Nov 20, 2014
Executives
Thomas Iacarella - Vice President and Chief Financial Officer Daniel A. Rykhus - President and Chief Executive Officer
Analysts
Andrea James - Dougherty & Company LLC Robert A. Kosowsky - Sidoti & Company, LLC John K.
Rankin - Boranco Management, LLC
Operator
Good day, ladies and gentlemen, and welcome to the Raven Industries’ Third Quarter 2015 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 be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded.
I would now like to introduce your host for today’s conference, Tom Iacarella, Chief Financial Officer. You may begin.
Thomas Iacarella
Thank you, operator. Joining me on today’s call is Dan Rykhus, Raven’s President and Chief Executive Officer.
Before we begin, we would like to remind participants that the information contained in this call is current only as of today, November 20, 2014. 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 third quarter.
Daniel A. Rykhus
Thanks, Tom, and welcome everyone. I’ll start off with an overview and then talk about each of the divisions in more detail, and conclude with our expectations going forward.
Tom will then provide you with a look at our financials, including a discussion of margins in the balance sheet. And after that, we’ll open up the call for your questions.
As you can see from the new release, our performance was below where we want to be, but despite a tough quarter financially there were a number of bright spots, which I’ll talk about my comments today. Let me begin with Raven’s performance.
For the third quarter, sales were $91.3 million, sales and operating income rose in Engineered Films and Aerostar delivered operating profit increases over the prior year period. This was offset by declines in Applied Technology, which as we set is facing persistent and significant headwinds.
As we look to exits our low growth contract manufacturing business, which were size in both Applied Technology and Aerostar, we’re steadily increasing our strategic proprietary product lines as a percent of sales. These represent all the companies’ lines excluding contract manufacturing.
For the third quarter, these lines rose to 93% of total sales up from 88% in the prior year third quarter. As we anticipated, our fiscal third quarter was difficult, persistent weakness in the Ag equipment markets continue to constrain sales and net income for the corporation.
The significant challenges that we face in agriculture have given us an opportunity to rebalance the Company’s profit mix by aggressively growing our Engineered Film and Aerostar division and right sizing Applied Technology for the current conditions. This is a pivotal point in the Company’s evolution in growth, after announcing this intentional shift on the call last quarter we embarked on our rebalancing plan in the third quarter.
We’ve take into sizes steps that will help shift Applied Technologies percent of the corporation’s operating profit from 65% where it has been to approximately 50% over the next two years. Again, we will accomplish this by aggressively growing Engineered Films and Aerostar, while we strengthen Applied Technology’s existing lines of business.
Historically, we've relied heavily on profit contributions from Applied Technology, which works extremely well and the Ag market is in a growth phase. However, during prolonged down cycles, like we’re in now, our dependence on that market makes growth for the corporation very difficult.
It's imperative that we build a more diversified sales and income mix for Raven, which is true to our business model, while still maintaining a strong emphasis and commitment to precision agriculture. And that’s exactly what we’re going to do.
As evidenced, we recently announced our acquisition of Integra Plastics, a privately held company that specializes in the manufacture and conversion of specialized plastic film and sheeting. This is a great acquisition for us.
It expands our Engineered Film production capacity, broadens our product offerings and enhances Raven's current converting capabilities, giving more critical mass to our fastest growing division. As we work to transform and evolve our business to capitalize on key growth opportunities, we’re actively managing Raven to optimize our performance.
This entails narrowing our investment focus to the essential strategic initiatives that will directly fuel growth and continuing to reduce our operating expenses. In pursuit of targeted growth initiatives, we invested $9.8 million in research and development and capital expenditures during the third quarter.
These investments included Vista Research R&D, Google Project Loon R&D and ongoing new product developments for application and planter controls in Applied Technology. Given market condition we’re working diligently to balance growth investments with capital expenditure reductions.
I’ll touch on this more in a moment and Tom will talk about R&D and SG&A later in the call. As a company, we rely on our strong cash position to fund dividend growth and deliver above average returns on invested capital for our shareholders.
I’m pleased to report that our cash and investment balances at the end of the third quarter stood at $66.6 million, up from $48.6 million last year. Now I’ll talk about each of our three divisions starting with Engineered Films.
