Raven Industries, Inc. (NASDAQ:RAVN)
Q1 2017 Earnings Conference Call
May 19, 2016 10:00 am ET
Bo Larsen - Investor Relations Manager
Daniel A. Rykhus - President and CEO
Steven Brazones - VP, CFO and Treasurer
Ben Hearnsberger - Stephens Inc.
Good day, ladies and gentlemen, and welcome to the Raven Industries' First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Bo Larsen, Manager, Investor Relations. You may begin.
Thanks. Good morning and welcome to Raven Industries fiscal first quarter 2017 investor conference call. Today's call is being Webcast live and will also be archived on the Company's Web-site for future listening. On the call today will be Dan Rykhus, Raven's President and Chief Executive Officer, and Steven Brazones, Raven's Vice President and Chief Financial Officer.
Before beginning, the Company would like to inform everyone that certain matters discussed during this call will include forward-looking statements, as that term is defined under the Private Securities Litigation Reform Act of 1995. Since such statements reflect the Company's current expectations, actual results may differ.
I would now like to turn the call over to Dan Rykhus, Raven's President and Chief Executive Officer.
Daniel A. Rykhus
Thank you, Bo, and welcome everyone. We're relatively pleased with our first quarter performance. It's hard to call Q1 a big success when sales actually declined on weak comparables but we are gaining good momentum and we're pleased with that. While our sales declined slightly year-over-year, we continued the trend of incremental improvement and took a big step in restoring the Company back to a growth trajectory.
The declines we experienced in the first quarter in both Applied Technology and Engineered Films were substantially less than those we've been experiencing in the second half of last year. There are several reasons for this improvement. For Applied Technology, we're starting to see more stability in end market demand. While conditions are still tenuous, they are not deteriorating. For Engineered Films, the portion of the division tied to the energy and geomembrane market is substantially less than in previous years and the challenging comparisons are easing. But more importantly, we are successfully executing our strategy to generate growth opportunities across all three divisions despite the challenging market environment.
The decisions we made in March of last year to restructure the Company, while largely maintaining our investment in research and development activities, positively impacted our results in the first quarter and are expected to continue to benefit the Company going forward. It's still early in the year and there's a lot to accomplish but we are off to a good start. I'll now discuss the results of the first quarter in more detail division by division and then turn the call over to Steven for a review of the financial statement.
Beginning with Applied Technology, momentum continues to build for the division and we're pleased with the strong start to the year. The sequential improvement in the sales development for the division continued with sales nearly flat to the prior year in the first quarter. Sales to the aftermarket channel increased approximately 6% year-over-year while sales through the OEM channel declined 12% year-over-year, a substantial improvement from the fourth quarter.
From an international standpoint, the division's sales activity remained strong with sales outside the U.S. growing 26% year-over-year. All major regions experienced solid growth during the quarter led by Europe. Our European results continue to benefit from the commercial synergies resulting from the acquisition of SBG over two years ago. SBG has been very successful in selling Raven field computers, such as Viper 4, through our European sales channel.
Although the underlying strength of the ag market remain subdued, conditions appear to be stabilizing. Steady market conditions combined with our early success in growing our market share position give us reason to be optimistic for the balance of the year. New product introductions are gaining traction. Hawkeye is on pace to achieve the growth expectations we have for the year and we're excited about the prospects for our next-generation rate controller which we will launch later this year.
With the enhanced quality of our new product portfolio, we expect OEM sales declines to ease further in the second quarter and ultimately achieve growth in the second half of the year, driven by increased Raven content per machine and new OEM development.
With respect to Engineered Films, the division experienced a moderate decline in sales in the first quarter driven by declines in the energy and geomembrane markets. Energy-related sales declined $2.5 million or approximately 60% while sales into the geomembrane market were down about 13% year-over-year. Combined, these two markets were down approximately 40% versus the first quarter of last year.
