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Raven Industries, Inc. (NASDAQ:RAVN)

F2Q13 Earnings Call

August 21, 2012 10:00 am ET

Executives

Dan Rykhus – President & Chief Executive Officer

Thom Iacarella – Chief Financial Officer

Analysts

Andrea James – Dougherty & Company

Andrew O’Connor – Harris Investments

Operator

Good day, ladies and gentlemen, and welcome to Raven Industries’ F2Q 2013 Earnings Conference Call. (Operator instructions.) As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mr. Thom Iacarella, Chief Financial Officer. Sir, you may begin.

Thom Iacarella

Thank you, Operator. Joining me on today’s call is Dan Rykhus, Raven’s President and Chief Executive Officer. Before we begin we’d like to remind participants that the information contained in this call is current only as of today, August 21, 2012. The company assumes no obligation to update any statements including forward-looking statements. Statements that are not historical facts are forward-looking statements and subject to the Safe Harbor disclaimer in today’s press release. With that, I would now like to introduce Dan for a strategic look at Raven’s F2Q.

Dan Rykhus

Thanks, Thom, and welcome everyone to our first F2Q conference call. I’ll start off with an overview of our performance then talk about each of our divisions in more detail, and finally speak to our expectations going forward. Thom will then provide you with a look at our financials, including a discussion of margins and the balance sheet. After that we’ll open up the call for your questions.

Let’s begin with our F2Q performance. The top line trends we saw in F1Q continued in F2Q with sales rising 13% to $101.7 million from the record $90.3 million in the prior year period. Revenue growth was driven by strength in the Engineered Films and Applied Technology Divisions, along with the addition of Vista Research revenues in Aerostar.

We continue to benefit from favorable market dynamics in agriculture and energy and we’re leveraging these trends to drive revenue gains in Engineered Films and Applied Technology. Sales in these divisions continued at a record pace in F2Q. Even though a difficult federal spending environment existed and negatively impacted Aerostar’s performance we delivered a strong first half. The ability to do so once again highlights Raven’s diversified model.

We remain steadfast in our commitments, helping customers solve great challenges in the areas of hunger, safety, environmental protection, and energy independence. As customer needs evolve and market dynamics vary, we embrace change and have the flexibility to shift our operational focus and innovative drive to succeed as a business.

Our ability to meet these challenges and aggressively expand and pursue new opportunities requires important capital investments. During F2Q we spent $15.5 million to support our ambitious F2013 product and growth strategy. Despite these investments we were still able to deliver a solid performance and Thom will talk more about our research & development and SG&A later.

To fund future growth, increase our dividend each year and maintain a low debt balance sheet we rely on our strong cash flows, a trademark of the Raven model. I’m pleased to report that our cash balance at the end of F2Q stood at $44.1 million. This was up slightly from the end of F1Q and includes capital spending that was up 53% from the prior year.

I’d now like to talk about each of our three divisions, starting with Engineered Films. As you saw in the release, this division’s sales were up 13% and accounted for 36% of total F2Q sales. Net income rose 29%. Both sales and operating income came in at record levels. We continue to see solid, sustainable growth in the energy and ag markets. Energy currently comprises about 40% of our EFD revenues and that’s lower than our recent historical levels which had approached 50%, and we see this as a positive trend.

As our ag and geo membrane businesses continue to grow we expect to move to an even more diversified base. Deliveries of geo membrane films for environmental protection were particularly strong in F2Q, stemming from a reservoir project that we recently completed in Ohio. We anticipate that geo membrane films will be a rising part of our market mix for this division due to the critical need to protect water and environmental resources.

Within Engineered Films we’re committed to further enhancing margins and profitability, and we’re accomplishing this by reducing scrap, improving operating efficiencies and implementing a strong pricing policy. While plant utilization rates continue to rise according to plan, we do have extrusion capacity to further grow this business which we intend to do through R&D investments in new growth opportunities as well as enhancements to our existing product line.

