May 23, 2017
Executives
Bo Larsen - Investor Relations Manager Dan Rykhus - President and Chief Executive Officer Steven Brazones - Vice President and Chief Financial Officer
Analysts
Craig Bibb - CJS Securities Brett Wong - Piper Jaffray Jon Fisher - Dougherty & Company
Operator
Good day, ladies and gentlemen and welcome to the Raven Industries, Inc. First Quarter 2018 Earnings Conference Call.
[Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Investor Relations Manager, Bo Larsen.
Please go ahead.
Bo Larsen
Good morning and welcome to Raven Industries’ fiscal first quarter 2018 investor conference call. Today’s call is being webcast live and will also be archived on the company’s website 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.
Since 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
Thanks, Bo and good morning everybody. Before we begin, I want to let you know that we are changing the focus of these calls this morning to a longer term view.
And yesterday, we released our first quarter earnings report and you have had an opportunity, hopefully, to look that over. And we are not going to step through the press release like we have in the past and like many companies do.
We are going to focus our comments on a little longer view and hopefully give you a little more color into where we see our business heading and a little bit more depth on how we have accomplished what we have accomplished. Over the last couple of years, we have endured many challenges, we made a lot of adjustments, what we feel were prudent adjustments.
We have kept our overall strategy intact and now we are starting to see the returns on all of that. And I want to start with our Raven business model, and that’s really our strategy and this has been intact for a couple of decades now.
I think it’s important that you, as shareholders, have a good understanding of the Raven strategy that we have been executing and that we intend to execute going forward. This is proven successful in all circumstances and it really starts with our intentional selection of diverse market segments, segments that we believe we can win in, that offers strong profitability, growth opportunities and those markets today in ATD are the agricultural sprayer control systems for Engineered Films, includes our reinforced multilayer high-value film solutions to selected end markets and for Aerostar, our focus is on high-altitude balloon platforms.
Those are our core markets and the Raven strategy has been guided by carefully selecting those markets as I have said and then also having willingness over time to move in and out of certain markets as we determine that the opportunities are strong or less so. The second important element of our strategy is that we intentionally differentiate ourselves from our competitors on quality, service and innovation.
And we make long-term investments to separate ourselves from those competitors on quality. We introduce high-quality products, we deliver exceptional service, better we believe than our competitors, and we are focused on innovation as the long-term driver of our success.
Thirdly, we manage a pipeline of growth initiatives that includes research and development investments again focusing on our cores. It includes strategic acquisitions along the way and really also seeks to expand our markets that we serve geographically in particular.
We drive continuous improvement. We have been committed to this for over a couple of decades now.
It takes a form of value engineering, process improvements and other initiatives and it’s those efforts that allow us to continue to expand our profit margins and uphold the strong margins that we do. We maintain a strong balance sheet and this is something that’s been core to Raven for a long time and we are fiscally conservative.
Having a strong balance sheet gives us flexibility to make the investments that we feel are prudent at the time when those come available. But it also gives us the resiliency during difficult market cycles.
And when you serve the ag and the energy and defense markets, you will have cycles where those markets are favorable and less so. And then finally, we uphold our corporate social responsibility by being a good corporate citizen and that’s the Raven business model that describes how we compete, how we select the markets that we serve.
Next, I want to talk a little bit about the drivers for our recent performance. And as I have said and you saw in our press release, we made good progress we believe in the fourth quarter of last year and we continue that progress through the first quarter this year.
And in ATD, I can really link our performance to the innovation. Our steady R&D investments that we have made over the last couple of years have resulted in Hawkeye and the Raven Rate Control Module.
And those two combined deliver $11 million in growth last year and are a significant part of the growth in Q1 and that’s that diligence and commitment to innovation and investing in R&D even when our market segments in ag were difficult, that is providing that growth opportunity now. Secondly, in ATD, I link our success to our service.
We have been very active in our channel, providing more training and proactive interaction with our end customers and our customers continuously tell us that it’s that service that they receive from us that sets us apart from our competition and that’s a performance driver for ATD. And then finally, over the last 1.5 years, 2 years, we have doubled down on our commitment to our core.
We have focused on sprayer control systems and various products that enhance that control system to truly separate ourselves from competitors in that marketplace. An example of that is our chemical injection technology that we have been – we designed many years ago, we have refined it over the years and now the market conditions are right to offer good growth with that product line and we saw that in Q1.
