevco, but were offset by cost containment programs and increased capitalization of investments in.
Element project.
Focused on developing new technology that will enable test in simulation to continue as a leader in our respective markets.
We continue to manage our operating cost structure to increase bottom line performance and selectively use some of these savings to make prudent investments that are required for future growth and stability as a company.
During the first quarter, we incurred $1.7 million of acquisition related expenses related to the Endevco and R&D acquisitions compared to $761000 of acquisition related expenses in the first quarter of last year relating to the two m. acquisition.
Net interest expense of $8.3 million increased by $1.5 million compared to the prior year quarter, primarily due to the increase in debt utilized to acquire each one in November of 2018 and Endevco in August of 2019.
Interest expense for the first quarter was slightly below our guidance range on a quarterly basis. However, with the acquisition of R&D closing in January 24th 2020, we continue to expect interest expense to be within the range previously announced of approximately 8.7 million to $9.3 million per course.
<unk> for the remaining fiscal 2020 quarters.
The effective tax rate of 17.8% for the first quarter was in line with our expectations and guidance range for the full fiscal year with no discrete benefits being recognized during the quarter.
After a few years of unusually low tax expense due to tax reform and discrete tax benefits. It is important to note. The following tax rate in calculating earnings per share comparisons as we experienced a consolidated tax benefit of 9% in fiscal 2017, and the benefit of 38 point.
7% in fiscal 2018.
Furthermore, we had consolidated tax expense.
11.4% in fiscal 2019.
We're now expecting a more normalized rate of 15% to 19% for full year fiscal 2020.
First quarter adjusted EBITDA of $29.6 million was essentially flat versus the prior year quarter.
This metric includes adjustments for $2.2 million of stock based compensation expense, which we do not exclude from our adjusted EPS.
$1.7 million of acquisition related expenses and $540000 of acquisition inventory fair value adjustment adjustments.
Adjusted EBITDA was 14.4% as a percent of revenue for the first quarter compared to 14.8% last year same quarter.
We ended the quarter was $64.1 million in cash a slight increase from the end of fiscal year 2019, we used $5.7 million of operating cash in the first quarter, which was an anomaly for us with higher acquisition related costs, the temporary inefficiencies for moving one of the.
And that full production facilities into our existing sensors facility.
I spent and working capital for inventory stocking and lower advance payments received from customers.
During the first quarter, we had capital investments of $10.6 million to meet the growing demand in our sensors business and to address the long term needs of our facilities ultimately generating negative free cash flow of $16.3 million in the quarter.
Moving forward, we expect a marked improvement in free cash flow coming from a return to more optimal working capital profile higher revenue and improved bottom line performance.
We ended the quarter with total debt of $540 million, a slight increase from the end of fiscal year 2019 for positioning of the R&D acquisition and general operating needs.
Our outlook for generating cash and managing debt is driven by expectations that each of the recent additions to the MTS portfolio will generate strong incremental free cash flow pay down the existing debt balance.
We ended the first quarter with a gross debt leverage ratio, a 4.08 times and a net debt leverage ratio near 3.6 times.
With the completion of the R&D acquisition, the leverage will increase slightly however, we have confidence that our financial profile of both our existing and combined businesses.
Decreased gross leverage to below four times by the end of fiscal 2020.
Now I'd like to provide a quick update on the industrial acquisition. The integration is on an aggressive timeline and we have already completed the move of one manufacturing facility into our sensors production facility within a span of only four months. Our integration team has done an outstanding job overcoming the inherent challenges present in it.
Move of this magnitude over a short time span.
Second final production facility migration is scheduled to be completed by the end of fiscal 2020, and I have full confidence that we will integrate the business successfully and build on the strategic opportunities we envision with this acquisition.
Due to this rapid production migration first quarter results were slightly muted for Indepth go compared to our anticipated results. However, we continue to expect business to deliver approximately $30 million of revenue in fiscal year 2020, as previously stated.
Customer reception to this combination remains extremely positive market served by this product line continues to be solid and our execution to our plan is progressing as expected.
