CNH Industrial N.V. (CNH) Q1 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Raven Industries First Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce our host for today, Mr. Tom Iacarella, Chief Financial Officer. Sir, please go ahead.

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, May 20, 2013. 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 first quarter.

Thanks, Tom, and welcome everyone to our Fiscal 2014 First Quarter Conference Call. I'll start off with an overview of our performance, then talk about each of the divisions in more detail. And finally, speak to our expectations going forward. Tom will then provide you with a look at our financials, including a discussion of margins and the balance sheet. And after that, we'll open up the call for your questions. So let's begin with our performance. As we anticipated, we met economic headwinds and faced near-term challenges in the fiscal first quarter. Sales were $103.7 million versus $117.9 million in the prior year first quarter. Modest softness in the company's Applied Technology division, declining demand from U.S. agency customers in Aerostar and a moderated energy market in Engineered Films resulted in the overall quarterly sales decline of 12.1%. The macro situations in each of our divisions vary, but we're closely monitoring all the indicators such as oil prices, ag commodity prices, GDP, unemployment and distribution channel checks, while factoring in longer-term potential for each of our divisions. Importantly, we're aggressively working to leverage our targeted investments in new product development, capacity expansion and new market penetration. And looking ahead to the rest of fiscal 2014, the quality of our business development pipeline remains encouraging. Specifically, we see opportunities in new products that use our multi-layer film capabilities and lighter-than-air and radar system sales outside of U.S. government channels. Additionally, we have several new precision ag products that will launch in our second half and are expected to help drive growth in Applied Technology. Going forward, it's imperative that we execute and turn those opportunities into positive returns. As a company, Raven remains well-positioned for growth. We're financially strong with no debt and we have fantastic long-term prospects. When facing economic headwinds, it becomes even more important to invest carefully in our business development pipeline. This is one strength that ensures our competitiveness and gives us the ability to grow our business and fulfill our purpose, which is to solve great challenges. Tackling these monumental challenges of developing technology that helps the world grow more food, produce more energy, protect the environment and live safely, while we aggressively expand and pursue new opportunities requires important capital investments. During the first quarter, we invested $12.4 million in research and development and capital expenditures to support our fiscal 2014 product and growth strategy. Tom will talk more about R&D and SG&A later. As a company, we rely on our strong cash position to, among other things, fund dividend growth and deliver above-average returns on invested capital. I'm pleased to report that our cash balance at the end of the first quarter stood at $51.1 million, up from $43.5 million a year ago. I would now like to talk about each of our 3 divisions starting with Applied Technology. For the first quarter, sales in Applied Technology were down 5%. This was primarily due to lower demand in the U.S. aftermarket for our products. We believe growers and custom ag service providers remain mindful of last year's drought and were slow getting into the field this spring, thus delaying purchases. Operating income for the quarter declined 13%. The decrease stem from the lower sales amid continued investment in research and marketing, product development to secure future growth. Despite these year-over-year declines, demand built for certain products. In particular, we saw OEM strength in Raven's advanced guided steering systems that increased crop yields and reduced operating costs. Also on the OEM front, we're customizing product solutions, tailoring the services that we provide and entering long-term agreements that provide stability and competitiveness for both Raven and our partners. This commitment is resonating with our customers globally. As an example, one of the major ag equipment OEMs finalized the integration of our chemical injection systems into its sprayers and sales of Raven's injection systems almost doubled in the first quarter. Recently, we announced a new Slingshot API implementation that allows data to move seamlessly between machine and office. Within Applied Technology, our focus is on helping farmers feed the world's rapidly growing population. We'll help them to do so and ultimately succeed as a company by driving innovation in new product development. Slingshot and our injection systems are 2 very different examples of our commitment to this purpose that illustrates the substantial breadth of our product lines and services. Internationally, first quarter sales were strong in Brazil, more than doubling year-over-year. We continue to lay the groundwork for expansion in this growing agricultural nation. For example, we strengthened our volumes with Jacto, a major sprayer OEM, by customizing product solutions for this market. And we're in the process of establishing in-country service, support and assembly capabilities for certain high-volume products. As I've mentioned before, our success internationally results from having the right products for the right market. The emerging agricultural markets abroad all are at different life cycle stages and therefore have different needs, and Raven has the breadth of precision ag products to meet those needs. Looking ahead, we expect the second quarter will again provide a challenging year-over-year comparison. We anticipate that sales growth internationally will outpace growth in the United States. We expect to see particular strength in South America and Canada. And for the full year, we expect