Raven Industries, Inc. F3Q10 (Qtr End 10/31/09) Earnings Call Transcript

| About: Raven Industries, (RAVN)
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Raven Industries, Inc. (NASDAQ:RAVN) Q3 2010 Earnings Call November 19, 2009 3:00 PM ET


Ron Moquist – President & CEO

Tom Iacarella – VP & CFO

Dan Rykhus – EVP

Leslie Loyet – IR Financial Relations Board


Jeff Evanson - Dougherty & Company

John Rankin - Boranco Management


Welcome to the Raven Industries third quarter 2010 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Leslie Loyet of the Financial Relations Board. Please go ahead.

Leslie Loyet

I’d like to thank everyone for joining us today. Earlier in the day, we sent out a press release, outlining the results for the third quarter of fiscal 2010. If anyone has not received the release, please visit Raven’s website at www.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.

Management will provide an overview of the quarter and then we’ll open the call up to your questions. Before we begin, we’d like to remind participants that the information contained in this call is current only as of the day of the call, November 19, 2009 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.

At this point, I’d like to turn the call over to Ron for his opening comments. Please go ahead.

Ron Moquist

Okay thanks Leslie, and thank you all for joining our third quarter conference call. As Leslie mentioned we released our third quarter results this morning and you all should have received a copy of those.

Overall I think Raven is performing at a high level and although I’m not at all bullish on the American economy and the prospects for a quick turnaround, I do feel that Raven has some unique opportunities to grow and be profitable in a bad economy and that’s because of our diversification and our ability to stay flexible and invest in those businesses that show the most promise and potential for growth.

Last quarter I said that our third quarter might be the toughest on a year over year basis but not significantly worse then our first six months and that’s how it turned out. Sales were down 20% and net income was down 13% for the quarter and I think any time net income drops percentage wise less then the sales drop, you’re operating pretty efficiently.

In manufacturing net income usually drops at least twice as much as the sales drop. This is my 37th conference call and I have two more to go before my retirement at the August, 2010 Raven Board Meeting and its clear to me that transparency and how we make the numbers and what’s in the balance sheet plus some insight as to how we’re thinking about our future prospects and performance make these calls worthwhile.

Plus the Q&A is always the best part of the meeting. Analyst meetings used to be just that, for analysts. Now the audience is competitors, suppliers, customers, employees, shareholders, and anybody who just wants to listen in and I suppose that’s made these things a little more structured and cautious plus the effects of the Sarbanes Oxley Act.

I know when I first became CEO I did these things without notes and that wouldn’t work today although it would probably be a lot more fun and probably more interesting for all of you. Some people think that I try to dampen expectations during these calls and actually I tell you exactly what I’m thinking and investors take it from there.

But I think Raven stock has never been our thing, making money, growing the business is what matters and I think we do that fairly well. Well let’s get started with our applied technology division, their third quarter was pretty much within expectations.

Sales were down 19% and operating income was off 15% on a year over year basis. Not great, but consistent with or maybe a little better then what we were seeing in the overall ag market and it shows again that we’re controlling our costs.

All overhead in the division has been cut except R&D which has stayed level. We kicked off our program to sell a limited number of our precision products through John Deere and that was launched in the third quarter but its really just starting and hasn’t contributed anything to the bottom line at this point.

But its an important program for us because it gives us access to a large number of Deere dealers and Deere customers and that allows us to expand our market reach. And I think you all know by now that we acquired Ranchview, a small start up company in Canada for cash up front and a cash earn out on the back end.

They’ve developed a product that uses cellular networks instead of radio systems to deliver real time kinematic, or RTK corrections to GPS appliances. I want to emphasize that this technology does not process RTK corrections, its simply transmitting those corrections through cellular networks.

So what’s the value proposition, for the dealer who’s setting up the network for growers, there is lower base station start up costs then with radio towers. It also gives you greater range. The signals transmitted can carry 30 to 50 miles versus the six to 10 miles with existing towers. Which again, cuts the investment in transmission and receiving towers.

And the system can provide in cab, high speed internet connectivity which is limited in competitive technologies. Its proven technology but new to this market so we have some missionary selling work to do but we just felt that it was a potential game changer for us with a high upside and it’s a great fit with our plan to improve the movement and use of data in the field and to generate great earnings from software and service sales. And we expect it to contribute to earnings in our next fiscal year.

Another investment we just announced this morning, I hope you’ve got a copy of that press release is that we took a minority equity position in a company called SST Software. SST is a 15-year old privately held agricultural software development and information services provider that specializes in site specific field mapping applications.