Moving on to Applied Technology, sales grew 13% compared to the same period last year. This was another record and accounted for 39% of total sales. However, operating income was down 2% due to the relatively higher sales of lower margin products and an increased investment in research, marketing, and product development. As you may recall, our F2Q 2012 results were over 100% increase in operating income, which made a very challenging comparable period for the current year F2Q.

As I talked about last quarter, we announced the realignment of our Electronic Systems Division. I’m pleased to report that the realignment is complete. As a result, approximately 75% of Electronics Systems sales went to Aerostar in F2Q and the balance to Applied Technologies. All sales and operating income amounts we talk about on today’s call reflect the realignment for current and prior periods.

International sales in ATD remained robust in F2Q, comprising 27% of division revenues. We saw particular strength in Brazil and Canada. As nations evolve their agricultural practices they’re rapidly adopting our advanced guided steering systems that enhance farm yields and reduce operating costs. Domestically we remain in a strong agricultural market and sales of guided steering systems, field computers, and application controls reflect that.

One thing I do want to touch on domestically is this season’s ongoing drought. While this is very difficult for growers in certain regions as their yields are adversely impacted, we continue to see strong demand from our OEMs. Distributors are still optimistic about the overall market but are becoming cautious in some regions. The general tone we hear is that a single-year drought will be mitigated by prior year successes and a strong crop insurance system. A multi-year drought in the US would begin to have a more dramatic impact on our business.

Moving to the OEM front, we continue to cultivate and deepen relationships with key OEM partners. This expands market share and extends Raven’s technology to a broader range of manufacturers and their dealers. Our work with John Deere continues to ramp and we remain strong with partners AGCO and Case. We also continue to collaborate with Monsanto to reach US growers and help them improve yields.

Looking at product developments, we introduced Smartrax 6 during F2Q. This is the newest version of Applied Technologies’ auto-steering package which continues to improve online steering performance and simplifies the initial calibration process. Steering kits for Smartrax 6 will work on more than 300 tractors and machine models.

We’re committed to further product development in F2013. To that end we recently held the Raven Innovations Summit at our Innovation Campus near Baltic, South Dakota. This 190-acre state of the art research center is dedicated to precision agriculture. In addition to sharing our latest product advances with hundreds of customers throughout the week we were able to get their feedback and input, and this kind of information is invaluable as we work to develop next generation products.

Finally, let’s look at Aerostar. Sales in F2Q were up 15% and comprised 25% of total sales, however that figure is a bit misleading as most of the increase came from the addition of Vista Research revenues and an increase in electronics systems sales. From an operating income standpoint, Aerostar declined 32% year-over-year.

As we noted in the press release, Aerostar does have breakout potential and we’ve seen that in the past. However, it is also subject to significant variability due to federal spending and that’s what happened in F1Q and again in F2Q as a lack of Aerostar orders impacted potential top and bottom line gains. Quite frankly, Aerostar is not where we need it to be right now.

Though we continue to manage the short term responsibly, carefully controlling discretionary spending, staffing levels and R&D, we’re also developing opportunities to add stability and mitigate volatility in the business, and ultimately generate longer-term growth. To that end I’m pleased to report that we’ve had some recent success. At the end of F2Q, Vista Research signed a $6 million contract with the US government to support and further explore applications of Vista’s radar technology. Through Vista we’re also working on a number of other initiatives that would broaden our customer base. We see significant future potential with Vista, both here and overseas as we work to fill in the new markets.

An additional highlight for Aerostar is the continued solid performance of our parachute, protective wear and high-altitude balloon product lines. During the first half, revenues for these product lines are up 20%.

Finally, as a company Raven is committed to enhancing shareholder value. During the quarter our Board of Directors voted to initiate a stock split. This makes Raven’s shares more accessible, broadens our shareholder base and increases market liquidity. The split reflects our collective belief in the company’s long-term growth strategy and commitment to shareholders.

