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RAVN > SEC Filings for RAVN > Form 10-Q on 30-Aug-2013All Recent SEC Filings

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Form 10-Q for RAVEN INDUSTRIES INC


30-Aug-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following commentary on the operating results, liquidity, capital resources and financial condition of Raven Industries, Inc. (the Company or Raven) should be read in conjunction with the unaudited Consolidated Financial Statements in Item 1 of Part 1 of this Quarterly Report on Form 10-Q and the Company's Annual Report on Form 10-K for the year ended January 31, 2013. There have been no material changes to the Company's critical accounting policies discussed therein.

EXECUTIVE SUMMARY
Raven is a diversified technology company providing a variety of products to customers within the industrial, agricultural, energy, construction and military/aerospace markets. The Company is comprised of unique operating units, classified into three reportable segments: Applied Technology Division, Engineered Films Division and Aerostar Division. While each segment has distinct characteristics, the products and technologies are largely extensions of durable competitive advantages rooted in the original research balloon business. Management uses a number of metrics to assess the Company's performance:
Consolidated net sales, gross margins, operating income, operating margins, net income and earnings per share

Cash flow from operations and shareholder returns

Return on sales, assets and equity

Segment net sales, gross profit, gross margins, operating income and operating margins

Vision and Strategy
At Raven, there is a singular purpose behind everything we do. It is: to solve great challenges. Great challenges require great solutions. Solutions driven by quality, service, innovation and peak performance set Raven apart in the development of technology that helps the world grow more food, produce more energy, protect the environment and live safely.
The Raven business model is our platform for success. Our business model is defensible, sustainable and gives us a consistent approach in the pursuit of quality financial results. This overall approach to creating value, which is employed across the three unique business segments is summarized as follows:
Serve a set of diversified market segments with attractive near- and long-term growth prospects;

Consistently manage a pipeline of growth initiatives within our market segments;

Aggressively compete on quality, service, innovation and peak performance;

Hold ourselves accountable for continuous improvement;

Value our balance sheet as a source of strength and stability; and

Make corporate responsibility a top priority.

The diversified business model enables us to weather near-term challenges, while continuing to grow and build for our future. It is our culture and it is woven into how we do business.

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Results of Operations
Consolidated financial highlights for the second quarter and first six months of
fiscal 2014 and fiscal 2013 include the following:
                                             Three Months Ended                        Six Months Ended
(dollars in thousands, except        July 31,     July 31,                   July 31,      July 31,
per-share data)                        2013         2012        % Change       2013          2012        % Change
Net sales                           $ 93,421     $ 101,674        (8 )%     $ 197,101     $ 219,589       (10 )%
Gross profit                          26,735        30,064       (11 )%        61,651        71,199       (13 )%
Gross margins(a)                        28.6 %        29.6 %                     31.3 %        32.4 %
Operating income                    $ 12,568     $  17,407       (28 )%     $  33,502     $  45,839       (27 )%
Operating margins                       13.5 %        17.1 %                     17.0 %        20.9 %
Net income attributable to Raven
Industries, Inc.                    $  8,333     $  11,546       (28 )%     $  22,336     $  30,589       (27 )%
Diluted earnings per share          $   0.23     $    0.32                  $    0.61     $    0.84

Operating cash flow                                                         $  29,737     $  44,462
Capital expenditures                                                        $ (13,746 )   $ (16,870 )
Cash dividends                                                              $  (8,727 )   $  (7,618 )

The Company's gross and operating margins may not be comparable to industry
(a) peers due to the diversity of its operations and variability in the classification of expenses across industries in which the Company operates.

Net income attributable to Raven for the three months ended July 31, 2013 was $8.3 million, or $0.23 per diluted share, versus $11.5 million, or $0.32 per diluted share. For the second quarter, net sales were $93.4 million, down $8.3 million compared to $101.7 million in the prior-year second quarter. Net sales rose modestly in the Engineered Films division and were down slightly in Applied Technology. Aerostar sales declined 23% reflecting the current constraints on federal spending and planned transition away from avionics customers.