For the fiscal 2015 third quarter, sales in Engineered Films rose to $41.2 million from $40.2 million a year ago. Operating income was $5.5 million, compared to $5.2 million in the year-earlier quarter.
Driving growth were sales of Construction, Industrial and Geomembrane Films. While deliveries of energy films and barrier films for specific high-value Ag applications moderated from the relatively strong levels we saw earlier in the year.
We believe these market declines in energy and Ag were primarily a function of timing, but we are watching them closely given the recent decreases in oil prices and the ongoing Ag market conditions. Operating income rose 5% during the quarter; pricing changes, operating improvements and leveraging our reclaim production line have enabled Raven to improve margins.
We also continue work on developing and growing sales of higher-margin barrier films, as well as other lower-cost product formulations that meet customer needs across the product spectrum, including pit liners for the energy market and several construction market products. Let me comment a bit more about Integra, combining that organizations fabrication and conversion skill with our ability to develop value-added innovative products strengthens Raven's position in the polyethylene film and sheeting industry.
Additionally the move complements and further expands our major markets of Ag energy, geomembrane, industrial and construction. And Integra brings more than a 100 key members who will help provide key resources to further strengthening and expand our footprint with additionally extrusion capacity in Brandon, South Dakota and fabrication locations in Madison, South Dakota in Midland, Texas.
With Integra’s EBITDA of $6 million for the current year, we paid around eight times EBITDA the multiple is approximately the same, when you add the debt and compare that to planned EBITDA growth for next year. Looking ahead, we’re excited about the opportunities to better serve our customers and strengthen Engineered Films’ profit contribution.
As well as our enhanced ability to adapt to shifting market conditions. Now let me cover applied technology.
For the 2015 third quarter, sales in Applied Technology were $33.2 million versus $43.8 million last year. Operating income was $6.4 million compared to $15.1 million in the prior year period.
Included in the sales decrease was a $1.2 million in planned run-off related to our contract manufacturing exit. At a high level, we’re seeing weak commodity prices continuing to erode grower sentiment.
As a result, demand remains subdued for precision Ag equipment and we anticipate that to be the case for the foreseeable future. Also at play is a fact that the anticipated revenue decline of non-strategic legacy customers.
more than offset the sales growth from the recent acquisition of SBG. We are pleased with SBG which we acquired in May of this year, located in the Netherlands, SBG designs and manufactures advanced GPS steering systems for a variety of agricultural applications.
For the third quarter, SBG sales were $1.0 million and integration continues to progress as planned. We expect first full year sales from SBG to be in the $6 million to $7 million.
While we are persevering targeted investments in research and development, we have implemented cost control measure to manage spending levels closely for this division. And I would like to detail those for you now.
As of yesterday, Raven has initiated the exit of our non-strategic St. Louis, Missouri, contract manufacturing facility.
This is a facility that produces bed control for Leggett & Platt. We expect this process will take six-months.
We’ve also reduced our international sales infrastructure and scaled back marketing initiatives. We’ve lowered our general manufacturing overhead and we sharp into R&D focus on strengthening core product lines for the aftermarket and strengthening our OEM relationships.
An example of this includes the Hawkeye nozzle control system, which will be released in January 2015. These targeted and tough, but necessary actions given market condition are expected to drive $7 million in annual savings.
Looking ahead, our long-term view of the North American Ag market remains optimistic. The fact remains that there is a growing global population and greater demands for food, which will ultimately support healthy growth.
And through our initiatives Raven will be in an even better position to leverage our technology expertise and product portfolio with the leaner more focused organization. Moving on to Aerostar, for the fiscal 2015 third quarter, this division reported sales of $19 million versus $24.3 million in the year earlier quarter.
Aerostar’s operating income was $3 million up from $2.7 million in the fiscal 2014 third quarter. Plan sales declines of $6 million in contract manufacturing were partially offset by $1.1 million increase in Vista revenues.
Excluding the contract manufacturing revenues sales for this division increased over year earlier levels. Our contract manufacturing continues to wind down is planned.