That concludes my comments in the first quarter results next I would like to add a few remarks on our full year guidance.
We are reiterating our full year guidance for the fiscal year as we continue to manage and expect fluctuations in performance by our businesses on a quarterly basis. The result for the first quarter were anticipated and included in our full year guidance projections. After the end of fiscal year 2019.
Our reference the range for full year revenue is 955 million to $995 million the range for GAAP diluted earnings per share is $2.05 to $2.35. The adjusted earnings per share range of $2.20 to $2 of 55 cents.
Which includes adjustments for acquisition related expenses.
And the range for adjusted EBITDA is $138 million to $158 million.
It is important to note that our adjusted earnings per share does not adjust out amortization expense for acquired intangible assets related to our multiple M&A transactions, nor does it adjusts for stock based compensation costs.
The amortization of purchased intangible assets decreased our earnings per share by 20 cents per share for the first quarter and is expected to impact earnings per share in the range of 80 cents to one dollar per share for the full year.
The quarterly increase in amortization expense going forward will be attributable to the acquisition of R&D.
Any changes made in the purchase price allocation of Endevco.
And minor roll off of amortization expense from our M&A activity.
In summary, we are continuing to execute on a growth and diverse pay diversification strategy, making prudent investments across MTS to deliver sustained long term revenue and profitability growth.
Along with the efficiency and productivity improvements that create share holder value long term.
We believe that overtime. This consistent focus will prove successful in building upon our legacy as a technology and customer focused test and measurement company and one that is more diversified and resilient to changes in the external environment and is better positioned to sustain a higher level of financial performance.
Finally, I would like to welcome the entire team from our newly acquired R&D company the Mcs family.
We envision a great future together in combination with our legacy MTS team and other newly acquired businesses need to eminent depth, though we are excited for a great future ahead of us delivering excellent customer focused technology.
Ill now turn the call back over to Jeff.
Thanks, Brian.
So Brian just mentioned, we expect fiscal 2020 to be a benchmark year for us one of which we see the development of a very strong backlog exciting sustainable growth prospects and expanding margins by year end, we're confident that the transformation of MTS into a larger more robust test and measurement company comprising two strong and.
Complimentary business units that have global scale and outstanding customer base and World Class technology, all delivered with a passion for total customer satisfaction will become fully appreciated by all of our stakeholders.
With a slow start to the fiscal year now behind US we will increasingly see progression in our metrics that we laid out for you in our full year guidance.
Let me conclude with what we believe were the keys to our success MTS is a complex business that employ some of the smartest most insightful engineers in the industry.
Our story is a simple one to understand at a high level and it remains consistent.
First we need to keep executing on sensors, it's a great business with a strong leadership team that we believe will generate significant value for our customers employees and shareholders alike.
Second we need to take full advantage of the strengthen our non vehicle related test and simulation equipment and service opportunities to drive growth and margin expansion.
This strategy has been consistent and is showing positive results.
There are we need to continue with the same disciplined integration methodology that we've employed in the past with our more recent acquisitions, we have the experience and focus needed to ensure success.
Executing well in these three ways will help ensure that we achieved strong financial performance in the year ahead, delivering solid growth with expansion of our margins and free cash flow performance successfully creating value for our customers employees and shareholders alike.
With that Brian and I are happy to take questions and Shelby you can open up the line. Thank you if he would like to ask a question. Please signal by pressing star one on your telephone keypad.
Our using a speaker phone. Please make sure your mute function is turned off to allow your signal to reach our equipment again press star one to ask a question well pause for just a few moments to allow everyone an opportunity to signal for questions.
We'll take our first question from John Franzreb with Sidoti.
Good morning, Jeff and Brian Hi, John.
John John.
I just want to start with the order trends.
Finally, we now for three quarters.
Jeff you're signaling Neely hockey stick kind of recovery.
Last year I, just want you to maybe talk as to why you will get confidence is that kind of recovery, especially considering.
Weakness you're seeing in Europe.
I suspect the continued weakness you can see leasing bookings coming out of China, given the Rona virus, what gives you that confidence on whether we're going to seize sharp recovery and order trends.
