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Raven Industries, Inc. (RAVN)

F1Q09 Earnings Call

May 19, 2008 3:00 pm ET

Executives

Leslie Loyet – Financial Relations Board

Ron Moquist – President, Chief Executive Officer

Dan Ryhkhus – Executive Vice President, Flow Controls General Manager

Tom Iacarella – Vice President, Chief Financial Officer

Analysts

Jeff Evanson – Dougherty & Co.

Tom Hayes – Piper Jaffray

[John Rankin – Baranco Management]

Operator

Good afternoon ladies and gentlemen and thank you for standing by, welcome to Raven Industries first quarter 2009 earnings conference call. (Operator instructions) At this time I would like to turn the conference over to Ms. Leslie Loyet of the Financial Relations Board. Please go ahead ma’am.

Leslie Loyet

Thank you, I’d like to thank everyone for joining us today. Earlier in the day we sent out a press release outlining the results for first quarter of fiscal 2009. If anyone has not received the release please either call Han Huie at 312-640-6688 and she will send you a copy or visit Raven’s website at RavenInd.com to retrieve a copy.

Joining us today from management of Raven Industries we have Ron Moquist, President and Chief Executive Officer, Tom Iacarella, Vice President, Chief Financial Officer and Dan Rykhus, Executive Vice President and Flow Controls Division Manager. Management will provide an overview of the quarter and then we’ll open the call to your questions.

Before we begin we would like to remind participants that the information contained in this call is current only as of the date of this call, May 19, 2008 and the company assumes no obligation to update any statements including forward-looking statements made during this call.

Statements made by the company that are not historical facts are forward-looking statements that are subject to the Safe Harbor disclaimer in today’s press release. With that said, I’d now like to turn the call over to Ron. Please go ahead.

Ron Moquist

Thanks Leslie and welcome everybody to our first quarter conference call. Well the year got on to a good start with sales up 29% and earnings up 27%. The earnings were probably better than what we were thinking when we talked with you in March, but the way we got there was pretty consistent with what we discussed with Flow Controls doing better and Electronic Systems doing somewhat less.

The first quarter is important to set the tone for the year and also to test the strength of our agricultural markets and our Flow Controls division was expected to have a strong first quarter but they surpassed even that. Last year’s first quarter operating income for Flow Controls was up 38%. So we had a strong base that we have to build on and this year’s first quarter was up another 90%.

With prices for corn and soybeans and what at or near record highs and with input costs such as fuel and fertilizer, seed and chemicals also topping out, the demand for our precision ag products with minimize input costs and maximize yield are I guess you could say just exploding, at the very least in very high demand.

And these conditions really exist worldwide. Flow Controls got 20% of sales outside of the US in the first quarter versus 16% for last year. Keep in mind how large the increase was in the United States for this past quarter. You can see just how big that increase internationally really was for us.

That’s been a fast growing part of our sales volume and we expect it to grow in the 30-50% range at minimum. Brazil, Canada, Europe and Eastern Europe all recognized the need to improve productivity through technology and with current commodity prices the way they are, the incentive is certainly there to do just that.

With the possible exception of John Deere, I believe we had the broadest and deepest lineup of precision agricultural products in the industry. So we can put together integrated solutions for planting, for spraying and harvesting and with the high cost of inputs and the need to maximize yield, it’s necessary but not enough to just have a very accurate GPS steering system.

Growers want to optimize seed population when they’re planting, they want precise control of chemical and fertilizer usage when they’re spraying, they want to maximize yields when they’re harvesting and we have a complete suite of products that can be fully integrated which simplifies and optimizes operations and data collection. Our competitors just don’t have that, I don’t think they can get there in the short term.

Our new products are also doing very well. Our new low cost Cruizer GPS steering system which we’ve talked about in March was introduced in the fourth quarter and just took off and this may be the best new product introduction we’ve ever had. But the fact is everything in our product line is selling well at this time.