So we are pleased to report an operating income gain for the quarter. This reinforces our strategic decision to focus on proprietary product lines.
Aerostat and radar shipments increased as a result of previously announced government contracts. And we continue to expect additional deliveries on these contracts before fiscal year-end.
We continue to believe in the value potential of Tethered Aerostat for Persistent Surveillance. Marketplace interest in our technology in our products is high resulting in several demonstrations of our products and systems.
Not all demonstrations result in orders and the sales cycles are very long, but the pipeline is full of good prospects. For those of you who are new to the Raven’s story with Project Loon, Google is striving to provide Internet access to remote and underdeveloped areas throughout the world.
And our Aerostar division continues its support of the program, bringing decades of experience in high-altitude balloon engineering and manufacturing, including the latest breakthroughs in super pressure balloons. Our product continues to perform very well for Project Loon, with consistent balloon endurance in the 75-day range and we expect the project to continue to build in the coming quarters albeit at a measured pace.
Overall we’re encouraged by the fact that our lighter-than-air business grew 12% year-over-year. Within Aerostar, Vista Research’s sales grew 20% in the fiscal third quarter, fueled by Vista’s Radar Systems.
Vista continues to develop and grow relationships with major U.S. Prime contractors like Raytheon, and we are also delivering highly innovative new products for our long-term customers like the U.S.
Navy. Additionally, Vista’s Technology as being integrated with Aerostat solutions under an $8.4 million contract to support the U.S.
Army. Vista’s contribution during the quarter was a key factor in realizing increased operating profits despite a top line decrease.
Looking ahead we remain steadfast in our focus for Aerostar, expanding our proprietary technology opportunities, including advanced radar systems, high-altitude balloons and aerostats to international markets. Now, I’d like to discuss our expectations for the fiscal 2015 fourth quarter and year.
We expect as do our peers in the space that the Ag markets will remain challenging going forward. That said we are confident in our long-term opportunities and we're aggressively pursuing our fiscal 2015 objectives, which are measurably growing revenues from our situational awareness and lighter-than-air product lines; bringing high-value plastic film applications to each of our Engineered Films markets, and selectively pursuing targeted Applied Technology opportunities through new products and broadening OEM relationships.
We are also intently focused on rebalancing the organization, reducing costs and actively managing the business for future success. For the fiscal 2015 fourth quarter, we expect the impact of the acquisition of Integra Plastics to be accretive to earnings per share and anticipate higher profit contributions from Engineered Films compared to the fourth quarter last year.
Aerostar continues to move away from contract manufacturing, there by reducing revenues, but expects higher profits due to contributions from its proprietary products. We do not believe, however, that growth in these divisions will be sufficient to offset the expected continued declines in sales and operating income from Applied Technology.
As a result, we don’t anticipate profit growth in the fourth quarter over the year-ago period. Our ATD profit performance will fully realize the benefit of the cost reductions outlined earlier starting in Q1 of next year.
Going forward we will invest more aggressively in Aerostar and EFD to drive our rebalancing of Raven's profit mix. As part of this strategy we will stay focused on profitable opportunities for our existing divisions.
We will invest in organic growth throughout all. We will enhance Raven's existing product lines through quality and competitiveness; and, we’ll put our balance sheet to work making sound investments.
We are committed to strengthening our overall business, ultimately creating an even healthier corporation that is fiscally sound and we’ll continue deliver above peer median returns on sales, assets and equity. As we will even this year despite our challenging market conditions.
Before I turn the call back over to Tom, I want to thank him for serving as our CFO during some pivotal years in Raven’s lifecycle. As Tom transitions out of the CFO role, over the next few months we release Raven’s accounting and finance functions well positioned for the future.
And with that I will turn it over to Tom and after that we’ll be glad to take your questions.
Thomas Iacarella
Thank you, Dan. Hopefully all of you had a chance to review this morning release.
I’ll discuss our balance sheet changes and operating margins in more depth. First balance sheet we ended the quarter with $66.6 million in cash that’s up $18 million from last October.
Subsequent to the end of the quarter we paid $9 million to Integra shareholders and repaid a portion of Integra’s debt. Our current cash balance is approximately $54 million today.