The SST AgX platform is a standardized data structure and reference data base that enables efficient in field record keeping and seamless communication with Raven’s Viper Pro and Envisio Pro field computers. So why the need to take a minority equity position when we already had a strategic alliance with SST.

The answer lies in establishing permanence to the relationship and enhancing cooperative new product development. This was not a financial investment but a strategic move to again strengthen and expand our position in providing software, data, and service solutions to growers plus selling more of our in cab field computers.

We see a lot of opportunities in this ag market in spite of the decline in sales and profits this year. Besides our investments in Ranchview and SST, we continue to expand our international sales especially in Europe, Russia, and South America to invest in new product development specifically in precision planting and harvesting technologies, and in the storage transfer analysis of data.

And we continue to build new relationships with large OEMs and will be announcing some of those soon that give us a larger worldwide footprint. Let me move on to the engineered films division which had a better then expected third quarter with sales down 30% and operating income down 18% year over year.

Another example of mitigating the sales drop with cost controls and productivity improvements, last year’s third quarter was pretty strong so the comparisons are not good but when you take into account that our largest market, energy, is down over 50% and our other big market, construction, is down 30% for the year, we’re holding up as well as can be expected and these two markets, energy and construction, have historically made up 80% of our business, so the impact they have when they’re down, that substantially is dramatic.

I’ve always said that the magic number for us in the energy market is oil at $60.00 a barrel or better and that no longer holds true. In fact oil is close to $80.00 a barrel and that’s because of volatility and uncertainty about whether the dollar will remain weak and oil prices remain high and because of that a lot of oil and gas rigs have been kept on the sidelines.

About half of them have been mothballed from the go go days of a year or two ago when oil prices peaked. The third quarter results look a lot better when you take into account that raw material costs have gone from about $0.50 a pound to $0.62 a pound since the beginning of the year.

And these materials make up 60% of the cost of sales, so they’re hard to overcome. So we’re not getting the benefit of cheap raw materials as we did in the first half of the year. The suppliers have simply shut down capacity or shipped it overseas rather then sell plastic at or near cost in the United States.

A new supplier in Saudi Arabia is coming on line and has come on line with a lot of capacity so we’ll see if that changes the pricing models for resin. The only market that is holding up is geo membranes and these are heavy duty tarps that are used to cap and line landfills and to line and cover water canals and reservoirs.

And this is still a relatively small market for us but one that has the most growth potential and where we are putting a lot of our R&D investment. I spent a lot of time last quarter talking about engineered films so I think you understand that its one of our toughest businesses right now.

When you have 80% of your sales in the energy and construction markets, you can’t avoid a major downturn. There isn’t much new to report this quarter other then we continue to squeeze costs, develop new products like our silage covers and geo membranes which are gaining in market acceptance.

We’re converting some of our sales force to a more technical and engineering orientation and we’re even buying new equipment if it can get us a return on investment. I know that sounds somewhat counter intuitive when you’re operating at less then 70% of capacity but you really can’t get defensive worrying about some costs.

If you spot an opportunity and you have the cash to invest, which we do, then you have to go forward and we’re being selective in our CapEx but we’re not going to shut off the spigot. Right now we’re investing in geo membrane technology and equipment to make our product even better.

Its not going as fast as I’d like but we’re taking our commodity type plastic sheeting and converting to a more highly engineered product which has qualities that justify a higher price. And that quality may be a gas barrier or a UV inhibitor or a special texturing. For the customer there has to be a value proposition that justifies the higher price.

For Raven its about using our financial and technical strengths to separate us from the crowd of commodity extruders and that’s the strategy that drives everything we do in this division. Differentiate the product, and replace commodity films.

The hurricane season coming to a close without much activity in the US and that’s good news for Americans but it means we won’t be selling any disaster film for the second straight year. Our electronics systems division had a weak third quarter compared to last year and the first two quarters of this year and there were really three main reasons for that.

Lower sales volume, a supply chain breakdown, and a poor product mix and these three issues together dropped operating income by about $1.2 million. Sales slowed down in our avionics product line because of a reduction in aircraft shipments. There was also a breakdown in the supply chain in the product line.

A number of avionics components can only be sourced from a very small supplier base so when these parts are in short supply or are rejected by our quality inspectors, deliveries suffer and because of problems in both of these areas, we incurred $500,000 in costs in expediting, testing, and rework.

All of these avionics products are built to the highest reliability standards so any marginal parts will cause a high rejection rate. We’ve not had this problem before and believe its been corrected and there won’t be any additional write-offs in the fourth quarter.