With such explosive growth in the past two years in Flow Controls, it’s required a really well orchestrated build out of sales, engineering and service support as well as manufacturing. If we thought this were just a temporary sales spike, we would have held back but it isn’t, so we’re aggressively moving forward with a large investment in intellectual capital in other words, in people.

And in the past year we’ve added 40% more engineers, we’ve added 32% more sales and marketing personnel and we’ve added 30% more service and support technicians. So profits aren’t growing simply because we’re holding back on adding people and overhead, which often happens during a growth spurt. We’re building out the necessary infrastructure to keep growing and to keep the momentum going.

The first quarter is the strongest quarter for Flow Controls, so we won’t see this level of sales and profit in the second and third quarters but we will see continued strong year over year growth as Flow Controls makes up for the shortfall on engineered films and electronic systems.

Engineered films had a first quarter that at least on paper doesn’t look very good but sales were up 12%, operating income was down 23%, but given the condition of the construction market and the continued high cost of plastic resin and competitive pricing pressure, I think we did a good job optimizing a tough situation.

They’re close to where we thought they’d be in sales and profit when we put together the budget six months ago. Almost all of our material cost increases came in the second half of last year when plastic resin went from about $0.50 to almost $0.80 a pound. So the first and second quarters of last year were virtually unaffected while the first quarter of this year felt the full weight of those increases to the tune of just under $2 million.

We made up about half of that $2 million from increased sales and price increases but couldn’t make up the rest. Our two largest markets are construction and energy which accounts for about 40% and 35% of total sales respectively and we’re seeing some slippage for existing products in our construction business but not as much as you might think. But it’s become a more competitive area with greater price discounting and that’s hurting margins.

Energy, that’s a strong market for us because of increased oil drilling in North America. We line holding ponds which are placed near drilling rigs to hold the water and the sludge and with $120 oil you can imagine that this would be a good market for us and it is.

Our plan to improve profit margins is to introduce new products which have performance advantages and are not easily copied by the competition and we’re doing that with our line of multi-layer barrier films. These films are almost 100% impermeable to gases such as radon and methane, oxygen and barrier films are not uncommon in food and medical packaging, companies like [Deanus] out of Minneapolis and now they’re in Wisconsin, their headquarters are, but they’ve been doing this for years.

But these products are unique in industrial applications and we’re one of the few companies that has taken that technology and moved it into the industrial area. And I talked about these films at our last meeting in March and about how the next challenge will be establishing and building out our distribution network and that’s always the most difficult part of marketing, introducing new products is tough but setting up new distribution is even tougher.

But I’m encouraged by the progress we’ve made in the last three months. We see initial orders for our radon barrier film which is placed under the concrete slab of residential and commercial buildings and protects the occupants from radon gas inhalation which can cause lung cancer. And we’re just getting started with this product but it has potential and it’s creating a lot of interest on the part of architects and contractors who are part of the green and healthy homes movement.

Another type of multi-layer barrier film is one we recently sold to a company in California to cover strawberry fields before planting and injecting methyl bromide under the plastic sheeting to sterilize the soil. And methyl bromide is an extremely volatile chemical that is damaging the ozone layer and can only be used under strict environmental guidelines.

It’s the type of material much like anhydrous ammonia that’s [knifed] in but as soon as it hits the atmosphere it turns to a gas. And so traditionally low end plastic films were used to cover it but they weren’t impermeable and the methyl bromide gas passed through them fairly readily.

Our barrier film is able to contain the methyl bromide gas from escaping and that can cut applications rates of methyl bromide by 50% or more, so that’s good for the environment and good for the strawberry grower’s profits. So these are just two of the many applications we’re developing and why we’re excited about the future of these unique films.

Our Electronic Systems division had a difficult first quarter. We knew it’d be a tough quarter but it was even tougher than we thought. Sales were down 8% and operating income went from $2.4 million all the way down to $640,000. Last year we had an extremely favorable product mix in the first quarter and this year was almost the exact opposite.