And Steven, I’d like to ask you to touch on EFD at this point and share with the listeners your perspective on the long-term growth drivers for EFD.
Steven Brazones
I’d be happy to do that. As we step back and look, we are very pleased with EFD’s strong performance in the first quarter.
The division benefited greatly from the rebound in the geomembrane market. But importantly and more importantly, the rebound of the geomembrane market was not the sole driver of growth.
The industrial market was also up significantly year-over-year, growing over 50% versus the first quarter of last year. The new production line that we put in place about 18 months ago is really driving growth and market share gains in the industrial market.
Construction and ag were also up for us in the first quarter, so we saw all of our markets served within EFD growing year-over-year. The division’s superior product performance in service and focus on specialty solutions are driving market share gains.
Additionally, the division has continued to drive profitability improvements. They are focused on expense discipline, value engineering and pricing discipline are really having a positive impact on the financial performance of the division.
In the first quarter, EFD achieved a 20% division profit margin, so the profitability is very strong within EFD in the first quarter. EFD has weathered the downturn in the geomembrane market very well and we are well positioned for growth in the future in this marketplace.
In support of this, we increased our investment in EFD’s geomembrane strategy in the first quarter with an investment in a new facility in Pleasanton, Texas that allow us to expand our geographic footprint serving the geomembrane markets and we are excited for the growth opportunities that, that investment will allow us to make. All-in-all, a very strong quarter for EFD.
Dan?
Dan Rykhus
Thanks Steven. And I want to touch on Aerostar and it’s really simple with Aerostar.
The drivers for performance improvement, our focus in cost and expense discipline. And Aerostar is benefited and we are starting to see it in Q1 with a nice profit contribution Aerostar made by focusing.
And that has generated new customers for our stratospheric balloon opportunities and good growth and good performance on those strato-balloon opportunities. And our cost structure has continued to be monitored and held tight and that has allowed us to start to generate profit, which is a great change for Aerostar and for the company.
I want to talk about our capital allocation model and give you a little bit of insight on that going forward at this point. Just at a high level, we do invest in research and development, we invest in capital expansions and we occasionally make acquisitions.
And those are important as we consider how we allocate capital. We also are committed to returning cash to our shareholders.
As you have seen, last year we have returned over $25 million to our shareholders via our dividend and then an additional share repurchase. And in the prior year, we returned about $50 million to our shareholders.
So we are committed to both. First, to growing the business by allocating capital wisely and secondly, returning cash to our shareholders.
Steven, if you could provide a little more detail on that overall capital allocation model, I think our shareholders would appreciate that.
Steven Brazones
Sure. We are in a very strong and enviable position today.
We have got a lot of flexibility. As I step back and take a look at the business, we have got $50 million in cash on the balance sheet and the profitability improvements that we are driving through all three divisions, coupled with our intense focus on net working capital efficiencies is resulting in strong free cash flow generation.
On top of that, we have an unused $125 million revolving credit facility at our disposal. So we have a lot of options and I think our first priority is to focus in on acquisitions and driving acquisitional growth within ATD and EFD.
At the same time, we are going to continue to invest in our R&D efforts to drive the development of new product offerings. We have seen a lot of success in the new product introductions over the last 12 months, particularly within ATD, but also within EFD and aero on their stratospheric balloon platform.
At the same time, we are going to continue to return capital to shareholders through our dividend policy and also being opportunistic with share repurchases. Over the long-term, we are targeting a payout ratio of 30% to 40% on our dividend on prior year earnings and with the growth in earnings that we have seen to this point and expect in the future, we expect to go back into that range in time.
And with respect to repurchase activity, I think we are going to be opportunistic here in fiscal year ‘18. We have $13 million remaining on authorization and we expect it to be active with that in the fiscal year.
Dan?
Dan Rykhus
Thanks. Let’s shift to the full year outlook and before we open up the call for questions, I would like to touch on not only this year as I see it, but beyond that.
As you know, we don’t give much numeric guidance historically, so I won’t be sharing a lot of that with you this morning. But I will say that we are off to a great start and the rest of the year we expect to be good, but more challenging than our first quarter.