Over the past year we’ve been able to increase our cash position while making important investments in geographic and product reach and production capacity. Our nine-months operating cash flows of $45.7 million compare positively with $37.2 million last year.
The $8.5 million increase reflects a very favorable working capital influence driven by improved inventory and accounts receivable cash flows. Inventories were flat from last October, but down $3.1 million from January levels, this down from the fact that Engineered Films inventory was lower than January despite higher revenues.
Overall inventory returns were $5.0 million down from $5.3 million last at this time. Accounts receivable decline $9.4 million from last October.
Inline with sales Engineered Films was higher and Applied Technology and Aerostar were lower. Overall our receivable position is solid and our average days sales outstanding has stayed in that 51 day range.
The company’s current ratio was 5.96 versus 4.79 last year, indicating that our balance sheet remain very strong. Raven’s cash position increased by $15.4 million from last January, we believe we have the capacity to fund the investments we are making in our operations continued to pay dividends and repurchase shares.
As Dan discussed we acquired Integra Plastics in November using a combination of cash in Raven shares. We would not normally use stock for purchase of this size but the sellers had a unique tax situation in which the use of stock was beneficial to them and to Raven.
The purchase price of approximately $48 million was comprised of $9 million of cash and $1.54 million shares of Raven’s stock. As Dan pointed out the combination of our Engineered Films extrusion capabilities with Integra’s fabrication and rapid response capabilities will provide great value to our customers and as a result improve our performance.
On the Applied Technology front we acquired SBG in May. As Dan explained SBG provides both the technology that expands our product offering and presence that can grow our European distribution.
We continue to look for opportunities to expand and rebalance the corporation through acquisition. Looking at our capital spending for the nine-months was $12.8 million down from $23.9 million a year ago.
The longer-term investments in corporate infrastructure are winding down we continue to invest a new capacity for Engineered Films. We expect capital expenditures to be less than $20 million in fiscal 2015.
Over the past three years we’ve invested in research and development capabilities and corporate functions and support of a more dynamic business model. With a lower growth profile we are working to reduce spending for number of these initiatives.
Selling, general and administrative expenses were flat in the third quarter compared to last year’s third quarter. R&D spending in support of new products rose 9% in the quarter, but as we noted in the release these efforts are very targeted and will be focused in future periods, at a reduced rates.
We will continue to invest where necessary to support the growth pipeline required for future success, while looking hard at overall spending. Now I'll touch on third quarter operating margins by segment Engineered Films had operating margins of 13.3% compared to 13% last year.
If you exclude acquisition cost, margins would have been 13.5% in the just ended quarter. We were able to maintain the margin gains we saw in the first half despite a challenging marketplace and a less favorable product mix.
Additionally plant efficiencies continue to improve, despite competitive pricing pressure, we were able to increase our average selling price about 5% over a year ago. We continue to emphasize of marketing of more highly Engineered Films with a higher margin potential.
Compared with last year’s third quarter, pounds extruded were down about 14% to £19 million, as we work to control inventory. We believe integrating Integra Plastics with Engineered Films will allow us to add value to our customers through fabrication and improve return on sales.
Within Applied Technology, we reported a 19.4% versus 34.6% last year. We lost almost 10 percentage points on the gross profit line in the quarter.
With this declining market we are seeing higher levels of product returns as customers clean up their inventories. Sales of legacy control products in St.
Louis are down over 50% and that overhead burden is going to the bottom line. In addition the impact of lower sales and production levels on overhead costs hit us hard overall.
As we controlled inventory levels in an environment of rapidly declining orders. This division carries our highest gross profit rates and sales have a very direct impact on profit margins.
Additionally R&D expenses were up about 19% in the quarter to support new products and product enhancements. A 9.4% of sales, this was a rate we believed we could not sustain; we are looking to get back to the 6% to 7% range.
Finally Aerostar operating margins came in at 15.7% an increase from 11.2% last year, higher sales of proprietary products including Vista’s radar processing units and lighter-than-air products help drive the gain. Higher gross profit rates combined with lower R&D in selling costs to help improve profitability over the third quarter last year.