Yes, John It just gets well I'd tell you two things number one.
As you know things can vary quarter to quarter, we've seen a few like quarters now in terms of of actual order placements, but continuing growth in our opportunity pilot pipeline and acts some points that just has to be relieved at some point.
Just a fundamental theres. These the launch of new products in the World continues the spending on those new products continues at some point.
Pipeline builds up to a point where customers this need to place orders or they're not going to launch new products on time, so theres that under an underlying fundamental.
Beyond that we're just deeply embedded with our customers and we see the timing on these orders now their capital investments, especially in our test simulation business. So so management can always make a decision in one quarter. Another to postpone an order. They are rarely cancelled they are rarely taken out of their planning add the what usually happens is there pushed off what we've seen that for a few.
Quarters, now and our and our day to day feedback from customers is they're running out of time, they've got to get orders placed and they got to get moving so as I said guys try to be very clear and the commentary we expect that to start happening in the second quarter and continue accelerate in the second half now your point about the krona buyers is a good one.
Tracking a very closely we do have a wonderful customer base in China, which we expect we expect to be out on holiday now they've extended holiday so will that delay ordering willa delay normal commercial activity.
I doubt only it's a headwind John what I don't know is how rapidly this risk may decline and how rapidly they'll move back to normal operation I can tell you I don't expect that demand to go away and and if this runs its course and goes down I expect to have minimal impact, but it's all in the future. We just have to.
How plays out I can tell you. We're monitoring is daily we have extensive sales and service guys in China, we get great feedback from the ground on what's happening and I can just tell you I feel very good about the overall order trajectory for the year that is certainly a known headwinds us going forward.
Just maybe sticking with the stage geographic mix here is the opportunity pipeline is the best gross is seeing here in North America.
Does that give you some sort of confidence.
And if it's okay.
Well I know I'm, sorry, I cut you off John Good finished question and that was just say and just on the Corona virus on I mean.
In the past numerous times, we've had deferral jobs.
For numerous reasons, that's one XOMA seemed like a legitimate reason that the second quarter it might be weaker than expected.
Just on that basis alone should we be factoring that into your thinking about that what are your thoughts about that in general both those questions.
Yeah, I'd certainly the from an ordering standpoint, you could see orders push out now those orders would not have turned into revenue in the second quarter largely anyway. So I wouldn't have expected a lot of that's impacted revenue and flowed outperformance there, but in terms of order rates you can certainly see a push out there.
Before that before this virus emerged I would have been even more bullish about the second quarter in orders now I just think it's not known headwinds back to the first part of your question in terms of geography.
Yes, certainly the demand in China is terrific, we love seeing that but I would tell you a worldwide I mean, we view the they've been try I think kind of quietly to.
Increased liquidity and the investment environment in Europe, we're starting to see the flow through of that now to increasing opportunities our pipeline.
And if thats broad based.
I would expect you know in energy and renewable energies to be a big factor. There I think thats really really going with gusto now and you're going to see a lot more of that in our structures area and I think at some point you to automotive Elisa stabilized in the you know we're encouraged to see that and I think it'll it'll will hang in there for the rest of year, Europe's coming back a little bit I don't want to oversee.
Well that but it's doing a little bit better in North America remains.
Very good environment for us across the board I think North North America installed bases biggest so we have a big services opportunity and the companies are relatively cash rich right now and able to make the investments now will they depends on their outlook for their new products and things of that can change, but right now all saw.
Things are green in terms of basically worldwide demand, even places John like India, I'm very pleased with.
The prospects in India now, it's a small part of our business today, the you'll see us increasingly talk about that the populations or this is very high and they need infrastructure they need to build out their infrastructure and they want to make is safe.
You will see.
Our our equipment that goes into building a bridge designs, you'll see renewable energies all of that stuff growing there too. So it's what gives me encouragement is it's broad based strengthening.
You know some areas more than others, but broad base stabilization strengthening and.
In the emerging markets strong demand growing which were bullish about the risk factor, we see on the horizon Here's the current buyer. So obviously, we just have to see how that plays out.