Our comparison quarters are going to become more challenging in Q3 and Q4 as we anniversary the improvement that we saw in our energy market late in last year as well as we anniversary the introduction of Hawkeye in ATD. There is a lot of time left in the year for things to go well or otherwise.
But we certainly have regained our momentum, that’s clear. As we approach our historical non-contract manufacturing revenue peak of $330 million, growth will become more difficult.
And what I mean by that is there is really a couple of ways to look at the Raven revenue peak. One is in FY ‘13 we generated $406 million of revenue.
The other is to understand that we intentionally got out of contract manufacturing following that and we ran off about $75 million in revenue as we exited contract manufacturing. So, the $330 million is a good mark as you think about what’s our core revenue peak and I believe that this year, we will approach that revenue peak.
But more important than that, we have good growth and the only reason that we are getting that now is the focus that we have had over the last year. We have focused on margin expansion and those efforts improved our operating return on sales after tax margin to 7.5% last year.
And for the trailing 12 months, we are running at a 9.5% return on sales after-tax for the company. That’s a nice improvement and we will continue to work on that and I believe that we can do better.
We are committed to what we are spending on our R&D and investing aggressively in R&D on our cores. We have seen the returns that we can get as we focus more on our core business and you will see more of that going forward.
We are intent to find good acquisitions that complement our strategy for ATD and EFD and we are carefully considering several right now in our pipeline. And as we are successful with those, we will share that with you.
And in summary, one of the lessons that I have learned over the last couple of years is just the tremendous strength of the Raven business model. And I started my comments by sharing with you and reminding you the Raven business model and how we compete and our strategy and it’s been successful over many, many years.
I just want to – I want you to know that we are committed to that winning business model. We have got a great team in place to execute on it and that gives me great confidence in our future.
And with that, I would like to turn the call back to the operator and open it up for questions.
Operator
Thank you. [Operator Instructions] And our first question comes from the line of Craig Bibb with CJS Securities.
Your line is now open.
Craig Bibb
Hi, guys. A very impressive quarter and I appreciate that longer term view forward.
Could you maybe go into more detail on where the demand is coming from at Engineered Films and where you are in ramping the new facility?
Dan Rykhus
Sure. Go ahead, Steven.
Steven Brazones
Yes. So we started up the facility here in April in Pleasanton, Texas and revenues from that ramp will grow.
I think we did about $100,000 in the first month and we would expect that to continue to ramp as we go through the year. It’s going to help us serve the Eagle Ford basin in Texas and it’s an area that we have not serviced before.
So, we do see that as incremental growth for EFD. But stepping back, we saw the geomembrane market rebound quite nicely for us in the first quarter, growing over 200% versus the first quarter of last year.
As I mentioned in my comments, industrial was up about 57% in the first quarter. Construction was also up on increased construction activity and market share gains and agriculture was up mid single-digits.
Craig Bibb
And the strong industrial product is the Flexitank product?
Steven Brazones
Yes. Flexitanks is one of the big drivers for industrial growth in the first quarter.
We have seen some market share gains in that market for us. And our investment in the industrial capabilities of the organization is driving that.
Operator
And our next question comes from the line of Brett Wong with Piper Jaffray. Your line is now open.
Brett Wong
Hey guys. Congratulations on a nice quarter.
Thanks for taking my question. On a higher level, it sounds like you are again focused more on EFD than maybe you spoke about last year and so I am just wondering as you look at the growth opportunity between those two segments, how are you going to view them in terms of your focus in terms of building them out and investing in each one of those?
Dan Rykhus
Thanks Brett. Good question.
I wouldn’t say that we are more committed to films than we ever have been. I think the balance remains the same and we know that our Applied Technology division has tremendous potential and has a strong, strong influence on the performance of this company.
And we are committed to spending the majority of our R&D efforts on ATD this year. We are also committed to looking for strategic acquisition and we are actively engaging in that now that can assist us both in our product strategy and also in our distribution strategy internationally.
So we are no less focused on ATD than we ever have been. But we are opportunistic, too.
That’s been a characteristic of Raven over the long-term. And when there is opportunity for growth in the core part of our business like we see with films, we are going to aggressively invest in that too and that’s what you have seen over the last year.
Operator
And our next question comes from the line of Jon Fisher with Dougherty & Company. Your line is now open.