For the six-month period, net sales decreased 10% to $197.1 million, from $219.6 million one year earlier. For the same period, net income attributable to Raven was $22.3 million, or $0.61 per diluted share, down 27% from $30.6 million, or $0.84 per diluted share, in fiscal 2013. Each of the Company's three divisions reported sales declines compared with the prior year period and lower Engineered Films gross margins were the main drivers for the decrease.

Applied Technology
Net sales of $39.1 million in the second quarter of fiscal 2014 were down $1.0 million, or 2%, as compared to the prior year period and operating income decreased $1.0 million, or 8%, to $11.9 million. For the six-month period, net sales declined $3.5 million, or 4%, to $90.3 million as compared to $93.8 million and operating income decreased $3.9 million, or 11%, to $31.0 million. The decrease in sales reflects softness of demand during the first quarter of fiscal 2014 compared to fiscal 2013, which continued into the second quarter. Lower operating income is primarily the result of the decrease in sales as well as continued investment in research, marketing and product development to secure future growth.

Engineered Films
For the second quarter, net sales of $37.3 million grew $0.5 million, or 1%, as compared with the second quarter of last year. Second quarter operating income of $4.8 million declined 30% year-over-year. Fiscal 2014 first half net sales decreased $6.1 million, or 8%, to $71.8 million and operating income of $9.5 million was down 40% from the prior year period. Net sales for the first half of fiscal 2014 were impacted by lower energy market sales compared to the first half of fiscal 2013. Operating income for the three- and six-month periods were negatively impacted by substantially higher resin costs compared to the comparative periods.

Aerostar
Fiscal 2014 second quarter net sales were $20.7 million compared to $26.8 million in the previous year's second quarter, a $6.1 million decrease. Operating income decreased by $1.3 million, or 58%, to $1.0 million from the previous year second quarter results. Fiscal 2014 year-to-date net sales of $42.4 million were down $10.1 million from $52.5 million and operating income of $2.8 million was $1.0 million, or 26%, lower than fiscal 2013 year-to-date comparative results. The net sales decrease was expected and due primarily to reduced demand from Aerostar's U.S. government customers and planned declines with avionics customers. Higher research balloon sales and Vista radar system sales partially offset these expected decreases. This change in product mix

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and higher operating expenses were the main driver of the operating income decline for the three and six-month periods ended July 31, 2013 versus the prior year's comparative periods.

RESULTS OF OPERATIONS - SEGMENT ANALYSIS

Applied Technology
Applied Technology designs, manufactures, sells and services innovative
precision agriculture products and information management tools that help
growers reduce costs, precisely control inputs and improve farm yields around
the world.
                                     Three Months Ended                                  Six Months Ended
(dollars in            July 31,     July 31,                              July 31,     July 31,
thousands)               2013         2012       $ Change    % Change       2013         2012       $ Change     % Change
Net sales             $ 39,091     $ 40,071     $   (980 )     (2 )%     $ 90,272     $ 93,812     $ (3,540 )      (4 )%
Gross profit            17,660       17,926         (266 )     (1 )%       42,443       45,249       (2,806 )      (6 )%
Gross margins             45.2 %       44.7 %                                47.0 %       48.2 %
Operating expenses    $  5,790     $  5,017     $    773       15  %     $ 11,416     $ 10,290     $  1,126        11  %
Operating expenses as
% of sales                14.8 %       12.5 %                                12.6 %       11.0 %
Operating income      $ 11,870     $ 12,909     $ (1,039 )     (8 )%     $ 31,027     $ 34,959     $ (3,932 )     (11 )%
Operating margins         30.4 %       32.2 %                                34.4 %       37.3 %

The following factors were the primary drivers of the three- and six-month year-over-year changes:

Market conditions. Global market fundamentals remained healthy as population and income growth in emerging economies have increased demand for food. Emerging agriculture markets abroad are at varying life cycle stages providing opportunities for Raven's precision agriculture products to meet market needs. Growth in these international markets has moderated in some areas of the world while there is strength in others. The Company continues to invest in growth internationally for the long term. Demand in the U.S. and Canadian aftermarket was lower in the first quarter of fiscal 2014 due to uncertainty in the marketplace. Apprehension given the drought conditions last year and falling commodity prices put pressure on demand through the second quarter of fiscal 2014. Original equipment manufacturing (OEM) partners maintained strong demand.

