MTS Inc., retools for profits

Early in his tour as the CEO at MTS Systems Corp., Chip Emery learned that a good technical shop is not always a good business.

Eden Prairie-based MTS, a tinkering engineer's dream for decades, had long been associated with top-quality equipment to test the durability of Boeing aircraft, Audi autos and Medtronic medical devices. But the company lost money in the first quarter of 2000 and the stock price withered as management battled fires.

"We had a whole series of very large, custom projects going through a lot of resources and one of the large ones got into difficulty and we had to pull resources off projects that weren't in trouble, and there was a domino effect," recalled Emery, an engineering graduate of the U.S. Naval Academy who was recruited from Honeywell to run MTS in 1998.

"We needed to make a great engineering and technology house into a really great business. We managed to make money in 2000, but that quarter was a wake-up call that we needed to change some things."

Emery & Co succeeded. MTS, which ranks No. 58 by sales in our Star Tribune 100 list of Minnesota's biggest companies, has been one of the state's best performers in recent years.

Analysts expect earnings growth of 17 percent or more to $1.95 per share on single-digit revenue growth to $405 million in the current fiscal year. MTS has returned about 44 percent annually in price appreciation and dividends to shareholders over the last three years. So far this year, MTS shares are up about 14 percent.

Emery has done several things that have changed the culture of MTS and led to improved performance:

• He took numerous, autonomous engineering businesses that served a variety of industries and consolidated them into one "test" business.

• Sold or closed several ancillary businesses, including an engine-testing shop, and restocked much of the executive ranks.

• Focused on key customers, repeat business and managing with an eye toward profitability and cash generation.

"We shifted the emphasis from engineering to marketing in terms of what products we chase and prioritization of resources," Emery said in an interview last week.

"We didn't even really have a marketing department until 2003," he said. "We had to hire people and empower them."

There were internal disagreements, cultural divides and many departures from what is now a leaner, 1,550-employee firm that generates more than two-thirds of its business from foreign shores.

"This management group wasn't that popular at times," conceded Emery, who also brought in Susan Knight, a new chief financial officer, from Honeywell.

In short, today's MTS is a better-focused global supplier of testing devices and related services to select industries and research universities. And through its industrial division, it generates about 15 percent of revenue as a maker of high-performance sensors, crucial to advance-technology manufacturing machinery.

"I think MTS was once an engineer's playground," said David Koch, stock portfolio manager at Windsor Capital and an investor in MTS. "Chip and Sue Knight instituted some financial discipline. They've broadened the product line, and that's paid huge dividends in terms of the stock performance and a good future. There's still some cyclicality to the business, but they've done things and added customers and that has evened things out."

MTS continues to focus on high-end customers, making test equipment for BMW, Honda and Michelin tires, for example, while it also builds more businesses around middle-market clients such as manufacturers of more-mundane stuff, such as car seats and dashboards.

"That means more standardization and some less-sophisticated equipment," said Emery, who earned $4.7 million last year. Three-quarters of his compensation was in the form of gains on stock he sold. "We have to move to the middle market to grow."

Luther Johnson, a senior engineer at MTS, talks about the slavish devotion throughout the company to reduce the number of different parts in inventory. The idea is to develop new and improved testing equipment -- such as $20 million-plus road-handling simulators for car manufacturers -- not from scratch but from technology and materials that may exist and that can be packaged with software in ways that deliver a higher-value product and economic proposition.

"They don't take on contracts anymore that have any question about profitability," said Bill Frels, portfolio manager at St. Paul-based Mairs & Power Growth Fund. "They've got a niche that is very attractive. There's just not a lot of competition around the world that can match the MTS testing equipment and service."

MTS's renewed focus on core competencies has resulted in new relationships with the race-car industry, growing business with Asian car manufacturers and global aircraft makers seeking smoother, more efficient flights.

Its next generation of test equipment increasingly combines software and integrated electronics as well as mechanical testing in a bid to be a one-stop shop to ensure that everything in the car works together and as advertised. It's a world of software-driven, gyrating road simulators and wind-tunnel-induced turbulence.

About two-thirds of MTS's revenue comes from Asia and Europe, where Germany has long set the standard in new-product development.

China is the single fastest-growing market.

"China is just starting to develop in research and development," Emery said.

Neal St. Anthony • 612-673-7144 • nstanthony@startribune.com