Okay Fair enough and then just switching over.
Brian you touched on in your prepared remarks kind of a rarity of free cash outflow.
Yes in the quarter.
You suggested that part of it was moving of facilities of and Devco.
Can you talk a little bit about what the Capex is expected to be for the full you. This year you.
You mentioned debt repayment, you're going to get down to under four times by the end of this fiscal year, maybe a little bit more debt repayments thoughts going beyond fiscal 2020% 2021.
So the color behind cash flow debt repayment capex will be helpful. Thank you and I'll get back into queue.
Yes sure. So this last year was higher capex year for us than what we have projected was is that it would be at an elevated level.
For the current year kind of in around that three to 3.5 times three net three and a half percentage of revenue for the full fiscal year.
As we just complete some investments that we're making so thats one item.
As far as debt repayments, we talked about a slower year of debt repayment on the actual leverage ratio a much improved continued improvement in the EBITDA side of the world in performance for the full fiscal year, which would help reduce leverage and then in fiscal 2021 is as when we expected more rapid.
Payment to our debt on the deleveraging side of it.
Again, if you would like to ask a question. Please press star one.
We'll take our next question from the renovation with Wells Fargo Securities.
Good morning Veeva.
Do you kind of life. Please speak.
Speaking so we will move on to our next question.
We have again, John Franzreb with Citi.
Tailored I'll just a quick follow up and maybe you can chime in again, it's not.
Chime in.
Has that guys said, okay, if they said space.
Okay.
I guess I wanted to ask a little bit about on the structures business.
You implied that it's going to be bigger than the ground vehicle by the end of the year.
I guess this three buckets to that did I want to talk about.
Bucket one how much is.
The inclusion of R&D.
Bucket to.
How much is it.
Because.
Weakening or on a year over year based on private stabilizing.
Second is being down on a year over year basis, and bucket three how much of that.
Gannett growth within structures.
And just just to tighten not around it Im sorry, guys start question, just wanted to be easier and tight.
Structure business, the legacy structures business, a higher margin business then the ground vehicles legacy business. Thank you.
So I'd say, what I'll, let Brian take that margin question at the end, but let me let me just comment John on on the rationale for being the largest there's there's a couple of factors I think you've touched on them. Several want all you know certainly ground vehicles and the biggest piece of that is automotive has come down in the last couple of years. It had really peaked out a few years ago. It at half of the.
Business and and it was driven by our success. There. We were we were pulled them by customers around the world is the automotive market invested a lot of money and new products.
And that investment is largely continued in total but its shifted more to safety related items right now for autonomy. So we've seen the durability and performance test test needs that we that we satisfy come down. So part of it is that percentage has come down and as we saw that happening we invested preferentially in materials testing and then if structures testing.
We've been in those business or for many many years. Unfortunately for us those those markets are really.
The strong and what's driving them as what I mentioned carbon fiber composites are going everywhere and you see additive manufacturing really taken off for materials testing our installed base as a record levels, we have a big service opportunity there for growth and then in structures John the emerging market is really a fabulous story has overshadowed a lot by all the other.
Or stuff, but when you look at the emerging market spend their GDP growth in their spend on infrastructure. It is really profound and so they are investing in a lot of newbuilding abridged designs, we've been in that business for decades, and we're absolutely. The recognized leader. So they continue to build out laboratories to design newbuildings and bridges, but on top of that.
Now energy as a part of that structures element is really growing and we've always been involved in energy testing you know for drilling and add even rock cracking for fracking things like that that are very basic to the industry, but it's always been a small part of our business now with renewables coming up we anticipate wind energy being a very large industry and.
Future and the the issue there John is those turbines need last 20 years.
And the evolution of the technologies really fast so they have to have a way to test them very quickly.
And you know you could you can't afford to build a whole. The you know what acres acres of a wind farm and then have all the turbines fail in a limited amount of years. So you have to do this accelerated testing in a lab, which we've been in and around for a while but R&D now the R&D acquisition gives us a chance to really grow that business and maybe.