a recovery in ATD, driven by planned new product introductions in the second half and continued growth in our automated steering systems and improvement in the U.S. aftermarket. Moving to Engineered Films. For the fiscal 2014 first quarter, sales in Engineered Films declined 16% with operating income down 48%. As we said at the end of our fourth quarter, we anticipated a challenging first quarter due to energy market softness and a very tough year-over-year comparison. Last year's first quarter in Engineered Films far exceeded anything that we've seen from that division in recent years. It was one of those quarters where everything seemed to come together in terms of volume, product mix and pricing opportunities. That performance shows what the division is capable of generating, given several favorable conditions. Looking at the current fiscal first quarter, there is some encouraging signs. Sequentially, energy has stabilized, which bodes well for the future. Moreover, sales of industrial films were up during the first quarter. Operationally, we expanded our extrusion and conversion capacity for multi-layer agricultural films. This new extrusion line is up and running now, producing great products for this growing market. Also our reclaim production line, designed to capture and recycle excess polymer material from internal manufacturing processes, is up and running, and we expect to realize additional efficiencies. The use of recycled material continues to generate interest in VaporBlock G, Raven's innovative, under-concrete-slab vapor barrier. VaporBlock G exceeds ASTM Class A and qualifies for LEED certification standards. We do expect growth for Engineered Films for the full year, which will require strong year-over-year performance for the next 3 quarters. We continue to believe that geomembrane film sales will be a rising part of our market mix due to the critical need to protect water and other environmental resources. We also anticipate growth in agricultural films for high-value crops. From a macro level, we will achieve it through R&D investments in new opportunities, enhancements to our existing products and development of specialty films with value-added characteristics. In the near term, specifically, we will leverage our introduction of agricultural barrier films, move aggressively with our energy market distribution partner into the Bakken formation, and deliver on orders for our new multi-layer geomembrane products that help reduce the environmental effects of landfills. Turning now to Aerostar. Sales declined 15% in the fiscal first quarter. The decrease was expected and primarily stems from reduced demand from our U.S. government customers and planned declines with avionics customers. Despite these declines, gross profit margins rose by over 4 percentage points as a result of a better product mix and increased divisional operating income from our proprietary product line. Within Aerostar, Vista Research sales and profits were a bright spot in the quarter, up almost 50% driven by sales of Vista's Smart Sensing Radar Systems. These systems use advanced signal processing algorithms and are employed in a host of detection and tracking applications, including wide-area surveillance for border patrol in the military. Sales on the company's -- of the company's high-altitude balloons also rose significantly. We're actively working on new opportunities for our high-altitude balloon technology, which has the ability to ascend to 20-plus miles into the atmosphere, delivering various experimental sensor and communication technology. Even though Aerostar faces continued government uncertainty and sluggish demand, we made progress on several high-quality business development pursuits during the first quarter. Specifically, we worked with the U.S. Navy to demonstrate the effectiveness of Aerostar's radar and aerostat solution for detecting illegal drug trafficking in the Caribbean. Looking ahead within Aerostar, we are intently focused on executing on a strong pipeline of high-quality business development pursuits for fiscal 2014. This includes new initiatives for the secure communications market and several opportunities for aerostat systems in defense, government agencies and commercial applications, both domestically and overseas. Concurrently, we're committed to broadening our customer base. We see significant future potential with Vista, both here and internationally, as we work to sell into new markets and secure key contracts. Looking ahead to the second quarter, I'd like to underscore Raven's strong balance sheet and technological leadership in our chosen markets. That gives us great confidence longer-term. But for the second quarter, Applied Technology performance will be driven by international market growth and a slowly improving U.S. aftermarket. Aerostar will continue to experience reduced demand from Raven's U.S. federal agency customers and we'll work to offset that through expansion of our proprietary radar, research balloons and aerostat product lines. Within Engineered Films, economic headwinds impacting certain market segments persist, while others are showing improvement. We expect to begin moving forward in the quarter with our new film capabilities. Given these assumptions, delivering year-over-year sales and earnings growth in the second quarter of fiscal '14 will be challenging. That said, looking ahead to the rest of the fiscal year, we expect stronger year-over-year performances. We obviously can't control the macro environment, but the quality of our business development pipeline remains robust and encouraging. Its impact on our current year results is contingent on our ability to execute. We believe that reaching last year's earnings level will also be challenging but it's still possible. We will execute the Raven business model, exercise fiscal prudence and stay true to our purpose of solving great challenges. In doing so, we will optimize fiscal '14 performance, while ensuring the soundness of our business and preparing for future growth. Now I'll turn the call back over to Tom. And after that, we'll be glad to take your questions.