And looking at our overall results sales were down 13% and net income declined 45% compared to last year. The impact of lower sales of high margin Applied Technology products was greater than improved performances in Engineered Films and Aerostar.
We have analyzed the implications of the Ag market cycle on our business. And as Dan detailed taken action to pull back spending, while at the same time investing in Engineered Films to help grow and rebalance the corporation.
With that I’d like to turn the call back to the operator. So we can take your questions.
Operator
Thank you. [Operator Instructions] Our first question comes from the line of Andrea James of Dougherty & Company.
Your line is now open.
Andrea S. James
Thanks for taking my questions. Congratulations on managing so well through a tough environment in Ag.
Just an Ag question, my sense in Q3 is that there was an OEM reset at the major heavy equipment manufacturers were - they were sort of shutting down the factories and trying to clear up inventory and I am wondering how much of your decline in Q3 was tied to OEM versus aftermarket sales.
Daniel A. Rykhus
Tom, go ahead.
Thomas Iacarella
Sure. We saw through the - for the first half of the year, we saw OEM sales stay pretty stable and really helped the business as we’re going through the first half and then it really did shutoff significantly as we got into the third quarter.
And you’re right a number of the OEMs did drop their sales levels and pull back on their operations, and we saw some significant declines in sales as well as some returns from them.
Andrea S. James
That’s helpful, so now that is helpful so - were you expecting that, you had said, Ag will be weak for four more quarters basically through December of next year. And I am getting the sense that still you are thinking, but and it should still be weak, but I am thinking that the OEM cause a particular drop that maybe is not repeatable.
Do you get kind of what I’m asking there, sorry to be confusing?
Daniel A. Rykhus
Yes, I think that we did see again a substantial drop I don’t that it’s going to just impact the current quarter. As I said before the sales from the OEMs really were pretty stable for us through the first half and then hopefully our results, so I think until the anniversary that we’re going to see continued headwinds in the Ag market.
Andrea S. James
Maybe just one more in Engineered Films I know there are tighter commodities price to an energy exploration. Can you give us an update on, it sounds like especially now what’s Integra acquisition, how diversified that business is energy versus all your other verticals?
Daniel A. Rykhus
Sure, very similar actually Integra serves the same markets with similar concentration. So as you know Andrea over the last two, three years we’ve been working to reduce our energy market concentration and we’ve had success bringing it down from about 50% of our Engineered Films revenues down to will be in the mid-30s at the end of this year.
And Integra is pretty close to that profile, so we see that concentration moving in the right direction and continuing to hold above where we wanted to be.
Andrea S. James
Thank you so much for taking my questions.
Thomas Iacarella
You bet.
Operator
Thank you. Our next question comes from the line of Robert Kosowsky of Sidoti.
Your line is now open.
Robert A. Kosowsky
Hi, good morning guys and Tom congratulations on a great career and helping to build a really strong company.
Thomas Iacarella
Thank you for those kind words.
Robert A. Kosowsky
And I guess the follow-up on the Applied Tec business, can you maybe dive a little bit more into the trend you saw within the aftermarket which has been stable at this lower level, because I know there was a little bit of de-stocking at the beginning of the fiscal year and I am wondering what you saw throughout the quarter from the aftermarket journal?
Thomas Iacarella
Well, we certainly saw some continued declines in the aftermarket and certainly haven’t seen a recovery, but now looking at the quarters the OEMs were down 30 plus percent, our international business was down close to 20%, the aftermarket was not down as much because that had really started to decline earlier in the markets cycle.
Robert A. Kosowsky
Okay, that’s helpful and the view that channel inventory is at a good level going into next year given that we might have another step down in production rates.
Thomas Iacarella
Well, what we are hearing is that people are trying to get their inventory rational and appropriate for the current market position that conditions that are out there. So they are positioning themselves - if we do see an uptick that should flow through fairly quickly into our business.
Robert A. Kosowsky
Okay, but always within the aftermarket size of the business you said inventories are out of good level right now.
Thomas Iacarella
I would say so. Yes.