The leader in the World in testing wind turbines, so and we see that moving it started in Denmark in largely it expanded from there and is now really growing fast in China, and we expect India in the United States. So we love that that growth aspect of that business.
And then what am I missing aircraft of course, so we've always been the aircraft airframe testing business and components that go into engines. What we can test now with the R&D add on is we can test the actual rotating structure like the rotating hardware in the engine and the and the gearboxes things that go into modern aircraft engines.
They are really determined the fuel efficiency and the performance that engine. So now we're a holistic provider to the aircraft industry and then with each of them acquisition of course, we can we've added on flight simulation. So I would tell you John you'll hear us I would like I said for the first time at 53 years structures business is going to be the biggest one for MTS.
By the end of year and I expect that to continue to grow I think we've got to gotten the business back in proportion now to where it's much more balanced and we've added on the services element all of those areas are going to grow now periodically John I would expect automotive to go through spending past periods, where it was higher but all in all week.
On a key but Brian and I've said, we want to keep that percentage down we'll get it down to 25% this year, but we want to keep it down by growing the overall by having higher growth rates in the other markets. So the dollars complying, but we want to have the niches, where we can really be successful and make money in that in that business. So so we've got a big few years ago.
We balanced the business out this year and I expect that balance to be retain going forward. So Brian do you want to in with the comment on margin performance yesterday, just real quickly I think what our expectations ours is that the R&D company will add about $40 million of revenue to our existing business.
So that that adds about 5% to 10% of as as we broke out the sectors within structures as far as the structural side of the world on gross margins, we generally see those about five to 10 points higher and execution on those projects.
Even better so original budget that completion of the project within budget timeline all of that is usually.
Very successful for us.
Great. So thats a mixed benefit that's looking here, that's that's correct, okay and directly that I'm going to get back going to get back into queue that other questions.
Chime in but if not I still have to more follow ups alright, guys. Thanks. Thanks.
Again to ask a question please press star one.
Well take our next question from deep Ragavan with Wells Fargo Securities.
Hey, good morning.
Good morning, Dave My question.
Hi between 70 cents is the first on the chatting this year, but Uh huh.
Can you this is something you've discussed extensively buddy.
Yes, something to give us a little bit more comfort.
Yeah.
Just given your commentary you do anticipate auto pick up in the second half.
As a backlog of flat replenishment that should happen the second half that dollar seems to be on track but.
We don't see that did not have captured in auto growth trends. So yes.
Soft commitment from clients that gives you the visibility of the confidence to say that there's the pickup coming and then I think I struggled with that is also another thing I struggle is.
Two in Q3 comps start to is this a little bit so how do you triangulate all of these and say Hey, we will still grow into second half orders backlog lives.
Yes, deep us so so with comps just you'd be sure and stay straight on on order comps versus revenue comps because the because in the test the tested simulation business, particularly the backlog driven business. So orders come in and then they flow through overtime into revenue so that that can be a little disconnected there, but in terms of order.
Growth I would tell you deepa.
Q1 was clearly life in Q3, and four last year were clearly life, but with Howard.
Our customer base and this is why would we this is why I really wanted to take time on the call to go through our orders outlook, because I don't like surprises in the future what and what we're seeing right now is a very strong demand profile coming and yes. There are risks factors. The corona virus, certainly throws a new risk factor out there, but what we see is.
Very strong demand profile, coming which will first translate into orders growth and that we I would have told you before the virus that would have clearly started here I believe in in the second quarter. We're in right now with the virus its and I know risk and we'll push out in time or not but we saw starting in Q2, and then and then going strongly through the second half of the year.
That order growth Replenishes backlog and some piece of it will actually translate into revenue for the year and then that revenue obviously that revenue growth will follow through in fiscal 2001. So most of my commentary was on the orders outlook from demand and I would tell you. The same thing I said to John a few moments ago that.
It's from being embedded in our customer base around the world very deeply and so what I'm, telling what I'm passing on to you as a feedback we get from our customers broadly around the world and nicely as I said before it's fairly geographically evenly distributed you see some strength coming back in Europe, you see the Americas or North American being strong and.