Jon Fisher
Good morning. As part of kind of the longer term focus and theme here of the call, how much international detail, whether it’s mix for total company or whether it’s international revenue contribution for the segments are you willing to provide and where do you think your international mix as a business overall can go thinking in terms of long-term?
Steven Brazones
Jon, this is Steven. Most of our international revenues are driven in the first quarter from ATD.
Within ATD in the first quarter, we had about 75% of our revenues generated in the U.S., 25% internationally. And that’s been pretty consistent over time.
And as we look to grow internationally, we expect that mix to change slightly, but it’s still sticking in that 75-25 range.
Dan Rykhus
And longer term for the full company, we are pursuing 12% to 15% international sales. We are not quite there yet, but that’s our goal that we have in the 3-year to 5-year range.
And we will continue as we grow. We think we have got stronger opportunities in certain international markets for ATD.
And so that’s why you are seeing so much effort there and emphasis.
Jon Fisher
Okay, thank you.
Operator
And our next question comes from the line of Craig Bibb with CJS Securities. Your line is now open.
Craig Bibb
Hi. And actually just sticking on the international theme, the year did particularly well in Brazil in their Q1, to what extent are they in your other OEM relationships bringing you into the new markets, particularly in South America where you are trying to reestablish yourself?
Dan Rykhus
So they certainly help and we see that, for example, in Canada, a lot of our OEM sales that go on self propelled sprayers built in the U.S. go into Canada.
So you may see a rise or a fall in our international sales component based on the content that’s either going in on a new machine, take Hawkeye for example, we have strong sales of Hawkeye continuing into Canada. A lot of those machines, those units are going in on OEM machine, whereas in the prior year those were being sold in the aftermarket in Canada during the first year launch.
That’s one example where certainly our OEM relationships persist and sometimes mask our overall international sales, because we count those as originating in the U.S. if that’s where they are sold.
Craig Bibb
Okay, great. Thank you.
Dan Rykhus
You bet.
Operator
And our next question comes from the line of Jon Fisher with Dougherty & Company. Your line is now open.
Jon Fisher
Yes, thank you. And just kind of wanted to focus on the ag cycle overall, just given the performance of ATD and ag, it sounds like was a contributor in EFD, which I don’t think it has been for a few quarters.
And then dovetailing that with some of Deere’s comments on their call last Friday both in their current quarter and in their outlook for the rest of their fiscal year and next fiscal year, what is the overall sentiment and intention to spend of farmers out there? Are we on the cusp of having a more positive macro ag environment?
I mean, like I said, Deere’s numbers and comments last week and even your performance this quarter would indicate that we are starting to come off the bottom in North American ag and there might be some macro tailwinds that might be forming in ag. So I guess if you could just kind of flesh out your ag sector outlook in North America, that would be appreciative?
Dan Rykhus
Sure. I am not going to be as bullish as you probably want me to be on ag.
I will tell you a few data points though, Jon. Our underlying – if we take out our successes with new products in Q1 in ATD, what we consider our underlying business performed at about a 6% growth rate year-on-year.
So, we are happy with that actually to be able to grow 6% without the benefit of our new products in a market that we believe is still generally very difficult. We count that as a strong performance.
But the reason for the exceptional performance is our new products that we have introduced. As far as the ag cycle, I would also remind you all that the farmers spending money as sort of the ag market, but for us, we sell a lot of our products that again are mostly on self-propelled sprayers to custom applicators.
These are ag businesses. And as those machines get years on them, they need to be replaced.
So, those cycles are eventually inevitable, because people will still fertilize and spray their crops with herbicides. So, I wouldn’t say that this year I am at all counting on in ag recovery no matter what other people might be saying in the marketplace.
But beyond that, one of the lessons that we have learned is that we can do better to manage our business more for mid-cycle conditions and that’s a broad statement, I know, but we sort of tested the highs and the lows in terms of what corn prices at $7 can do and corn prices below $3 and we will continue now to manage our ATD business for more of a mid-cycle condition, which we are not at yet. The ag market will continue to perform below mid-cycle, in my opinion, for the next year and then we will see after that.
Operator
And our next question comes from the line of Brett Wong with Piper Jaffray. Your line is now open.