Although oil prices did improve from the low 30s to the low 40s over the course of our fiscal first quarter, active land based U.S. rig counts have continued to fall and were down approximately 55% year-over-year. Sales to the remaining three markets in aggregate were up 3% year-over-year in the first quarter, driven by growth in both the construction and industrial markets. Although the division was unable to achieve growth in the first quarter, sales trends did improve sequentially.
With comparisons continuing to ease throughout the year for energy and our efforts to drive incremental growth in both the industrial and geomembrane markets from our new production capacity, we're optimistic that we will make meaningful progress during the year toward returning the division to growth.
Now let me turn to Aerostar. Sales for the division were up $1.3 million in the first quarter, driven by strength in stratospheric balloon related business, in particular Project Loon. Revenues related to the project were up materially in the first quarter of fiscal 2017 versus the prior year. Last year's first quarter Project Loon sales were relatively modest as we were in the midst of changing to the next generation balloon design and unit volumes were lower.
Project Loon revenues in the first quarter were consistent with our expectations and up slightly versus the fourth quarter. In addition to the growth in revenue related to Loon, we also generated stratospheric balloon sales from two new U.S. government customers during the first quarter. We're pleased with this development. While the revenues from these new customers were modest, they affirm that the advanced capabilities we have developed in stratospheric ballooning have alternative uses in the market.
This is a very important year for Aerostar. We are intently focused on turning around the performance of the division and returning it to profitability once again. The first quarter was a slight improvement versus the prior year but we need momentum to build quickly as we progress through the next two quarters, and we need to deliver a step-change in performance.
Key to achieving this will be winning meaningful new business in the second half of the year. Our pipeline of new business opportunities has improved significantly and this gives us some tempered optimism and near-term patience. Now we must turn these opportunities into revenue for the division.
And with that, I'll turn the call over to Steven for our financial review.
Thanks Dan. On a consolidated basis, sales were $68.4 million in the first quarter, down 2.7% versus the first quarter of last year. Applied Technology and Engineered Films, both declined year-over-year but exhibited improved sales trends despite continued end market demand weakness. Aerostar grew sales 20.5% year-over-year, driven primarily by stronger sales of stratospheric balloons and related products.
Operating income for the first quarter of fiscal 2017 was $7.6 million, up $400,000 versus the first quarter of fiscal 2016. Operating margin was 11.1% of net sales, up 80 basis points year-over-year. The increase in operating margin was principally driven by lower operating expenses year-over-year as a result of our continued expense controls and prior year restructuring benefits.
First quarter net income was $5.5 million or $0.15 per diluted share, versus net income of $4.9 million or $0.13 per diluted share in last year's first quarter. The increase in net income and earnings per share was driven primarily by favorable tax developments and lower shares outstanding as a result of repurchase activity over the last five quarters. Through the remainder of fiscal year 2017, we expect an effective tax rate of approximately 30%.
For Applied Technology, first quarter sales were $31.5 million, down $1 million or 2.9% year-over-year. Although sales were lower versus the first quarter of last year, the sequential improvement in the year-over-year sales development continued. Sales to the aftermarket channel increased 5.7% in the first quarter versus the prior year, compared to a decline of approximately 20% in the previous quarter. Sales through the OEM channel decreased 11.9% year-over-year in the first quarter, compared to a 33% decline experienced in the fourth quarter. Geographically, domestic sales were down 13.8% year-over-year and international sales were up 26% year-over-year.
Division operating income for Applied Technology was $8.7 million, essentially flat with the first quarter of fiscal 2016. The impact of lower sales volume versus the previous year and increased R&D spending was offset by the benefits of ongoing expense controls and the prior year restructuring actions taken.
For Engineered Films, sales were $29.1 million, down $2.2 million or 7.1% versus the first quarter of 2016. The decline in sales for the division was driven by declines in the energy, geomembrane and agriculture markets. These markets were up 61%, 13% and 5% respectively versus the first quarter of last year. Sales into the construction and industrial markets increased versus the prior year. Sales into the industrial market were relatively strong increasing 29% over the prior year, while sales into the construction market were up slightly, more than 1%, year-over-year.