This year’s quarter included the loss of an important high margin account, it had a large drop in bed control sales which make up almost one-third of Electronic Systems operating income. We had a pickup in new business but that new business won’t generate much profit in the first year. And then we had a push out in shipments of avionics products which is temporary by the way, but we did have that push out and that contributed to our weak first quarter in Electronic Systems.

As I mentioned last quarter we lost an important account that had been with us for a long time, it accounted for about $7 million in profitable sales and in addition to that we had our handheld bed control sales drop 20% and they continue to drop. But on the positive side our industrial and avionics business is picking up.

We supply sub assemblies used by Boeing and Airbus and the jet aircraft market is pretty strong right now, especially in the Mid East and in Asia. And when Boeing gets their 787 Dreamliner and Airbus gets their A380 jumbo jet into full production we’ll be part of that also.

So we see sales and operating income increased for electronic systems in the second quarter but it will still be a difficult year for them. We’ve already started taking measures to get costs under control and to get the organization right sized.

Electronic systems is important to us because it has the greatest expertise in advanced manufacturing processes and knowledge of key technologies like lead free soldiering and automated surface mounting of micro components and these technologies and disciplines are highly valued by us and are not something we intend to lose.

I think many companies and this is kind of an aside about private companies that have offshored their contract manufacturing, including electronics contract manufacturing, but I think many companies are beginning to reassess their past decisions to offshore so much of their critical manufacturing processes to cheap labor countries.

What they’re finding is costs are rising, supply chains are long and breaking down, quality is coming into question, to say nothing of the political instability of many of these countries. Unfortunately, it won’t be easy to bring back this manufacturing since so much of America’s manufacturing infrastructure has been destroyed. Raven is a company that has always believed in American manufacturing and we’ll be ready when the tide starts changing direction and I believe it will.

Our Aerostar subsidiary had just the kind of first quarter we were projecting. Sales were up 44%, operating income was almost fourfold. It’s still a small part of our total income of Raven, about 5%, but it has a lot of upside potential.

Right now all segments of Aerostar are showing improvement. The Army special forces parachute shipments went from unprofitable in the fourth quarter of last year to profitable in the first quarter as efficiencies improved and the same held true for our Army fuel handler coveralls contract which became profitable in the first quarter.

So we’re now through the startup phase on both of these contracts and profitability should continue to rise as we improve our processes and gain productivity. Our high altitude research balloon and Aerostat group had an excellent first quarter. Although our prototype high altitude airship, the Hi Sentinel did not fly in April as scheduled, we’ve got it rescheduled for June and this is the 180 foot long helium filled airship that is powered by solar panels and able to fly at 67,000 feet and stay in place for 60-90 days.

If we successfully complete the test in June, there should be a great deal of interest on the part of the military for products of this type. Aerostar is off to a good start with all three operations performing at a high level, so they should just have an outstanding year in this coming year.

So the bottom line is that it was a very good first quarter and that makes it the twenty-ninth consecutive quarter of year over year record earnings. As I mentioned already, Flow Controls exceeded our forecast, Engineered Film and Aerostar came in about where we expected and Electronic Systems did less. But we see Electronic Systems division second quarter to be much improved.

As I do almost every quarter, I’d like to reemphasize that Raven’s goals are to grow sales 12% and earnings 15% per year on average. Not all of our businesses are capable of that but we believe on average, over time, these are reasonable goals. Our last two years we didn’t achieve these goals, but the five years prior to that we far exceeded them. But on average over time again I think these are realistic targets for Raven.

We increased the quarterly dividend 18% on April 15 from $0.11 to $0.13 a share or our twenty-second consecutive year of dividend increases. And as of Friday, May 19, which is an update from the numbers that you have in front of you, we have $31 million in cash and that’s more than we normally carry but as we’ve discussed in previous calls, we just felt there could be a credit squeeze this year, that the extra cash would give us flexibility if we found an acquisitions or investment we wanted to move on.

