Aug 23, 2016
Executives
Bo Larsen - IR Manager Dan Rykhus - President and CEO Steve Brazones - VP, CFO and Treasurer
Analysts
Ben Hearnsberger - Stephens Beth Lilly - GAMCO Investors
Operator
Good day, ladies and gentlemen, and welcome to the Raven Industries Second Quarter 2017 Earnings Conference Call. At this time all participants are in a listen-only mode.
Later, we will conduct a question-and-answer session and instructions will be given at that time. As reminder, this conference is being recorded.
I'd now like to hand the floor over to Bo Larsen, Manager of investor relations. Please go ahead.
Bo Larsen
Thank you. Good morning and welcome to the Raven Industries fiscal second quarter 2017 investor conference call.
Today's call is being webcast live and will also be archived on the company's Web site for future listening. On the call today will be Dan Rykhus, Raven's President and Chief Executive Officer; and Steven Brazones, Raven's Vice President and Chief Financial Officer.
Before beginning, the company would like to inform everyone that certain matters discussed during this call will include forward-looking statements as that term is defined under the Private Securities Litigation Reform Act of 1995. Such statements reflect the company's current expectations.
Actual results may differ. I would now like to turn the call over to Dan Rykhus, Raven's President and Chief Executive Officer.
Dan Rykhus
Thank you, Bo, and welcome, everyone. We are pleased with the improvement in our financial performance in the second quarter and we are encouraged by the additional momentum we are creating.
Despite lackluster end-market dynamics we have remained focused on executing our strategic plan to drive growth. In the second quarter both Applied Technology and Engineered Films achieved this objective.
Combined, these two divisions grew sales and division operating income 6.3% and 25.7%, respectively. The sustained investments in research and development activities, together with capital investments to build new manufacturing capabilities, are driving positive top line results.
At the same time, improved capacity utilization, pricing discipline and continued expense control measures are benefiting the bottom line. This is encouraging; particularly in light of the very challenging environment we have endured over the last several years and continue to endure on a more modest basis today.
We are very proud of the team members for their commitment to preserving our core through innovation, customer service and quality. I will now discuss the results for the first quarter in more detail division by division and then turn the call over to Steven for a review of the financial statements.
Beginning with Applied Technology, we are very pleased with the division's strong financial performance during the second quarter. The division continued to build-off of the momentum created in the first quarter.
New product introductions continue to gain traction and are driving market share gains, particularly through our OEM channel. During the quarter we added a new international OEM relationship in Latin America and also expanded upon our relationships with two of our key strategic OEM partners in the U.S.
Regarding the latter, we are proud to announce a broadening of our strong relationships with both CNHI and John Deere. In the second quarter, CNHI selected our Hawkeye Nozzle Control technology for their 2017 model year Patriot and Guardian series sprayers.
As a result, we expect sales of Hawkeye to increase in the second half of the year as new model year production at both Case IH and New Holland commenced. Over the last several years, we have developed our next-generation rate control technology, which Deere is adopting into their product offerings for the aftermarket.
During the second quarter a limited production release was approved and initial units were shipped to select John Deere dealers. The official release will take place later this year.
This is a new innovation for the division and we are pleased with the market opportunity for our core technology. For Engineered Films, the division grew volume sold through division operating profit and improved profitability during the second quarter, but overall sales fell short of our expectations.
During the quarter, we started to see the first signs of stabilization in both the energy and geomembrane markets. Land-based rig count in the Permian Basin appear to have bottomed out recently.
After falling from a peak of approximately 560 rigs two years ago to a low of about 140 rigs earlier this year, we are starting to see activity pick up, albeit at a slow and steady pace. Combined, the energy and geo-markets decline more than 40% year-over-year in the first quarter, but during the second quarter we saw these declines moderate significantly to only 6%.
Although we don't expect these markets to rebound for some time, we also don't expect them to be a significant detriment to divisional growth in the second half of the year. We continue to see strength in the construction and industrial market.
Sales into these two markets in aggregate increased nearly 19% versus the second quarter of last year. We have seen some very positive developments in the industrial market as a result of our investment in new production capabilities earlier in the year.