You see a growing demand in China in the emerging markets and with the caveat again of the virus, but and the impact there, but okay. Fundamental demand is growing order placement has been weak. The last few quarters. Our pipeline is is much bigger than ever and we expect those orders to break through and star being placed and that's the best intelligence.
We have today.
And clearly there are always risk factors that could change that can change the outlook. Once those orders are placed we will continue to give you updates on revenue and EBIT flow through from those from from our operations right now we're holding guidance assuming that our initial revenue outlook and EBIT EBITDA flow through whereas model the beginning.
For the year within that range. So that's we're holding to that we're pinning it really on our outlook for orders for the remainder of the year, which we believe is very strong organically and then you add on the acquisition of R&D, which will will be on top of that I believe it will end up being a very good year from an order standpoint and backlog.
Okay got it.
Well as as of this was asked earlier John to eliminate that.
These sensors business.
The pace of Odder Lilly's.
Beginning with them I mean, you should be looking to backfill.
Pretty soon I'm just curious how the next tranche of audits released on them is looking at this point.
Yeah, we'll let you know we'll update you every every every quarter on that we landed as you as you know from from what we described previously we landed the big contract, it's funded incrementally and discrete purchase orders from the OEM that we support the systems that goes into so I can tell you. The budget that was passed from from Congress.
Fund the Deo the.
Trying time now a month ago are sold six weeks ago, clearly that opened the spigot for the Oems to receive their funding on contracts and and largely if I look at the broad industry. Those contracts have been placed I would expect that flow through to suppliers to continue and we're obviously a key supplier for the platforms abroad. So I would expect that to.
Continue timing of the government is is then precise science I know, what I want to throw that out as a caveat I can't guarantee when the purchase orders are going to come through we still have enormous confidence that that contract will be funded the technology is really rock solid it is going into a great platform. So we feel really good about the contract the exam.
Timing on purchase order placement from the government I know well really from the OEM it'd be via the government funding I can never be precise on but we will update you quarter by quarter and all in all its going to be a great program for us.
Hey, guys sorry can you do in my last question is is there way you could size.
China exposure as it relates to maybe just a specific region within China.
Revenues that driven from or.
The way to just the ring sense, just the exclusive area within China Tour. Thank you sure. Let me make a general comment and I'll hand, it off to Brian to give you numbers depot, but you know China's been a really great market for us for 30 years, and it's driven by the same factors.
In the in the beginning they were you know it was University work basic research they were trying to ramp up.
Restructure testing you know for as they have to say become more affluent now in the world. Their GDP has gone up they do a lot more research on building designs and bridge designs for their population as their cities have grown and now you see the emergence of an automotive industry at an aircraft industry domestic one for them that every large economy wants to have.
And that flows through to supply chain. So we've been in laboratories for 30 years very broadly materials, you know things that go into structures things are going to automotive.
That is really ramped up in the last several years and we see great long term potential for us over there. It is very broad based we basically have followed the development of the Chinese economy. So we started off in the big cities of Beijing Shanghai.
And down South and Guangjo Province, where that first joint ventures went in and laboratories were built and we spread from there basically throughout the country. So we're very we sell all over the country, we sell to laboratories, and OEM laboratories, all over the country and universities all over that country.
We have a very broad and deep sales and service team around around there and we do most of the fulfillment out of the state's here primarily so so that's been our model. It's worked very well for US Brian do you want to and we have about we have roughly 400 employees in throughout China, but there's no one has.
Traffic region, it's mainly the big coastal cities and then spreading from there across the country. Brian you want to add anything overall, our business is about 35 or 36% in eight in Asia and about 20% to 25% of that as specifically in China. You can think about that as a ring fence around what what revenue we saw.
I'll into China and.
Complete shutdown of the economy, the China, everything obviously would put a ring thanks down below which I don't believe is the case.
Or you know this thing irons itself out and we've seen maybe a little blip here in the in our second quarter. The first calendar quarter here and it irons itself out through the rest of the year, it's somewhere in between that I wouldn't state that it is at the drastic level at this point based upon the way that we monitor it.