We don’t have anything we’re ready to close on at this time but we are looking at some interesting opportunities, but if nothing appears by our November Board meeting, the Board will start discussing whether we want to buyback more shares, declare a special onetime dividend or just roll the cash over into next year and continue to look for opportunities.

As you know we increased the authorized limit for stock repurchases from $2 million to $10 million at our March Board meeting and in the first quarter we repurchased $3 million worth, about 100,000 shares versus only $600,000 worth for all of last year. Accounts receivable are very high and that’s because Flow Controls gives extended terms to its customers and those accounts look solid and the receivables will come down significantly by the end of June.

And just before this conference call I talked to Tom Iacarella, our CFO and asked him what the current accounts receivable looked like as of this afternoon and he told me that they’re down to $39 million as of today. So just in the 19 days since these financials came out we’ve dropped accounts receivable from $50 million to $39 million and that’s why our cash position went up from $21 million to $31 million.

So again these receivables look very solid and sound and we’re not concerned about our ability to collect them. Looking ahead the second quarter won’t be a 27% growth quarter but it will be solid. Flow Controls will again lead the way with engineered films and Aerostar continuing the trends we saw in the first quarter and Electronic Systems showing improvement but still not at last year’s levels.

And with that, Leslie I’ll open up to questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Jeff Evanson – Dougherty & Co.

Jeff Evanson – Dougherty & Co.

Starting with Engineered Films, great job to Jim there getting that stabilized, I guess what I’d like to know, Ron, can you talk about some kind of percentage of sales in the quarter that came from new products, whether that’s introduced in the last 12 months or some period of time, it would be helpful if that would be a metric you could provide us on a quarterly basis but if you have some sense of that now, that would be helpful.

Ron Moquist

Yes as of today that’s not a big number at this point. As you know the equipment that we brought on stream was brought on stream about a year late and so what we brought on in terms of new product is in $1-$2 million type of category at this point. And so it’s not a huge percentage.

Geo membrane films for example are about 5% of our total sales and these multi-layer barrier films that I talked about, they are just getting introduced now. House wrap which I’ve talked about too many times and we haven’t done much is getting reintroduced and has not generated much interest. But the interesting thing is that the construction market today is more receptive to those new products than they were three years ago.

If we had introduced those same products three years ago, nobody would have wanted to talk to us because they had more business than they could handle, they had a backlog of work yet to do, they did have time to talk to suppliers and sales people. But today, they’re hungry, they’re looking for ways to differentiate themselves.

So a radon barrier, an improved house wrap material, many of the things that we have going on right now are of interest to them because they’re able to talk about something new and differentiate themselves from the competition. So long answer but the short answer is it’s not a large number at this time in terms of products we’ve introduced in the last 12 months.

Jeff Evanson – Dougherty & Co.

Could you talk about your sense of the level of channel inventory that might be out there in the Flow Controls division?

Dan Ryhkhus

Very little.

Jeff Evanson – Dougherty & Co.

And give us some sense of why you’re so confident about that, I’m sure you are but give us some sense of your visibility.

Dan Ryhkhus

Well we’re just now starting to get back off of a four to five week reported delivery time on our products to our resellers. So we’re paring that down to maybe a two to three week timeframe now. So unfortunately our distributors and resellers and OEMs just have not had any excess raise in inventory to work from.

Ron Moquist

I think part of that Jeff is the level of frustration you start getting on the part of your customers when they call frequently and want to know where their deliveries are and why things are late and couldn’t we expedite and ship sooner.

When you’re getting those calls they clearly are not moving through a long channel of distribution, they’re moving through very quickly and as the season starts as you know, once growers are out in the field planting, the buying slows down dramatically. So again, we just didn’t sense that any of this product was being built for stocking, it was being bought because it was sold and moving through the whole system right to the grower.