Avionics is 60% of our total sales in electronics systems so anything affecting that segment has a big effect on bottom line results. Sales and profits in our other two major product areas, secured communications for the military and government, and wireless hand held bed controls were close to budget.

Contract manufacturing is a tough business and there is no margin for error. I’ve been concerned about breaks in the supply chain for the past year and its finally caught us. We’ve tightened up our processes but it demonstrates once again how globally inner connected we all are.

Suppliers nine thousand miles away can bring production to a halt and can do harm to your income statement and reputation. You can’t monitor every supplier and that’s one of the down sides to global outsourcing. Standards in China are not the same as standards in the US so there’s a lot more incoming inspection with those parts.

But its been a great year so far for our electronics systems division and operating income year to date is still almost double what it was last year. Aerostar’s third quarter results were pretty much a repeat of the first and second quarters with sales up 9% and operating income up 38% and those results came despite shipping virtually no parachutes in October.

And we’ll be doubling up parachute shipments in November to catch up. Aerostar is still a small part of Raven’s total sales and operating income, 10% and 9% respectively, but they’ve come a long way and they have a lot of runway ahead of them.

We are coming to an end on the MC-6 parachute contract and we’ll be transitioning into the new T-11 parachute which will start shipping by the beginning of next fiscal year. The timing was just about perfect but margins on the new contract will start low and then ramp up as they always do, but at a much faster rate then the first contract four years ago where we had a steep learning curve.

We’ve learned a lot in those four years about how to build parachutes. One negative in the third quarter for Aerostar was the cancellation of the test flight of the high sentinel steerable airship. We had high hopes for a successful flight but weather related issues and government red tape kept the airship grounded.

And our next opportunity to fly won’t come for another four to six months. We still are optimistic about this product because the military tells us that there’s a definite need for a high altitude airship that can stay parked in a fixed area and can provide persistent or continuous surveillance. UAVs or drones don’t give the military that persistent surveillance they’re looking for.

Our disappointment with the scrubbed flight of high sentinel was partially offset by the successes we’re having with our tethered aerostats. These aerostats or blimps also give our military a persistent presence in the sky but at a much lower altitude of one to 3,000 feet versus 60,000 for high sentinel and we’ve received aerostat sales orders for almost $2 million for shipment in the fourth quarter and the prospects for follow on orders are very promising.

Parachutes, airships, aerostats, high altitude research balloons, these are the four areas where we are concentrating our efforts at Aerostar. All of them have good prospects for the foreseeable future and will be our main growth drivers.

I’m spending more time on Aerostar in these meetings lately because its an operation to watch. Its an operation that we think has good growth potential. So overall for the company it was an okay third quarter with income down 13%. The same percentage we were down for the first six months.

Well let’s move on to the balance sheet, our current ratio is an extremely strong 4.8 and cash balances are at $46 million, up $3 million from the end of the second quarter. Our cash at the end of last year’s third quarter was $31 million but that was just before we paid out a special dividend of $22.5 million.

Cash as percent of total assets is 28% which is the highest that ratio has ever gone and that’s with no debt. I’m not uncomfortable holding that amount of cash, but if it goes to $60 million, we’d probably start thinking about giving some of it back to shareholders. Its an unproductive use of capital because it generates virtually no return but it’s a great safety net and it has become a strong sales and marketing tool to use against some of our weaker competitors and the cash also gives us a lot of flexibility to move quickly when the right opportunity comes along.

Ranchview and SST are two examples of small but important deals that strengthen our position in key markets. These two deals didn’t close until November so they didn’t affect the cash balance in the third quarter and with a total upfront out lay for both of them of only $6.5 million, it won’t materially effect our cash position next quarter.

We didn’t purchase any of our stock in the third quarter and have no plans to do so in the fourth quarter. Our total capital expenditures will only be $3 to $4 million this fiscal year versus $8 million last year and next year it could go back up to possibly $7 million, maybe a little higher, depending on how fast Aerostar grows.

Our inventory turns are up from last year and our accounts receivable turns are also improving. That’s a good sign when credit worthiness is such a big issue these days. We’ve really stayed on top of our working capital this year.

On the acquisition front, there is nothing else currently in the pipeline but as the third quarter demonstrated we can move quickly when the right opportunities come along. Our strategy has never been to grow through acquisitions and it still isn’t, but we’re always open to strategic investments which build on the strengths of our four operating units.