At the same time, the construction market was relatively strong during the quarter, driven by improved commercial activity and enhancements in the cost competitiveness of our product line as a result of successful value engineering efforts. As I have shared with you in the past, our focus on operational excellence continues to improve the profitability of our division, in particular Engineered Films.
Through value engineering, reformulation, pricing discipline and cost control action, the division has driven improved operating margins in the first half of the year. Despite a challenging end market environment, the team has done a great job in managing the profitability of the division.
Moving to Aerostar, the division's financial performance remained weak in the second quarter but the underlying fundamentals of the division showed signs of improvement. A renewed focus on business development over the last nine months together with prudent expense control has benefited the division.
The pipeline of business opportunities for Aerostar continued to grow across many of its platforms including stratospheric balloon, radar systems and aerostat. During the quarter, the division sold an advanced radar system to the U.S.
government for deployment overseas and they also advanced a number of other international pursuits. While we are expecting to close some of these pursuits in the second half of this year, we're also very mindful that we could experience delays in contract awards that could push out the turnaround of the division to early next year.
With that said, it's important to note that relative to this time last year the pipeline of high-quality business opportunities for the division has improved significantly. We're leveraging our core technology with key customers to pursue both domestic and international projects.
Additionally, we continue to make progress in building out the market for our stratospheric technology. Our significant advancements in balloon duration and station keeping continue to support the progress on Google's Project Loon and NASA's mission.
In addition, we are developing new stratospheric balloon solutions for additional new customers. Our pipeline is much stronger today and we believe it is a positive leading indicator for meaningful new sales later this year and leading into next year.
With that, I will now turn the call over to Steven for our financial review.
Steve Brazones
Thanks Dan. On a consolidated basis sales were $68 million in the second quarter, up 1% versus the second quarter of last year.
Applied Technology and Engineered Films both achieved growth year-over-year, increasing sales 13.2% and 2.4%, respectively. While Aerostar sales declined 25.7% year-over-year, driven primarily by the timing of aerostat contracts.
Operating income for the second quarter of fiscal 2017 was $6.4 million, flat versus the second quarter of fiscal 2017. Although both Applied Technology and Engineered Films grew division profits by $2.4 million on a combined basis, this was offset by the decline in Aerostar profitability and higher corporate expenses relative to the prior year.
Aerostar's year-over-year deterioration in operating profit was heavily influenced by the decline in aerostat sales year-over-year and the deferral of $1.4 million in pre-contract cost in the second quarter of last year. Net income for the second quarter was $4.3 million or $0.12 per diluted share versus net income of $4.2 million or $0.11 per diluted share in last year's second quarter.
The increase in earnings per share was driven primarily by lower shares outstanding as a result of repurchase activity over the last 12 months. For Applied Technology second quarter sales were $23.1 million, up $2.7 million or 13.2% year-over-year.
The growth in sales was driven by market share gains from the sale of new product and progress in key international markets. Sales to the aftermarket and OEM channels increased 13.5% and 12.9%, respectively.
Geographically, domestic sales were up 14% year-over-year and international sales were up 11.1% year-over-year. Division operating income for Applied Technology was $5.2 million, up 27.8% versus the second quarter of fiscal 2016.
The increase in operating income was driven primarily by higher sales volume and lower manufacturing costs versus the previous year. Operating margin for the division increased by 250 basis points versus the prior-year from 19.8% to 22.3%, driven principally by lower manufacturing expenses and volume leverage.
For Engineered Films second quarter sales were $36.7 million, up $900,000 or 2.4% versus the second quarter of 2016. Volume as measured by pounds sold increased 9.4% versus the prior year.
The increase in volume was widespread with only the agricultural market experiencing a meaningful decline. While volume was higher, average selling price declined 6.4% year-over-year.
The decline in average selling price was mostly the result of lower raw material costs. From a market perspective, the industrial and construction markets achieved strong growth in the quarter, but this was largely offset by declines in the energy, geomembrane and agricultural markets.
Division operating income for Engineered Films in the second quarter was $6.7 million, up $1.3 million or 24.1% versus the second quarter of last year. The year-over-year increase in operating income was driven principally by higher sales volumes and lower operating expenses.
Division operating margin increased 320 basis points year-over-year from 15% to 18.2%, driven principally by raw material efficiencies and improved capacity utilization. For Aerostar, second quarter net sales were $8.4 million, down $2.9 million or 25.7% year-over-year.