Division operating income for Engineered Films was $3.9 million in the first quarter of 2017, a decrease of $0.6 million or 13.3% year-over-year. Division operating margin was 13.3% in this year's first quarter, down 100 basis points versus the first quarter of last year. Lower gross profit margin resulting from the lower production volumes and scale-up cost of new production equipment primarily led to the decline in operating margin.
For Aerostar, first quarter net sales were $7.9 million, up $1.3 million or 20.5% year-over-year. The increase in sales was driven primarily by increased stratospheric balloon related revenues. Project Loon related revenues were up strong year-over-year and we realized first-time sales from two new customers interested in our stratospheric balloon capabilities. Research balloon revenues tied to NASA were up slightly versus the first quarter of last year. All other business lines in aggregate were down slightly versus the first quarter of last year.
Division operating loss for Aerostar was $600,000 versus an operating loss of $900,000 in the first quarter of last year. Fourth quarter 2016 restructuring benefits are meeting expectations but continued R&D spending in anticipation of improved sales is largely offsetting these benefits in the short-term.
Turning to the balance sheet, we ended the first quarter with $32.8 million in cash, down slightly versus the previous quarter. Repurchase of shares during the quarter reduced cash balances by $5.7 million, but this impact was largely offset by free cash flow generation driven by favorable working capital development and reductions in capital spending.
Net working capital as a percentage of annualized net sales decreased 510 basis points year-over-year, from 33.8% to 28.7% in this year's first quarter. The decrease in net working capital percent was primarily the result of lower inventory levels, particularly in Applied Technology and Engineered Films.
Cash flow from operations was $11.1 million in the first quarter of fiscal 2017 versus $9 million in the previous year's first quarter. Higher net income and favorable working capital developments principally drove the improvement year-over-year.
Capital expenditures were $800,000 in this year's first quarter, down $4.2 million versus the first quarter of fiscal 2016. Last year's first quarter spending included a significant amount of spend related to the new Engineered Films production line which was commissioned during the first quarter of this year. For fiscal year 2017, we continue to expect capital expenditures to be approximately $9 million. There are no significant Engineered Films capacity expansions planned for the year and the other divisions are expected to maintain a disciplined approach to capital spending.
During the first quarter of 2017, we repurchased approximately 380,000 shares at an average price of $14.93 per share, for a total of $5.7 million. Over the previous five quarters, we have repurchased approximately 2 million shares at an average price of $17.66 per share, for a total of $35 million. During the first quarter, the Company's Board of Directors authorized an incremental $10 million for share repurchases, increasing the total amount authorized to $50 million. Company's remaining authorization at the end of the first quarter of 2017 was $15 million.
With that, I'd like to turn the call back to Dan for our outlook going forward.
Daniel A. Rykhus
Thanks Steven. We're pleased with our overall performance in the first quarter, and in particular the improved performance of Applied Technology. Despite continued end market challenges, the decisions we made last year to restructure the cost profile of the Company and to continue R&D investment amidst declining revenues are positively impacting our results. We're off to a good start and this gives us optimism for the balance of the year.
With that said, our optimism is tempered. We still have a lot to accomplish to improve the growth and profitability of the overall business in order to meet our expectations for the year, and we believe we will.
For Applied Technology, we will continue to expand our OEM relationships and grow our share in a down market. We are executing our plan and driving for growth by leveraging our new product portfolio and investing more intently to drive international sales.
For Engineered Films, we need to increase sales volumes despite continued energy and geomembrane market weakness. We will continue our first quarter progress in ramping up sales in the industrial market, leveraging our new production line and we need to drive strong performances in ag and construction.