Operator

Your next question comes from Tom Hayes – Piper Jaffray.

Tom Hayes – Piper Jaffray

In looking through the earnings announcement you had indicated that you’re moving some of the circuit board production from Flows over to the Electronic Systems, can you just give me or provide some idea of the percent of total volume or how much volume you’re recovering from the lost $7 million business?

Ron Moquist

That’s not going to be a huge amount in terms of covering that loss. Dan what does that amount to in terms of total volume?

Dan Ryhkhus

I think it was about $1.5 million.

Tom Iacarella

It was probably a little less than that, if you look on the tables right now we’ve got a new line item of intersegment eliminations which was $983,000 for the quarter, the majority of that was shipped from Electronic Systems to Flow Controls. And some of it is also some shipments from Engineered Films into Aerostar, but it’s primarily the shipments from Electronic Systems to Flow Controls.

Tom Hayes – Piper Jaffray

In your discussion on the inventory you had indicated some increase in inventory on the films side. Can you just give us some magnitude, is that a seasonal buildup or just to match demand?

Tom Iacarella

I would say that the higher inventory levels in Films really reflects the fact that a year ago their inventories were down quite a bit, probably the lowest they’ve been in a couple of years. And I think we’re just getting up to a more normal level of inventory today and that does reflect as I said a little bit of a sales increase as well, so they’ll move that inventory through.

Operator

Your next question comes from [John Rankin – Baranco Management].

[John Rankin – Baranco Management]

On page 9 of the annual report and this is discussing geo membranes and I’ll read this, another example is water conservation in the southwest, farmers want to line their irrigation canals with our geo membranes to ensure precious moisture is not lost into the soil.

My question is or I guess my comment is I think you would want to pursue water companies because they’re the ones that have the money, especially where cities are buying up the water. I see a real big demand for this as most canals at least around here are 125 years and earthen. So my question is, could you give us a little more color on this, what is your strategy and do you have any cash flow and time projections?

Ron Moquist

Our strategy was to get several of these installed out there and then demonstrate that they work and that they were going to get a return on investment. Now we’ve got a couple of canals lined in California, we haven’t done as much as we had hoped. It’s going slower than we thought. So that’s a program that we’ve got to bump up right now. We’re not doing as well as we should.

I agree with you that there should be tremendous demand for it out there because water is the most important thing on the West Coast and they’re short of it. So our strategy is not what it needs to be and we’re going to have to put more attention on that and do a better job but we have not done a good job up until this time.

Operator

Your next question comes from Jeff Evanson – Dougherty & Co.

Jeff Evanson – Dougherty & Co.

So Ron I was wondering if you’d be willing to share with us roughly the pounds resin used in the quarter and what that price per pound was.

Ron Moquist

Less than 15 million pounds but I’m going to say somewhere between 12-15 million pounds. The price is going to be around $0.75-$0.76 a pound. And that was a little bit higher than Q4, maybe 3-4% higher.

Jeff Evanson – Dougherty & Co.

And then my follow up to that is, will the tax rate remain at this level?

Tom Iacarella

Our tax rate as I think we said in our annual report was going to be up at this level until such time as the R&D credit gets renewed. We’re waiting for that and until that’s been renewed, we’ll see a little bit higher tax rate.

Operator

Your next question is from [John Rankin – Baranco Management].

[John Rankin – Baranco Management]

My question on this is Flow Controls, the strip tillage map that farming is getting quite a bit of interest out in the ag community, what growth do you see in this farming method and do you have plans to serve it?

Dan Ryhkhus

Well we see that that practice is definitely growing but it’s still a small part of the overall acreage but a growing part. And really just about everything we do benefits from, our products improve on that practice because that practice requires very precise placement of seed, fertilizer and actual field operations cultivating and so on and so forth.