The decrease in sales was driven primarily by lower aerostat-related revenues. All other business lines in aggregate were flat versus the second quarter of last year.
Division operating loss for Aerostar was $500,000 versus operating income of $1.3 million in the second quarter of 2016. As I indicated earlier, the decline in operating income for the division was heavily influenced by the significant reduction in aerostat sales as well as the deferral of $1.4 million of pre-contract costs in the second quarter of last year related to certain international Vista pursuits.
These costs were subsequently written-off in the third quarter of last year as the timing and likelihood of completing these pursuits became uncertain. Turning to the balance sheet, we ended the second quarter with $40 million in cash, up $7.3 million versus the previous quarter.
The increase in cash was largely driven by free cash flow generation as a result of favorable working capital developments. Networking capital as a percentage of annualized net sales decreased nearly 500 basis points year-over-year from 32.2% to 27.3% in this year's second quarter.
The decrease in networking capital percent was primarily the result of lower inventory levels and an increase in payable balances as a result of an improved timing of payments to suppliers. Cash flow from operations was $14.5 million in the second quarter of fiscal 2017 versus $14.7 million in the previous year's second quarter.
Continued reductions in networking capital sustained relatively strong cash flow in the second quarter of this year. Capital expenditures were $1.4 million in this year second quarter down $900,000 versus the second quarter of the prior-year.
For the first half of fiscal 2017 capital expenditures were $2.2 million, down $5.2 million versus the first half of last year. We expect capital expenditures for the full year to be approximately $7 million.
During the second quarter of fiscal 2017 we repurchased approximately 100,000 shares at an average price of $19.57 for a total of $2 million. Over the previous six quarters we have repurchased approximately 2.1 million shares at an average price of $17.75, for a total of $37 million.
Our remaining authorization at the end of the second quarter of fiscal 2017 was $13 million. With that I would like to turn the call back to Dan for our outlook going forward.
Dan Rykhus
Thanks Steven. We are pleased with our improved financial performance in the first half of the year.
Despite continued market weakness we're making progress on a number of different fronts. In Applied Technology, we are increasing market share through technological advancements.
Through sustained funding of key R&D projects over the last few years we have been able to bring to market two significant new product introductions over the last 18 months. Our Hawkeye Nozzle Control System and our next-generation rate control system.
Together with purposeful incremental investments to enhance our customers' experience, these two new products are generating very favorable customer feedback and strong demand. This is expected to continue in the second half of the year and into fiscal 2018.
With U.S. corn prices persistently low and the forecast for lower ag equipment sales volume through the rest of the year, we believe the U.S.
ag market will remain challenging. However, the actions we have taken to preserve and optimize our core business within ATD are responsible for our performance this year and provide a solid foundation going forward.
In Engineered Films, we are starting to see the energy and geomembrane markets stabilize, albeit at a much lower level than the prior year. While the rebound in these markets is still in the future, they are no longer a significant headwind to growth of the overall division.
In the second half of the year, we do expect improvement in the overall sales performance for the division. Volumes should continue to grow as they did in the first half of the year, indicating fundamental progress for the business.
For Aerostar, we continue to focus on building our pipeline of opportunities and converting these opportunities to backlog. We continue to scrutinize all expenses in the division and focus on operational discipline, but we can't cut our way to prosperity.
We will need to convert pipeline opportunities to sales in order to meaningfully improve the profitability of the division. While we feel very good about the prospects we are pursuing, the timing of these awards are susceptible to delay.
On a consolidated basis, we are in a much stronger position today than we were at the beginning of the year. Applied Technology and Engineered Films both achieved growth in the second quarter and we continue to see favorable pipeline development in Aerostar.
All things considered, on a consolidated basis, we expect to exceed prior-year sales and adjusted operating income in fiscal year 2017. And with that, we would like to open up the call for questions.
Operator
Thank you. [Operator Instructions] Our first question comes from the line of Ben Hearnsberger from Stephens.
Ben Hearnsberger
Hey. Thanks for taking my question.
I wanted to start in ATD. We're having some success with new products and expanded OE relationships, which is driving some growth here.
I guess looking out a little bit further, corns come back in, as I know you mentioned and Deere is seeing early orders for the spring season are down kind of in the single-digit range. I would think about early 2017, given some of the success you are having with new products and these expanded OE relationships, in the context of what's happening in your end market?