For Aerostar, we must continue the progress made toward improved financial performance. Key to sustaining this progress will be establishing a regular cadence of new business wins across product platforms. Resources are aligned to continue the progress we've made but uncertainties do remain.
In addition to each division's sales initiatives, the Company will remain vigilant on costs, drive down inventory levels and generate additional value engineering benefits. Successfully driving growth when end market conditions are weak is not without its challenges, but doing so will while maintaining operational discipline has been and will continue to be our focus for the rest of the year. Given our performance in the first quarter, we are on track to deliver revenues and operating profit consistent with prior year revenue and adjusted operating profit, with the potential to achieve modest growth in both for the full year.
So with that, we'd like to open up the call for questions.
[Operator Instructions] Our first question comes from Ben Hearnsberger with Stephens Inc. Your line is open.
Congrats on a good quarter. So if we look historically, I think you've generated about a third of your earnings in the first quarter. Is there any reason why this historic seasonality wouldn't hold this year?
Ben, our seasonality has changed a little bit over the last year. We used to have an energy market in EFD that was relatively stable quarter to quarter to quarter last year and that's not the case this year. So for EFD, we've seen the seasonality shift a little bit, so the third quarter is the strongest quarter for EFD with fourth quarter being the weakest, first quarter gets a little stronger and second quarter a little stronger. And for ATD, the strongest quarter is in the first quarter. So you've kind of got to weigh out your assumptions by division to kind of get to what you think for a seasonality for our overall earnings.
Okay. So if we think about it that way and we've got probably more seasonality in the back half of the year with EFD now, ATD is stabilizing, and then we kind of make a slag at Aerostar, I guess it makes your guide for flat EBIT dollars on an adjusted basis look relatively conservative. I guess can you walk through the puts and takes on why you left the guide in place?
Daniel A. Rykhus
Sure. I'll make a few high-level comments and then I'll put it to Steven. I think each year, Raven – when you have three different business units, like we do, you're trying to forecast three different market conditions and three different sets of new products and opportunities, and it's challenging as you know Ben. We think our second quarter is going to be a challenging quarter to beat I think in terms of last year's performance. I think we have a shot at it but it's going to be the hardest quarter probably for us for the year.
And we think as we get into the second half, our third and fourth quarters provide good opportunity for us to realize growth from our ag OEM partners based on the new products that we've introduced in the take rates on those new products. We believe we'll continue the momentum we've had with Line 14 throughout the year, which is our new line for Engineered Films which will serve the industrial market, which will just add sort of on top of the normal seasonality and the point that Steven made about the energy market. Those will be new incremental revenues that will help the back half of the year in a new way for us.
And then as I said in my comments opening up, this is a big year for Aerostar, which means we've got to book orders in the second quarter. That's what we're going to be looking for in terms of progress and success as that we've booked meaningful orders in the second quarter for Aerostar and we have a nice product pipeline of new business development opportunities, much broader than we've had in the past, but that will lead to second half deliveries we believe for Aerostar.
So I think, high-level, I just want to make sure that you and others understand that second quarter is going to be challenging for us, but we have some good things happening. We're off to a good start in May. As I said, it needs to be a good strong quarter at our EFD. Q2 is a big quarter for EFD and for the Company that way. And then we see things continuing to grow throughout the rest of the year.
Okay, that's really helpful. And I've got some segment level questions here maybe I'll jump into. You mentioned the next gen rate controller. When is that expected to launch and what kind of revenue opportunity can that be?
Daniel A. Rykhus
Long-term it has incredible revenue opportunities for us. We'll be releasing that throughout the second quarter and third quarter with different OEM customers. It's a general platform that we'll be able to take to a wide variety of customers but there will be some specific announcements, and I'm not going to get ahead of our OEM partners on that, but throughout the second and third quarter you'll start to see those announcements come forward, and we're excited about it.