So it’s a growing segment, we’re well poised with the development of our farm pro system, our collaboration with Novariant Auto Farm which has brought us the dual frequency RTK two centimeter accuracy steering system.

And then you couple that with all the other applications that we already deliver to the marketplace such as [section] control and variable rate application, [broomite] management. So it’s a factor that is helpful for us, we like broader adoption of strip tillage because it definitely increases the demand for our products.

Operator

Your last question is from Jeff Evanson – Dougherty & Co.

Jeff Evanson – Dougherty & Co.

I noticed the corporate allocation was up fairly, I guess what to me historically seems fairly strong and I’m curious if you possibly have that front loaded this year or how I should think about that?

Tom Iacarella

Well it is up a little bit more than we would expect on a percentage basis to be up for the year. There is certainly some seasonality to that or they tend to be stronger in the first half of the year. We also were impacted by a lawsuit settlement of let’s say the $100,000 range in the quarter.

Jeff Evanson – Dougherty & Co.

You have some comments in the press release about labor transitions here from Electronic Systems to Flow Controls, I’m wondering if you could discuss how you feel that impacted operating margins in the quarter.

Ron Moquist

Well it’s always nice and we’ve done this ins past years so this isn’t just a recent thing that Electronic Systems often is a little bit slow in the first quarter and Flow Controls of course has their biggest quarter in the first quarter. So shifting people from one division to the other is fairly common practice.

We did more of it this year simply because we got off to a slow start in Electronic Systems and anytime you can move experienced people from one division to the next it’s going to make a lot of difference in terms of their productivity and their quality and their ability to hit the production floor running. So it’s a good thing for the Flow Controls division but it’s also good for Electronic Systems because they maintain that core manufacturing base that they’re going to need later in the year.

In terms of some of the other things we’re doing in Electronic Systems, we’re consolidating some facilities, we’re improving some processes and procedures, we’re right sizing the organization, we’re putting it in the shape it needs to be to be successful and we fully intend for it to be successful in the quarters ahead and certainly in the years ahead. So it’s going through a bump right now and we’ve had that happen in other divisions and we’ll get this turned around too.

Jeff Evanson – Dougherty & Co.

One thing I just want to clarify, you made some comments about new distribution in Engineered Films, I didn’t quite catch that, what are you doing on that front?

Ron Moquist

Well the type of people that are going to be interest in things like radon barriers, they’re going to be that new breed that’s out there, and you can’t pick up a magazine or a newspaper today without reading some article about green construction, lead type of building where you’re lead certified as a green building, you can’t pick up a magazine or a construction publication without talking, hearing about healthy homes and how important that is.

So the green movement, the healthy homes movement, the people that are playing in that area, the distributors, the architects, they’re not typical people we deal with which would be more lumber yards, general contractors, that type. And so we’re finding that we have to target a new group of people, people that are on the cutting edge and want to be differentiated and want to be part of that movement.

They’re more susceptible to new ideas. I think as it becomes more commonplace that radon barriers in this part of the world at least will be kind of a standard product. Then it’ll start moving into the more standard distribution. But to start off with, you’re going to have to find people that are interested in those things.

Jeff Evanson – Dougherty & Co.

And you’re starting to build that even in Q1 here or?

Ron Moquist

Yes, we’re already starting to build that and we’ve got one large shipment already of radon barrier that’s gone out. We’ve had one very large shipment of methyl bromide barrier that’s gone out.

And we’ve got a lot of interest, we were just at a show, homebuilder show which had a green orientation to it and we had a tremendous amount of interest on the part of architects and contractors. So the interest is there, they know we’ve got a good product, they know they need it and they know it’s something that can make them a little different than their competitors.

Operator

We have no other questions at this time.

Ron Moquist

Thank you all for joining us today. We’ve got our annual meeting this Wednesday morning, we look forward to seeing you there and so have a good day everyone. Thanks for joining us.

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