Like most companies we have over capacity at Raven but its lumpy. We have capacity constraints in Aerostar, and some parts of electronic systems and we of course have excess capacity in engineered films and to a lesser extent, in applied technology.

We’re transferring building space and workers from one division to another when it can be done. From a macroeconomic standpoint there are economists who think the recession has bottomed out and we’re poised for growth, others think that it will be a slow and painful recovery.

I guess I’m in the slow and painful camp and I say painful because I think unemployment will stay high for at least two years and maybe a lot longer. Because of cheap money and rising asset values our economy over [built], over bought, and over borrowed. And pulled trillions of dollars of future consumption into the present and now all of that excess spending and excess capacity has to be wrung out of the system.

And it seems to me the only corporation borrowing and spending right now is the government and that’s not productive investment. China is investing but in unneeded capacity and that could spark a trade war. But even in a poor economy there can be rich opportunities and that’s why I feel good about Raven’s prospects and our ability to grow and outperform the economy.

Looking to the future I think we’ll see a relatively flat or slightly better performance in the fourth quarter on a year over year basis. And that’s mainly because last year’s fourth quarter was so weak when we only earned $0.26 a share so the comparisons are easier.

Engineered films in particular has an easy comparison because they lost money in the last year’s fourth quarter. So engineered films should easily beat last year’s fourth quarter numbers. Electronic systems may have the toughest comparison in the fourth quarter, they had a very strong performance last year but now some of our customers want to keep inventories low through the end of this year so we’ll be most likely down in this division.

Our applied technology division should be about flat or slightly up with last year’s fourth quarter. The flow of new orders has slowed down but they also slowed down last year by this date. And Aerostar should come in pretty close to the big fourth quarter we had last year. Income could be down just slightly.

So the full year will be down in earnings but percentage wise, in very low double-digits. And that will be our first non-record year since fiscal 2001. Next year is still in the planning stages but we definitely feel like we can improve earnings and get back on a growth track and with that I’ll open it up to questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Jeff Evanson - Dougherty & Company

Jeff Evanson - Dougherty & Company

Thanks for the candid commentary as always and the straightforward thinking in business management. Could you talk a little bit about how much Ranchview and SST could add to, how I guess Ranchview is the way to look at it, what that could add to revenues and expenses next year and then maybe chat a little bit about how SST is going to show up on the income statement, as to a minority interest line item.

Dan Rykhus

As Ron mentioned we believe Ranchview will be accretive to earnings next year and to get there we expect that we’ll sell an additional $5 to $7 million in additional sales next year as a result of the Ranchview acquisition. Expenses are going to be minimal so we expect a strong profit contribution from Ranchview for next year.

Jeff Evanson - Dougherty & Company

Should have the same seasonality as the rest of your ag related business right.

Dan Rykhus


Jeff Evanson - Dougherty & Company

And how about SST.

Dan Rykhus

SST is going to be a longer curve. We’re really going to realize our return on investment through the sale of additional field computers and we’ll expect to see some impact next year from that, but that’ll be harder to measure and a longer curve. It really, there’s a lot more additional intangible contributions from that investment as well.

Jeff Evanson - Dougherty & Company

I think it might be helpful to just get your words on kind of the strategy here. May be some people understand it, may be some not so much. Obviously typical RTK signal needs to be delivered by a network of towers. This is a way to ride the cellular infrastructure so I’m assuming you think this can help drive adoption and lower subscription costs for your customers, is that kind of what you’re thinking here.

Dan Rykhus

That’s true, I think Ron outlined the value propositions well. The up front base station cost and the Ranchview solution is substantially lower then the traditional RTK tower investment. The base lines are substantially longer and that allows for easier entry from a cost standpoint but also a simplicity of set up is much improved with this cellular approach.

But the real, beyond that, we think that we’re going to sell a lot of our products as a result of those value propositions but beyond that, the fact that each cab ends up with a high speed modem in the cab really complements our overall information strategy as we go forward. That allows us to move that information back through our server and serve up the corrections but also be able to store and serve up other operational data that our users collect.

Jeff Evanson - Dougherty & Company

A lot of expensibility there, that sounds good. And how about the accounting treatment for SST.

Tom Iacarella

As Dan indicated the returns on SST as we see it certainly over the short-term will be in additional sales of our own products. And—

Jeff Evanson - Dougherty & Company

But we have to break out a line item for a minority interest there or something.

Tom Iacarella

Yes, but I don’t think that’s going to be a real significant item on our income statement going forward. It will not be a consolidated entity we don’t expect and it will essentially be an investment on our balance sheet and then we’ll get a percentage of their income running through our income statement essentially as a new line item or part of other income and expense.