And really it sort of is an indication of how we've changed our R&D investments over the last two years and we're carrying that forward, in ATD and in Films and Aerostar and all of them, but ATD we really narrowed our R&D investments toward a fewer opportunities with larger potential returns and we're seeing that get traction. So we delivered Hawkeye this last year and that's progressing well for us. We're going to deliver a new platform, a new rate controller platform, that's already attracting new OEM customers.
So I want to be clear, when I say we expect improved performance out of our OEMs in the second half, that's not because I somehow think that the ag market for OEMs is going to improve in the second half, that's not it at all. It's because our take rate for the products that we are introducing is going up and our content per machine is going up with our existing partners and we're bringing on new OEM partners because of the R&D investment that we've made.
Okay, that's helpful. Just to put it into context, could the rate controller in terms of revenue contribution, should it ramp similar to Hawkeye, is it maybe a smaller growth opportunity or larger in terms of thinking about it in the context of how Hawkeye has ramped over the last year and this year?
Daniel A. Rykhus
I think for the near term, Ben, that's a reasonable expectation that it would be in that range of what we expect Hawkeye. I think both of them have good 2017-2018 ramp-up potential. So, yes, they are similar.
Okay. And then last on ATD, Europe sounds like it's doing pretty well. Can you touch on Brazil? I know this is an area of opportunity for you guys this year.
Daniel A. Rykhus
Sure. As everybody on the call knows, the macro environment in Brazil is challenging, to say the least. And as some of you have followed us for a while, you know that we've had some challenges of our own in Brazil that link back to some product quality issues and then a market that was real tough. And we've really turned the corner on that and we are seeing substantial improvements out of Brazil in the first quarter, and maybe Steven can talk to that, but we expect to see a full-year improvement out of South America. And Steven, can you give us some more details?
So, Ben, Latin America for us for ATD was up 17% in the first quarter and it was largely driven by the performance in Brazil. Brazil was up about 45% year-over-year in the first quarter. We've seen some success in generating additional interests through Hawkeye in Latin America, and in Brazil in particular, and we've hired, we've got us new sales individual on the ground in Brazil now who is gaining a lot of traction.
Daniel A. Rykhus
In addition to that, our division leader, Brian Meyer, is spending considerable time there developing with our sales leadership and these new market opportunities. So definitely when we say we're focused on a narrower set of international growth opportunities, you should be thinking about Europe, both Western and Eastern Europe, and our Eastern Europe results have been outstanding this year, and then you should be thinking about South America and Canada.
Okay. And I've got a couple of questions here on Aerostar. Then I'll jump back in queue. You didn't mention Vista. I know that that's an area where you're trying to have more success landing some smaller contracts instead of going after some of the bigger fish out there that those had come through last year. How much success are you having filling up that pipeline and should we see some conversion as the year progresses?
Daniel A. Rykhus
I feel confident and comfortable that we have changed the profile of the pipeline greatly for our radar opportunity. Instead of having a couple very large contracts, those are done, and now we have a pipeline full of half a dozen to 10 smaller but really contracts that we think we can win. And as I said earlier in my comments that Q2 is going to be what, we'll know as we progress through Q2 and into early Q3, these pursuits will need to bear fruit and we expect that they will. I'm confident in the leadership that we have in place.
We have a gentleman running our Vista office now that's been with the Company for over 25 years. He has a great mix of sales and technical perspective and he's connecting very well with our past customers and developing new customers. So we'll see but I'm more confident in the transparency into that operation and the profile of our business development pipeline than I have been in the past.
Okay, that's really helpful. Thank you, gentlemen.
[Operator Instructions] I'm showing no further questions at the time. I would now like to turn the call back to Dan Rykhus for any further remarks.
Daniel A. Rykhus
Thank you, operator, and thank you, Ben, for asking all those great questions. I guess you covered all the bases for everybody. And it was a good quarter, it was a good start to the year. I'll say we're not out of the woods yet but we feel confident in the direction and progress that we've made and we look forward to updating you again in August. Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.
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