Steve Brazones
Well, Ben, thanks for the question. As I look out at 2017, it's tough to predict what the end market is going to do for us.
The signs are not positive yet, but we know at some point they will turn. But what we can control is our spending levels and our new product introductions, and we feel very confident in the progress that we have made on both of those fronts and we believe that that's going to do well for us in the second half of this year.
And assuming that the OEs can maintain on the sprayer side, in particular, the level of production similar at least to this year, within 90%, we feel good about our opportunities for the division rolling into 2017.
Ben Hearnsberger
Okay. And you probably have better insight into sprayer sales.
Can you give us a sense for the market headwinds you are fighting on that side?
Steve Brazones
Less than last year.
Ben Hearnsberger
Okay. So down in kind of the 10% range or better?
Steve Brazones
Right. They are down from last year but not as dramatically.
Ben Hearnsberger
Got it.
Steve Brazones
As the prior year.
Ben Hearnsberger
And on the new products, Hawkeye and the rate control, how much do they contribute in the quarter?
Steve Brazones
Ben, they contributed approximately half of the growth year-over-year.
Ben Hearnsberger
Got it. And the expectation is, that's sustainable to the back half or is that expected to ramp into the back half?
Steve Brazones
As we have said in the past, we would expect sales of those products to continue to ramp.
Ben Hearnsberger
Can you give us a sense for how big those products can be this year and how much they are expected to contribute maybe in the out year?
SteveBrazones
Well, we are not going to be specific about the numbers for those two products Ben. But in general terms, there's a significant opportunity there for growth in both.
And as we announced this quarter with our increased share of both CNHI and Deere, we feel very good about the path for those two new products.
Ben Hearnsberger
Okay. And are there other new products, think you expected to be released this year?
SteveBrazones
Not for the balance of this year, but we do have new products in the pipeline for launch next year.
Ben Hearnsberger
Got it. Looking at your OE relationships, I'm assuming Deere is still your biggest.
But is CNH closer to the eclipsing John Deere or is it still a ways away?
SteveBrazones
Well, with respect to certain customers we don't disclose relative size. Both are very important to us and we expect to grow our relationship with both in the second half of this year and into 2017.
Ben Hearnsberger
And are there other OE relationships out there or expanded OE relationships out there that are coming or expected in the back half of this year?
SteveBrazones
Ben, as we mentioned, as Dan mentioned in his prepared remarks, we did at an OEM in Latin America, new OEM this quarter. And we are pursuing opportunities to expand our relationships with our other OEMs with our new products.
Ben Hearnsberger
Okay. So looking at Engineered Films, I think that the one thing that surprised me the most was the margin profile, that EBIT margin of 18.2% was the highest we've seen in several years.
I guess is that a sustainable run rate, given some of the value engineering that has played out the way it has?
SteveBrazones
You are looking at what margins?
Ben Hearnsberger
Yes. Within EFD, on slight revenue improvement year-over-year, we saw some pretty significant margin improvement.
Is that kind of incremental leverage expected to continue in the back half of this year?
SteveBrazones
Well, I mean EFD does have significant benefits from additional volume. And we would expect -- we're at a very comfortable margin right now.
But peak margins from the division in the low 20% range, historically. And that's still in the realm of possibility for the division going forward.
Dan Rykhus
Ben, let's let others have been at this point and you can get back in.
Operator
Thank you. And our next question comes from the line of Beth Lilly from GAMCO Investors.
Beth Lilly
Good morning.
Dan Rykhus
Good morning, Beth.
Steve Brazones
Good morning.
Beth Lilly
I wanted to just drill down a little bit more about your two new products. Can you say a little bit more, because it's a substantial part of your improvement on the ATD side?
So can you give us a sense of what is so innovative about these new products?
Steve Brazones
Sure. The Hawkeye Nozzle Control System is a pressure-based system that allows users to control on a sprayer boom the range of operations so the volume of operation range expands greatly.
It also allows users to control the pressure and the rate differently across the whole length of the 120-foot boom. It also allows what's called speed compensation, so in terms with the white boom as you're making a sharp turn.