Jeff Evanson - Dougherty & Company

But that should be a very modest drag on operating income for the next fiscal year.

Tom Iacarella

I don’t think it will have a major impact either way.

Jeff Evanson - Dougherty & Company

And then very quickly on electronic systems, the supply chain issues, did that lead to any revenue miss in the quarter relative to your expectations.

Ron Moquist

Yes it did, I think the number was $2.4 million as I recall that got deferred because of delays and that $2.4 of course would have contributed additional margin.

Jeff Evanson - Dougherty & Company

So its delayed, can you make it up in one quarter or is it gone for good.

Ron Moquist

Its not gone at all, no, we will make it up. Whether we make it up all in this month or not, we’ll certainly make it all up in the quarter.

Tom Iacarella

I think that number is a little high, I think the actual revenue losses were more in the million dollar range related specifically to this issue.


Your next question comes from the line of John Rankin - Boranco Management

John Rankin - Boranco Management

Two questions here, first of all maybe a little more discussion on the lack of share buyback. If I understood correctly there’ll be 40 million on the books. Is your focus going to be to prepare for a special distribution or do you want to keep the cash for acquisitions even though you said that you didn’t see anything on the horizon, I would think there have been times that Raven, the share price reflected a really good value. That would be the first question. Question number two, on your color on not terribly optimistic on the US economy, a pseudo competitor of yours shared that same lack of optimism and they made the statement that within five years 40% of their revenues would be in China. I wonder if has there been any thoughts around the table to attempt to penetrate the Asian market more then you are if indeed our domestic economy is going to be soft the next few years.

Ron Moquist

The first question on the stock buyback and we used to do stock buybacks at a different time under different conditions. My feeling is its not so much an issue of trying to guess what the value should be, that’s not my job as to guess value. I always look at it in terms of where’s the best place to deploy that cash and always its for internal investment if you have enough opportunities to invest internally.

At this time, at this moment in time, we have more cash then we have opportunities and that’s unfortunate but that’s just the way it is and so we look at some of the other options. One is to keep the money on the balance sheet just to make sure that we’re always rock solid and there aren’t any glitches and so I don’t mind to have a little bit extra on the balance sheet.

It gives us flexibility, it gives our customers and our suppliers a lot of confidence and then I think at some point if it builds up too high a level, we’ve done it before, we did it last year. I don’t mind paying a special dividend and with capital gains still at 15% I don’t suspect they’re going to stay there long, the way things are going.

It might be a time to distribute that cash in the form of a special dividend. I’m not prepared to say that today but six months from now, a year from now, we certainly will be revisiting that whole subject. On the issue of China, contract electronics of course has no particular value to the Chinese. They do more contract and manufacturing then anybody in the world so that’s not going to work.

Aerostar with their blimps and airships might have some interest. Agricultural will be the one that potentially could have the most interest but they’re right in the middle right now in China of aggregating land. Their land usage is so broken up and chopped up that I think I heard once that the average size of farmer’s holdings was less then one acre.

Well you don’t use precision ag equipment when you’re farming like that, you’re using sticks and hoes and machetes and so until the Chinese figure out how to aggregate land into large farms and they’re doing that now, and they’re trying to put that together, until that’s complete there won’t be a place for our type of equipment.

When that is complete then we’ll look to moving some of our ag equipment over there, but as of now we’re looking at Russia, we’re looking of course at Europe and East Europe. We’re looking at South America, Canada, Australia are very strong markets for us. And those are the places that we’re putting out attention now. China at some future date could be a possibility but it isn’t today. Its not on the radar for us as of today.


There appear to be no further questions at this time, I’d like to turn the call to Mr. Moquist for any additional or closing comments.

Ron Moquist

Thanks for joining us today. Its been a tough year and one that tested our business model and management philosophy and I think we’ve come out of it in good shape. We held market share and in some places grew it. We are able to hold on to our profit margins and in fact our after tax margins year to date are 12.5% versus 11.9% year to date last year.

So we’ve done well in that area. We introduced some new products and didn’t cut R&D and we generated a lot of cash. We went conservative operationally but we stayed aggressive in the market and I’m really pleased with the way we’ve positioned Aerostar for the future and we’re not waiting for economic recovery.

I think that’s going to be a long wait. That’s going to take too long. We’re playing on offence now and we’re going for growth. We’ll talk to you again, I guess it won’t be until March, so good luck everybody. Thanks.

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