Robert A. Kosowsky
Okay, and then secondly on Engineered Films, Dan you mentioned energy and Ag were down a little bit due to the timing I’m wondering if you can shed a little bit more light on that and also do you generally see that your pit-liners might be a leading indicator for the rig count, because we haven’t see a rig count coming yet?
Daniel A. Rykhus
The timing, the Ag market that we serve with our Engineered Film is basically the high value crops in California that use [romulch] and then some dairy operations that are using our materials to cover Silage. And we saw some timing issues there and we really have strong relationships with those customers, those markets continue to be strong, they are not really impacted by the corn price driven real crop Ag market conditions that we are seeing.
So we really think that that Ag piece was a bit of timing, we had some really strong performance there last year. On the energy it’s a matter of a few large customers and how they are handling their stacking of inventory and they tend to build inventory and deplete inventory and from quarter to quarter that can impact our actual revenues in that market segments.
As far as rig counts go, what we look at tells us the Texas rig counts have not seen a decline relative to the recent oil price drop, North Dakota a little bit, but really not much of a rig count, active rig count decline there either.
Robert A. Kosowsky
Okay, do you have the sense that some of your customers might be drawing down inventory because of potential decline in rig count?
Daniel A. Rykhus
No, I wouldn’t - I can’t comment on that.
Robert A. Kosowsky
Okay, then finally was there an Aerostat shipment in the quarter and just any I guess increased details you can supply as to whether or not they did have a Vista Radar System in there and a lot of these new Aerostat opportunities that are in the pipeline do most of them or majority of them do have Vista on it or do they have Vista on it?
Daniel A. Rykhus
I’ll take the last part of that question and Tom you can talk to the details of the quarter, more and more we are seeing integration opportunities with the Vista Radar Systems on our Aerostat. So there is definitely a trending in that direction and our Vista team continues to find opportunities it actually can lead from a tower-based application to an additional Aerostat based application.
So we are seeing the synergy in the market development opportunities there that we had expected when we made the acquisition. So that’s a direction it’s going.
I can’t say that most systems at this point leave with Vista System on them, but certainly some do and it’s trending more in that direction.
Robert A. Kosowsky
And also then as far as the current quarter was there a large Aerostat shipment within the quarter or any details you can give on that product line?
Thomas Iacarella
There wasn’t a large shipment this time, but we had a number of smaller deliveries that went out and that really did drive the increase overall in our lighter-than-air business for the quarter.
Robert A. Kosowsky
All right. Thank you very much and good luck.
Daniel A. Rykhus
Thanks, Rob.
Operator
Thank you. [Operator Instructions] Our next question comes from the line of John Rankin of Boranco Management.
Your line is now open.
John K. Rankin
Hi, good morning. Could you please with the Integra acquisition explain in more detail the financial arrangements, there is quite a few moving parts here and my specific question is will it be dilutive as far as share account when it’s all over.
Daniel A. Rykhus
Tom, go ahead.
Thomas Iacarella
Okay, well the issuance of 1.5 million shares is certainly dilutive in terms of the number of shares that are out there. As Dan said earlier, we expect the income impact from the acquisition to offset that on an earnings per share basis.
And as we go forward that would be, consistently we have looked to perhaps buying back some of the shares that are out there. We have an authorization that would allow us to offset a lot of that.
And we think that would be prudent about that and obviously there is a lot of rules which you have to follow in the marketplaces, when you are buying them on the open market in terms of SEC regulations and another considerations that may causes to buy more or less shares as we go forward. But our expectation is that the actual transaction itself, the actual transaction itself in the acquisition of Integra will be accretive to earnings per share.
John K. Rankin
Okay. Thank you very much.
Thomas Iacarella
Sure.
Operator
Thank you. And I’m showing no further questions at this time.
I turn the call back over to Dan Rykhus, Chief Executive Officer for any closing remarks.
Daniel A. Rykhus
Sure. Thank you again for taking time to join us on today’s call.
By remaining true to the Raven business model and exercising fiscal prudence and honoring our purpose to solve great challenges, we’re optimistic that the markets we’ve chosen will continue to provide long-term profitable growth opportunities over time. We look forward to updating you on our fourth quarter in March.
Thank you.
Operator
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program.
You may all disconnect. Have a great day everyone.