Looking ahead to the remainder of the year, we continue to see positive trends in Applied Technology and Engineered Films. For the near term, Aerostar will continued to be impacted by order variability. We’re looking to mitigate that with new customer initiatives that will expand the use of persistent surveillance technologies to border and other non-military applications.

For the company overall we continue to believe that we can reach our long-term target of 10% to 15% earnings growth. Given the year-to-date performance from Aerostar and the challenging near-term outlook for Aerostar, reaching this long-term goal will be difficult in the current year but not impossible. We’re focused on leveraging our market position, technology and differentiated products to build sales and income.

Moreover, we’re continuing to invest for the long term, expanding both our base of fixed assets and portfolio of product lines. You can also expect to see us continue to allocate resources to adjacent product line expansions. We will continue to look for acquisitions to support our overall product and growth strategy. And finally, our financial performance and attractive balance sheet will facilitate investment in our expected $35 million capital budget that we have for this fiscal year as well as growth in our dividend.

Now I’ll turn the call over to Thom and after that we’ll be glad to take your questions.

Thom Iacarella

Thanks, Dan. Hopefully all of you had a chance to review this morning’s release. I will discuss our balance sheet changes and operating margins in more depth, and then as Dan said we’ll take questions.

First the balance sheet: at quarter end we had $44.1 million of cash and investments. While that’s down $2.9 million from last April it’s still very strong, $18.3 million more than the January 31 balance. We’ve been able to sustain our cash position despite investments in production capacity, research & development, and Vista Research. We paid $12 million to purchase Vista and paid off their short-term borrowing immediately after closing in January.

First half operating cash flows were $44.5 million compared to $26.2 million last year. The $18 million increase was driven by improved working capital utilization relative to sales growth and our higher profits in the first half. Inventories were relatively unchanged from the previous July. With sales up 13% over last year’s F2Q inventory turns have actually improved slightly over the last three months.

Accounts receivable was up $6.6 million over last July and DSO has been consistent with last year, reflecting higher sales levels. Our current ratio was 4.23 versus 4.04 in F2012. Our balance sheet and cash flows from operations provide a strong source for investment funding and dividend growth.

Now I’ll cover capital spending. As we’ve indicated previously we expect capital spending to increase as we continued to invest in our businesses’ growth and it rose by about $6 million in the first half of the year. In F1Q we invested in expanding our Engineered Films footprint as well as our corporate facility’s renovation project in Sioux Falls. We also started building out our state of the art research center for Applied Technology in Austin, Texas.

These projects continue and Applied Technology recently moved into the first converted space in our headquarters building. We are also enhancing our capabilities to more efficiently process plastic resin within our Industrial Park facilities and are utilizing our recently-expanded Innovation Campus north of Sioux Falls.

Turning to SG&A and R&D, we continued to invest in our research & development capabilities and corporate finance, information technology, and human resource developments to lay the foundation for long-term growth. Spending in all these areas continues to increase over the prior year. Substantially all the F2Q increase in R&D was in the Applied Technology and Engineered Films Divisions. We’re investing in the growth pipelines they require for future success.

We believe the historically low level of corporate support has been at times a growth constraint to our divisional initiatives. We continue to see the need to bring on new talent. Examples include resources to help us move forward on key competitive elements, identify and integrate acquisitions, find new talent and improve the service level of our information technology.

We are committed to maintain the current allocation of growth investments, but given the more modest growth we are now seeing we are critically reviewing spend levels as we look at the opportunities ahead of us. We are adjusting our plan to actively improve long-term prospects while we look to mitigate the impact on our shorter-term operating results.

Now I’ll cover operating margins. Remember, we realigned Electronics Systems assets and people during the quarter and the new segment information reflects that move. Within ATD margins were 32.2% versus 37.3% in F2Q 2012. F2Q is ADT’s seasonal low point and margins can fluctuate as a result. For example, two years ago F2Q operating margins were 26.2%.

While we saw the impact of higher investments in engineering, sales and research & development, gross profit rates were also affected by the relatively higher sales of our lower margin products in the quarter. Without getting into too much detail, products that have been in our product line for a long time and products in markets where we are trying to build market share carry somewhat lower gross profit rates.