Thanks, Dan. Hopefully, all of you had a chance to review this morning's release. I will discuss our balance sheet changes and operating margins in more depth. And then as Dan said, we'll take questions. First, the balance sheet. We ended the quarter with $51.1 million of cash investments, that's up $7.6 million from last April. We have been able to increase our cash position despite investments in production and infrastructure capacity and research and development. We reported operating cash flows of $14.9 million compared to $28.2 million last year. The reduction reflected an unusually strong working capital influence in the prior year, and we believe that this quarter's cash flows represent a solid performance. From a working capital perspective, inventories were down $5.6 million from the previous April and inventory turns improved over this time last year. Accounts receivable were up slightly in the fiscal 2014 first quarter to less than $600,000. Our average DSO was up 3 days due to the shift in sales mix. Our current ratio is 4.53 versus 3.28 in fiscal 2013. We strengthened our balance sheet through strong operating cash flows over the past year. Working capital increased by almost $15 million from last April. We believe we have the capacity to fund the investments we are making in our operations, as well as dividend growth. Turning now to investments and capital spending. We continue our commitment to invest in Raven. Capital expenditures were more than $29 million for each of the past 2 years and were $8.1 million in the fiscal 2014 first quarter. Specific investments include expanding our Engineered Films, extrusion and conversion capacity from multi-layer agricultural films, our reclaim production line designed to capture and recycle excess polymer material from internal manufacturing processes, and beginning the last phase of our corporate headquarters renovation project. While we continue to invest in research and development capabilities and corporate infrastructure, we have tempered the rate of growth compared to prior periods. The spending in all of these areas increased over the prior year. However, in the first quarter last year, R&D was up 52% and SG&A costs rose 30%. In the fiscal 2014 first quarter, R&D increased 25% and SG&A was up less than 5%. Substantially, all the growth in R&D in the first quarter was in the Applied Technology and Engineered Films divisions. We are investing in the new precision ag products, film and radar technologies required for future success. We believe that by improving our corporate infrastructure will provide support our operating division required to move their initiatives forward. We are also judiciously bringing on new talent. Examples include resources to help identify and integrate acquisitions, improve the service level of our information technology and handle the compliance burden coming from international opportunities. Now I'd like to touch on operating margins. As a reminder, we've repositioned Electronic Systems assets and people during the first quarter -- or during the second quarter of fiscal 2013 and this first quarter segment information includes that realignment. For the first quarter, Applied Technology's operating margin was 37.4% versus 41.0% last year. Last year's first quarter margins were driven by the leverage impact of significant 28%, sales increase is over a fixed cost base. In short, we needed to grow sales to maintain margin levels. With the gross margin rate of 48% in this quarter was down a couple of percentage points from last year because of the lower sales but actually higher than 2 years ago. In Engineered Films, operating margins came in at 13.8% compared to 22.3% in the prior year period. When you see tremendous growth as we did last year, 37%, margins can strengthen substantially because of our fixed cost base. Last year's first quarter margins were the highest by several percentage points of any quarter over the last few years. The weak economy generated pricing pressure and our average selling price was down about 6% from the first quarter last year. This year, we saw lower production levels and a negative impact of our fixed cost, based on those lower revenues. Compared with the first quarter last year, pounds extruded were slightly below 19 million, down about 10% as we work to keep inventory in line with the lower sales levels. For the first quarter, Aerostar reported operating margins of 8.3% versus 5.6% in fiscal '13. As Dan said, Vista Research was a positive contributor to earnings during the quarter. As you may recall in the first quarter last year, Vista was sustaining operating losses. In addition, a shift away from contract electronics and parachute manufacturing to proprietary products tends to improve our return on sales. In looking at our overall results, first quarter sales were down about 12% and the result profits were down 26% compared to last year's record level. Our net income return on sales is 13.5% versus 16.1% last year. The leverage impact of lower sales, reduced gross profit rates and higher spending from investments and research and development and other new business initiatives also reduced our first quarter returns. We will continue to constrain new spending as we move through the year and are tying that spending to the execution of growth opportunities and initiatives. With that, I'd like to turn the call back to the operator so we can take your questions.

