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Rating Action:

Moody's assigns B3 to MTS Systems' proposed senior unsecured notes, affirms B1 CFR; stable outlook

08 Jul 2019

New York, July 08, 2019 -- Moody's Investors Service (Moody's) assigned a B3 rating to MTS Systems Corporation's (MTS) proposed senior unsecured notes and upgraded the senior secured rating to Ba2 from B1. At the same time, Moody's affirmed the Corporate Family Rating (CFR) at B1, the Probability of Default Rating at B1-PD and the Speculative Grade Liquidity (SGL) rating at SGL-2. The outlook is stable.

RATINGS RATIONALE

The upgrade of the senior secured rating to Ba2 is based on lower expected loss in the event of default with the addition of a substantial amount of first-loss, senior unsecured debt in the capital structure.

MTS' ratings reflect a meaningful presence in the global test & simulation market driven by customers' largely inelastic research and development (R&D) expenditures. Largely favorable long-term trends within both operating segments (Test & Simulation and Sensors), an asset-lite operating model that translates into solid free cash flow (averaged nearly $40 million per year over the last five years) and expectations for accelerated growth (double-digits) in higher-margin sensors end markets further support the credit profile. MTS is well-positioned to capitalize on the importance of product innovation and accelerated product development cycles across numerous industries and the proliferation of "smart" machines and automation that require sensors to operate more intelligently and autonomously. Test segment revenues are dominated by blue-chip automotive original equipment manufacturers (approximately 25% of total revenues) but key end markets also include aerospace and defense, power generation, rail transportation and the bio-medical industry. Sensors key end markets are also well-diversified and include plastics and rubber, automotive, steel, aerospace and defense, construction and agriculture.

The ratings also consider challenges in generating organic revenue growth but with more recent trends indicating an accelerated pace as completed investments/projects in the test & simulation business provide valuable Intellectual Property (IP) for future orders. The company is vulnerable to occasional loss stemming from the largely fixed-price contract nature of the test business as well as the company's reliance on the cyclical automotive industry. Specifically, automotive OEMs are currently shifting more focus to safety and cost with regard to getting electric and autonomous vehicles to market whereas MTS' core strength is precision, durability and reliability testing. This dynamic is expected to become more favorable over time for MTS with additional outlays on durability and reliability testing expected to take place during the second investment phase of electric and autonomous vehicle introduction/production.

The acquisition of E2M Technologies B.V. (E2M) in November 2018 helps diversify away from occasionally volatile ground vehicle testing revenues, establishing a meaningful presence in solid growth end markets such as flight simulation (pilot training) and entertainment (amusement park rides).

The SGL-2 Speculative Grade Liquidity is supported by Moody's expectations for an ongoing cash balance in the $75 million range, annual free cash flow in excess of $40 million by the end of 2020 and no near-term debt maturities. MTS has a $150 million revolving credit facility set to expire July 2022 that Moody's views as adequately-sized in relation to the revenue base. After netting posted letters of credit, availability would be approximately $130 million. A maximum total leverage ratio (debt-to-EBITDA), with step-downs, and minimum interest coverage ratio (EBITDA-to-interest) apply to the revolving facility only. Substantially all assets are pledged to the bank credit agreement, providing limited flexibility to sell assets in the event the company needed to raise additional liquidity.

MTS plans to use proceeds of the senior unsecured notes to repay borrowings under the revolving credit facility and term loan, so the transaction is largely leverage neutral. However, the new unsecured debt will be effectively subordinated to claims of the remaining secured debt and will represent a substantial portion of claims in MTS's liability structure. This results in a rating of B3 which is two notches below the CFR.

The remaining secured debt will benefit from the large amount of first-loss absorption provided by the new senior unsecured debt and the improved collateral coverage following the paydowns, therefore the expected loss of the secured debt will be lower. This resulted in an upgrade of the secured debt - revolving credit facility and term loan - to Ba2, which is two notches above the CFR.

The outlook is stable, reflecting Moody's expectation that margins will continue improving, boosted by strong demand for sensors, and that consistent and growing free cash flow will be utilized for organic growth investments and/or debt reduction such that debt-to-EBITDA remains comfortably below 5x. Moody's also expects annual revenue growth of 3%+ as favorable end market fundamentals across both segments remain intact and/or strengthen over the next couple of years.

The ratings could be upgraded with sustained organic revenue growth in excess of normalized GDP growth rates. Additionally, leverage in the low-4x range or free cash flow-to-debt trending towards 10% could also result in upward rating pressure.

The ratings could be downgraded if debt-to-EBITDA rises above 5.25x, margins fail to improve or there is prolonged weakness in revenue growth. Erosion in the liquidity position or the inability to maintain steady-to-improving free cash flow could also place downward pressure on the ratings.

Moody's took the following rating actions on MTS Systems Corporation:

- Corporate Family Rating affirmed at B1

- Probability of Default Rating affirmed at B1-PD

- Speculative Grade Liquidity rating affirmed at SGL-2

- Senior Secured Revolving Credit Facility upgraded to Ba2 (LGD2) from B1 (LGD3)

- Senior Secured Term Loan upgraded to Ba2 (LGD2) from B1 (LGD3)

- Senior Unsecured Notes assigned at B3 (LGD5)

- Outlook, remains stable

The principal methodology used in these ratings was Global Manufacturing Companies published in June 2017. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

MTS Systems Corporation is a global supplier of high-performance test and measurement systems and sensors. The test & simulation segment provides testing solutions (hardware and software) that simulate forces and motions that customers expect their products to encounter while in use. The sensors segment provides products used to automate industrial machinery and equipment for improved safety and end-user productivity. Revenues for the latest twelve months ended March 31, 2019 were approximately $830 million.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Eric Greaser
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Robert Jankowitz
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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