In EFD, Engineered Films, margins were 18.5% compared to 16.3% in F2012. Margins were weak for the first three quarters of last year due to higher resin prices we could not pass through to customers. We moved from 13.7% in F1Q last year to the 16.0% range in the middle of the year, to 18.0% in F4Q. We did retreat a bit from the 22% we saw in F1Q this year as lower demand, pricing and production levels affected margins.

Within EFD, we improved plant productivity and operating efficiency. Compared with F2Q last year, pounds extruded increased about 9%, nearly reaching 19 million. We expect growth to continue throughout the year. F2Q operating margins for our Aerostar Division were 8.6% versus 14.5% in the prior year. We’re seeing the impact of a lack of Aerostat sales as a result. Proprietary products carry higher gross margins than our EMS business and Vista services revenue.

As Dan talked about, our parachute and high-altitude balloon operations continue to perform well. The EMS business gained from ESD was also strong, adding about $13.0 million to Aerostar’s sales for the quarter versus $12.5 million in F2Q last year. Vista Research’s new contract should help us to continue to cover its costs, but we recognize we need additional contractual funding to maintain our initiatives in the area of persistent surveillance.

Looking at our overall results, F2Q sales were up 13% to a record level while profits decreased 7% due to the factors that we’ve discussed. Net income return on sales was 11.4% for the quarter compared to 13.8% last year. The profit impact of the higher sales was offset by an overall lower gross profit rate and higher investment spending on research, business acquisition support and other new business initiatives.

We continue to look hard at new spending as we move through the second half of the year and balance that spending with the opportunity to move our growth initiatives forward. With that I would like to turn the call back to the operator so we can take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions.) Our first question comes from Andrea James of Dougherty & Company.

Andrea James – Dougherty & Company

Good morning and thank you for taking my questions. For Engineered Films, can you talk a little bit about the energy market? If you were to isolate the energy market contribution to that segment is that trending up or down year-over-year?

Dan Rykhus

The total concentration in energy is trending down and that is as I said in my comments that’s a good sign as far as we’re concerned. We were approaching a 50% concentration in that segment, and even though we’re showing growth in energy still we were able to reduce it as an overall component. It’s somewhere in the low 40%’s right now I believe and that’s good as long as we’re growing geo membrane, ag and industrial to lower that concentration.

Andrea James – Dougherty & Company

Thanks for that clarification there. And then can you talk about the Goodrich customer? It’s a major customer and do you think the United Technologies acquisition will affect their reliance on you guys as a manufacturer?

Dan Rykhus

Our business with Goodrich has been declining and that’s been a planned event over a multi-year schedule, and so they’re looking to reduce their dependence on us. We’ve become a pretty large supplier in their electronic controls business so I don’t think it has anything to do with an acquisition but more of a choice to be less reliant on us. So our challenge has been to replace that EMS business and we’ve been busy growing with our other existing customers as well as onboarding a few new customers that we’re looking forward to.

Operator

Thank you. Our next question comes from Andrew O’Connor with Harris Investments.

Andrew O’Connor – Harris Investments

Good morning, guys, thanks for taking my questions. I wanted to know can you further characterize Raven’s relationship or collaboration with Monsanto?

Dan Rykhus

I can give you a little bit more insight. For the last several years we have been working with Monsanto to explore different planter-related control systems and software development tools to help Monsanto deliver a more prescriptive seeding value proposition to their farmers. And really this is a continuation of that relationship, and as they take a more active role in the precision ag space we’re fortunate and feel strongly about our relationship with Monsanto that we’ve invested in.

And I can’t give you a lot more detail beyond that except to tell you that their long-term goal, to double food production on the acres that we have with less inputs, clearly aligns with our goals as a corporation. And we know that that’s a fundamental driver for agriculture and we know that technology will play a very important part in this necessity for our society to produce twice as much food over the next 35 years off a shrinking number of acres.