We are able to deliver the same amount of material across the entire boom regardless of, if that's a chip that's moving fast on the outer edge or the one that's moving very slowly on the inside or left side of the boom. So it's really, it's more of a platform and that's why we are having some success with OEMs, rather than a new steering product; it's just that, it's a product.
The next-generation rate control is along the same lines and that's our next step up in how we manage variable-rate application of all the chemicals and fertilizers that we support. So this is something that's been in the works for several years.
And it's a significant new product introduction, really a system introduction. And that's why we have had success at the OEM level.
Beth Lilly
All right. And can you give us a sense, then of the number of new products you hope to launch next year in ATD?
Steve Brazones
We have three significant new products that we expect to launch next year.
Beth Lilly
Okay. Great.
And then, my other question was you did a terrific job with working capital in the quarter. Can you say more about how you achieved that?
Steve Brazones
Sure. That's one of the key things that we have been focused on over the last 12 months is really focused on bringing our inventories down.
So all the three divisions have had initiatives in place to focus on how they can bring inventories down, Applied Technology and Engineered Films have been very successful in doing so. At the same time, we have seen progress in improving our payables, and we have made some process improvements internally to optimize the payment to our vendors and we are starting to see the benefits of that coming through as well.
Beth Lilly
Okay. Do you think there's more room to take out working capital in the business?
Steve Brazones
Yes. It's a concerted effort of the entire organization and so we are focused on all three components.
And I think we are probably in the later innings on the inventory side, but there's still room for improvement in all three areas.
Beth Lilly
Okay. Great.
And then, my last question, so as you look at your end markets, you are saying that -- your 2017, fiscal 2017, is going to be up over 2016. So can we surmise from that that, in fact, you think those markets have bottomed, I mean the ag has markets bottomed and the energy market has bottomed?
Steve Brazones
We think that our performance for our FY 2017, which ends at the end of January of 2017, just to clarify for anybody out there that doesn't follow our fiscal year peculiarity. We think that our performance this year is going to be driven not by necessarily a market that's improving but one that has stabilized at a very low, low level for ag and energy.
But our performance improvement over the year in terms of our profitability are driven clearly by the new products that we have introduced and cost that we have taken out and our really tight management of expenses going forward. And we think that operational discipline is going to continue to serve us well as we sort of move along the bottom here in these end markets of energy and ag, and have us in a good position when those markets start to come back.
Beth Lilly
Okay. But it doesn't feel as though to you the market -- there's further deterioration in those markets?
Steve Brazones
We think that corn prices are one factor that are concerning for us. I think that the energy market -- we're not planning for further deterioration in that end market.
And even if it did happen, it's got to be such a small part of our current book to business. It's not going to hurt us significantly.
But the corn price is one of a handful of variables that impact U.S. foreign income and that's troubling.
But, we are operating at a low level already debt levels are better than they have been in prior cycles going back 20-30 years. So it's concerning, but we are not really running the business as if there's going to be another significant step down in the next six months.
But we also are planning for an improvement.
Beth Lilly
Okay. Great.
Thank you very much. Nice quarter.
Steve Brazones
Thank you.
Operator
[Operator Instructions] We have a follow-up from the line of Ben Hearnsberger of Stephens.
Ben Hearnsberger
Thanks for taking my follow-up. On CapEx, I think we were looking for $9 million for the year, last quarter we revise that down.
What's driving the change in expectations there?
Steve Brazones
Well, as we've taken a look at the next six months, Ben, certain projects are getting pushed out a few months. So it's more a factor of project getting delayed and pushed out further than anything else.
So this time, based on our forecast, we expect CapEx to be in that -- closer to $7 million range now.
Ben Hearnsberger
Okay. And I have a higher-level question.
If you think about your business kind of normalized for the cycle, how do you think about, at a very high level, top line growth normalized for the cycle of your business?
Steve Brazones
10%.
Ben Hearnsberger
Okay. Thank you.
Operator
Thank you. And that concludes our question-and-answer session for today.
I would like to turn the conference over back over to Dan Rykhus for any closing comments.
Dan Rykhus
Thank you again for taking the time to join us on our call today. And we look forward to speaking with you again next quarter.
Operator
Thank you. Ladies and gentlemen, thank you for your participation in today's conference.
This does conclude the program and you may now disconnect. Everyone have a great day.