Yeah specific dusty, but we have a handful of employees actually station and move on and in that province, there and clearly we've taken all the precautions that the government recommencing beyond in terms of protection of those employees.
But it gives you a sense out of 400 people, we've got a handful that located in that region now Unfortunately for China and the rest of World. This virus came up at their or their holiday period, where there was a lot of travel. So we're taking extended precautions every company I'm sure is in the government to make sure that people either don't traveler travel.
Safely that they stay in their home if they've into that region and don't contribute to the risk of spreading the disease. So all of those precautions. We're taking we get daily reports and it looks very rational right now to us in terms of the actions being taken but no one knows the future and our hope is this subsides like past issues here.
Yes.
But I think Brian put a put the ultimate ring fence around it and I am sure every company is doing the same.
Did that answer your question.
Yes.
On small classification is.
Brian is this consider then are you considering any impact at all within your guide at this point I know you have a pretty good range within the guide, but is there any impact from the similarities actually and you guys.
Well, what I would say is theres been a swap and within that range and before we had tried to encompass than our original guidance what could happen in the trade discussions and that's largely starting to.
Iron itself out and now it's been kind of swapped with with the current virus issue. That's out there. So I think it's still encompasses our existing range for the full fiscal year.
Alright, thanks, so much.
Thanks, Steve.
Well take our next question from John Franzreb with Sidoti.
Hi, guys all right. So in the interest of time you can make this is Sean as you want.
Two questions one the service business was down both sequentially and year over year.
Jeff you suggested that business is going to do well for the balance of the or could you briefly discuss why and too.
Each when you purchased since before the 737 Max issue.
Anecdotally were hearing more simulate is being put out there.
About how that business is performing relative to expectations from then to now how much is it performed better than expected.
Not as well as expected given.
The Boeing's issue both those two topics and how many words, if you can fit it.
Yes. So so again, let me give you a couple of general Commissars, Brian to two to add any any numbers on top of it. So in service in general John is a great business for US we have over $6 billion Saul base now and so what we're doing as you know is with what we're calling on customers to service that base and we're embedding our service before we can great business. It does.
A little bit of seasonality to it fourth quarter is generally a little bit lighter as people as customers watch their spend because a lot of that spending comes out of expense customers expense line rather than capex. So there's there's always a little bit of shading at the end of the year on that but all in all I expect our service business to grow.
Strongly going forward as we've been delivering kind of high single digit growth occasionally end of the doubles I expect that kind of trajectory to continue each II I just love the acquisition, we're using their electric technology now and a lot of our platforms. So technology that technology synergies excellent the demand profile I believe for.
Flight simulation is excellent.
The the actually the incremental impact of any any 737 Max issue.
We've not really seem but I wouldnt, John Frank I would've expected to see it right now it's it flows through to our customers they factored into their capital planning and build out.
I don't expect a spike and I do have the demand profile out there has been been significant so I don't know that will even really notice it but it can be a negative it has to be a positive for us. So we're very very encouraged about that we love those guys. We love the business and I wouldn't underestimate the amusement business side, the more and more amusement parks are gearing there.
Sure they're high end attractions toward flight simulation and I think it's a marvelous business to be so we'll be growing in all those Brian you want to add the numbers.
Just in total I would say that service orders to grow about 5% within the first quarter here. So thats from last year, we succeeded orders and revenue above $100 million than revenue.
For the first time in company history. So we're just building on the progress we've made to date and we really like the profile plus in addition, with each of them and the R&D acquisitions, they add additional service opportunities.
Okay guys. Thanks for taking all my Mccain and there were of course no. Thanks. Thank you John for the interest inside Shelby I know, we're at 10 o'clock. So so maybe I'll just say thank you all for participating in the call today and the interest in the company, we'll look forward to giving you an update again next quarter have a good day guys.
This concludes today's call. Thank you for your participation you may now disconnect.
[noise].
[noise] [noise].
[noise] [noise].