Andrew O’Connor – Harris Investments

Sure. So at this point can you speak to goals and timing to achieve goals with Monsanto?

Dan Rykhus

I think I’ve given about as much detail as I’m able to at this point.

Andrew O’Connor – Harris Investments

Okay, and then further to this I wanted to know if you could expand on your comment that the company is continuing to cultivate and deepen relationships with its key OEM partners. How should I interpret that? Thanks again.

Dan Rykhus

Sure. We’ve had a long relationship with AGCO and Case primarily related to their agricultural sprayer businesses and we continue to develop technologies that make their sprayers competitive in the marketplace. And the take rates on the various technologies that we deliver to that segment for those two companies continues to grow.

Our relationship with Deere I’ve talked about over the last year or two, a couple years I guess, where we are developing technologies for Deere that fill gaps for their product lines. Where they’re not interested in internal development they’re looking to a few technology partners to fill those gaps so we’ve developed a variety of products – one steering-related product that we’ve had very good success with over the last couple quarters. And we expect to be able to continue to have those kinds of opportunities going forward.

So it’s not a comprehensive product line that we’ll be delivering to Deere; it’s more opportunities here and there. But with their channel strength that they have those opportunities can be pretty fruitful for us.

Operator

Thank you. (Operator instructions.) We have a question from Andrea James from Dougherty & Company.

Andrea James – Dougherty & Company

Hi, thanks for taking my follow-up. From a modeling standpoint, when you applied the certain percentage of Electronics Systems’ revenue and cost did you equally do that both years or did you have to go back and kind of look at which products were sold last year – so it wasn’t a 75%/25% split for last year’s number? Does that make sense?

Dan Rykhus

I’m going to let Thom handle any of the disaggregation model-building questions today. Go ahead, Thom.

Thom Iacarella

Sure. Yeah, that’s fine. What we’ve done is we’ve actually segregated. We’re not doing just a straight percentage split but we are actually taking a look at the various product lines and where they’re served from, and using that to help us break down the difference between the years. So we’re trying to have an apples-to-apples comparison here, so for instance our EMS business related to Aerostar we said was around $13.2 million and it was about $12.4 million a year ago, and we’ve tried to associate the profits with that as well.

Andrea James – Dougherty & Company

Got it, thank you. And can you expand a little bit more about the $6 million Vista win and just kind of what that symbolizes? I mean you talked about it a little bit but I was just wondering if you could go into more detail about what the DOD is looking for help with there in the application.

Dan Rykhus

Sure, I can give a little bit more detail. So this is one of the DOD branches and they are evaluating and helping to refine the Vista Research radar algorithms with us to optimize them for their applications. This contract represents both unit sales as well as ongoing engineering and product development funding, and some test and evaluation funding. It’s critical to us because it gives us opportunity to continue to refine and demonstrate and establish strength in this technology in the marketplace with one of our key customers going forward.

Operator

Thank you. Our next question comes from Andrew O’Connor with Harris Investments.

Andrew O’Connor – Harris Investments

Thanks for the follow-on. Thom, I wanted to ask what is CAPEX for F2013 and are you able to take a shot at or hazard a guess at CAPEX in F2014? Thanks again.

Thom Iacarella

Sure, well we’ve been talking about the $35 million that we’ve budgeted and I think that’s probably a pretty accurate number. We’ve got a lot of projects in the works. If we were going to look forward into the future we think that that’s a pace that is probably comparable to what we’d see for the next year or two.

Operator

Thank you. I would like to hand the conference back over to Mr. Dan Rykhus for closing remarks.

Dan Rykhus

Sure. Thank you again for taking time to join us on today’s call. We are encouraged by our F2Q performance in ATD and Engineered Films and we remain focused on leveraging our market position, technology and differentiated products to build sales and income. Moreover we’re continuing to invest for the long term, expanding our base of fixed assets and building our portfolio of product lines. We look forward to updating you on our progress in the future and thanks for joining us.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes our program. You may all disconnect and have a wonderful day.

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