Brett Wong
Hi, thanks for taking my follow-up. On the comment about longer term growth and the more difficult expectation for top line growth beyond the revenue peak, what aspects can help keep that growth momentum growing?
Is that expectation of being more challenging, if you will? You have more partnerships now, I believe you continue to plan to keep growing that ongoing product launches.
And also how does M&A going to fit into the comment that you have made? Thanks.
Dan Rykhus
Thanks, Brett. Well, we touched on our capital allocation strategy, so I would guide you back to those comments in our overall business model.
And those are the things that are going to permit whatever growth we can realize. As far as the comments as we pressed the peak of our prior revenue, we will return to our expectation for a 10% long-term year-on-year annual revenue growth.
We believe that Raven has proven over the last several decades that executing on our business model which guides us to profitable market segments with growth that differentiates ourselves from our competition on quality and service that both invests prudently in the growth of our core divisions and returns cash to shareholders and maintains the solid balance sheet, we believe that, that combination historically has generated 10% annual growth and will in the future.
Operator
Our next question comes from the line of Craig Bibb with CJS Securities. Your line is now open.
Craig Bibb
Hi. You guys had terrific margins at Aerostar in the quarter.
I think in the press release you referenced a large contract that was fulfilled and I was wondering if there is any lumpiness to revenues there? And then in your comments I think you referenced a new relationship for stratospheric balloons and if you could just give us some background on that?
Dan Rykhus
Yes, Craig. So in the first quarter, we traditionally have a large sale to NASA of a super pressure balloon that typically falls in the fourth quarter of the year.
And that delivery got pushed out to the first quarter of this year. So there is some lumpiness in the first quarter from that.
That’s a very large sale to NASA. In addition, as we indicated on last quarter’s announcement, we did solidify a new contract with a new customer on the stratospheric side.
And that began in the first quarter of this year and contributed to the first quarter growth versus the prior year. So we had those two benefiting the first quarter.
On top of that, we saw growth in Google as well. So, the stratospheric balloon business for Aerostar is performing very, very well and had a very strong quarter in the first quarter and that’s what’s driving the revenue growth.
And on top of that, as we look back over the last 12 months, we have done a very good job and division has done a very good job in managing their cost structure down given the challenging conditions that existed over the previous 24 months. So, the combination of the revenue gains on the stratospheric side and expense reductions contributed to the improved financial profitability in the first quarter.
Operator
And our next question comes from the line of Jon Fisher with Dougherty & Company. Your line is now open.
Jon Fisher
Thank you for taking an additional question. Just when I look at this quarter’s operating discipline, obviously, really strong revenues, but when you look at the amount that was spent on CapEx and then operating expenses really strong discipline there.
To the extent that as we look out the next three quarters of this fiscal year and revenues in any given quarter aren’t as large as this specific quarter, is it fair to kind of look at CapEx spend and the OpEx spend for this quarter as a percent of revenue, is that a fair gauge to look at how disciplined you are running the business or if revenues or when revenues in subsequent quarters are slightly lower, will those percentages of revenues drift higher and therefore the discipline that you showed on spending this quarter was maybe more to the extreme of the conservative side than kind of what your internal targets are?
Dan Rykhus
I will make some comments, Jon, on our longer term and we are really avoiding these calls being model building.
Jon Fisher
Sure.
Dan Rykhus
So the CapEx, we expect to spend $10 million or $12 million in CapEx this year. So what we spent in the Q1 versus that is what you will see throughout the year.
We believe that that’s what’s necessary to support the growth initiatives that we have, that depend on our CapEx investments for this year and next year. As far as the R&D in the selling expense, we are going to continue to invest R&D at a similar rate as what we did in Q1 and the same for selling expenses.
So, those are not going to flex on a short-term basis with revenue performance that follows the annual seasonality of our business.
Operator
And at this time, I am showing no further questions. So, with that said, I’d like to turn the conference back over to Chief Executive Officer, Mr.
Dan Rykhus, for closing remarks.
Dan Rykhus
Okay. Thank you, operator and thank you all for your questions.
And welcome, Craig, we appreciate having you on the call today. And we look forward to sharing more on our long-term outlook and our progress on the year when we give you a call again in August.
Thank you.
Operator
Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program and you may all disconnect.
Everyone have a wonderful day.