[Operator Instructions] Our first question comes from the line of Marc Heilweil from Spectrum.

I wonder if you could talk a little bit about execution and sales calls during the quarter? Do you feel like there were some shortfalls in those 2 areas, Dan?

Sure. I wouldn't say in the quarter that we had sales call shortfalls. I think our execution challenges, Marc, are more related to larger business development initiatives and things that we start several quarters before. And you guys have heard me talk about the importance of our business development pipeline. And certainly, we have market conditions that weren't helpful this quarter, but really a part of our performance is due to execution that doesn't really meet our standards on some of our larger BD pursuits. And we're working -- I'm personally working with each of our division VPs to improve on that ratio. And I will remind you, we do -- we maintain a mix of BD pursuits, some are slam dunks in our markets -- core market space and others are less likely and others have a high risk and a high return profile. And we keep some of each of those in our BD pipeline. But we need to execute better on those BD pursuits that we believe have the most promise. And part of what we're doing to improve on that is to sharpen our focus and narrow the number of pursuits that we're actively engaging on. We think that'll help. We're not necessarily paring down the amount of resources available to us, but we're narrowing those pursuits so that we can focus more on those that we believe have the best prospects for this year and to set us up for long-term growth.

And my follow-up is with regard to the new ag introductions planned for the second half. Would you -- I know you don't want to discuss the specifics of them, but could you just give us some idea of whether these are just incremental or will they involve some products that are additive to your line?

Sure. I'll tell you what I can that's out there or going to be released shortly. We'll have a brand-new field computer that we believe will give us opportunities to grow that part of our business. I suppose you could say that's incremental and that it'll eventually replace an existing line but it will bring new functionality and a better user interface and lots of features and capabilities that we don't have today. So that's part of what we'll introduce. Another part of what we'll introduce is a variety of products into our steering product line and that'll include the ability to function on a broader, a continuing broader line of ag equipment in both the tractors, sprayers and combines, as well as some specific brand new steering solutions that we'll be introducing throughout the summer and fall. And there's a few more products but I'm not able to give you a lot more color on those right now.

[Operator Instructions] And I currently see no additional questions in the queue at this time.

All right. Thank you, operator. And thank you all again for taking the time to join us on the call today. The Raven team is aggressively working to leverage our targeted investments, as I just spoke about and new product development, capacity expansion and new market penetration. And looking ahead to the rest of the fiscal '14, the quality of our business development pipeline remains encouraging and we're intently focused on execution and turning those opportunities into positive returns. We look forward to updating you on our progress throughout the year, and thanks again for joining us.