Sales volume. Second quarter fiscal 2014 net sales decreased $1.0 million, or 2%, to $39.1 million compared to $40.1 million in the prior year second quarter. Lower demand for application controls was partially offset by higher OEM demand for guidance and steering systems. Year-to-date sales of $90.3 million were below the prior year comparative results by $3.5 million or 4%. Sales of field computers and application controls were down due to weaker demand in the U.S. aftermarket and timing of demand year-over-year. These decreases were partially offset by strong OEM demand for guidance and steering products.

International sales decreased. For the three-month period, international sales totaled $11.0 million, decreasing 7% from a year ago and representing 28% of segment revenue compared to 30% in the prior year three-month period. International sales of $24.9 million in the first six months of fiscal 2014 accounted for 28% of segment revenue for the six-month period. This percentage of revenue remained consistent with the prior year six-month period but represented a decline of $1.5 million year-over-year. Product deliveries to South America increased year-over-year; however, lower demand in Canada, South Africa and Eastern Europe offset this increase for both the three- and six-month periods.

Gross margins. Gross margins increased to 45.2% for the three months ended July 31, 2013 from 44.7% for the three months ended July 31, 2012. First half gross margins declined to 47.0% from 48.2%. The decrease primarily reflects the lower sales volume during the current year period. The prior year-to-date gross margins were favorably impacted by the early buyout of an acquisition related contingent liability discussed in Note 5 in Item 1,

Part 1 of this Quarterly Report on Form 10-Q.

Operating expenses. Second quarter operating expense as a percentage of net sales was 14.8%, up from 12.5% in the prior year's second quarter. Year-to-date operating expenses as a percentage of net sales was 12.6% compared to 11.0% for fiscal 2013. The increase is attributable to higher spending in research and development (R&D) on lower sales volumes.

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Engineered Films
Engineered Films manufactures high performance plastic films and sheeting for
industrial, energy, construction, geomembrane and agricultural applications.

                                      Three Months Ended                                   Six Months Ended
                        July 31,     July 31,                               July 31,     July 31,
(dollars in thousands)    2013         2012       $ Change     % Change       2013         2012       $ Change     % Change
Net sales              $ 37,264     $ 36,785     $    479         1  %     $ 71,757     $ 77,879     $ (6,122 )      (8 )%
Gross profit              6,253        8,242       (1,989 )     (24 )%       12,636       18,771       (6,135 )     (33 )%
Gross margins              16.8 %       22.4 %                                 17.6 %       24.1 %
Operating expenses     $  1,483     $  1,423     $     60         4  %     $  3,112     $  2,773     $    339        12  %
Operating expenses as
% of sales                  4.0 %        3.9 %                                  4.3 %        3.6 %
Operating income       $  4,770     $  6,819     $ (2,049 )     (30 )%     $  9,524     $ 15,998     $ (6,474 )     (40 )%
Operating margins          12.8 %       18.5 %                                 13.3 %       20.5 %

The following factors were the primary drivers of the three- and six-month year-over-year changes:

Market conditions. Declining demand for pit liners in our energy market beginning in the second half of fiscal 2013 has rebounded slightly during the second quarter of fiscal 2014, marking signs that the energy market is stabilizing. Environmental and water conservation projects increase demand for the division's containment liners in the geomembrane market and provide sales growth opportunities for these products. Beginning in the second quarter of fiscal 2014, demand has also strengthened for agricultural barrier films used in high value crop production.

Sales volume and selling prices. Second quarter net sales were up 1% to $37.3 million compared to the prior year second quarter net sales of $36.8 million. Selling prices were down about 4% as compared to the prior year quarter. First half fiscal 2014 net sales were down $6.1 million, or 8%, to $71.8 million compared to first half fiscal 2013 net sales of $77.9 million. Lower energy market sales, primarily during the first quarter, drove the decline - down $6.0 million from the prior year six-month period. Geomembrane market sales decreased slightly year-over-year as the prior year included sales for a significant geomembrane reservoir project in Ohio. Sales volume and selling prices for the fiscal 2014 six-month period were down 3% and 5%, respectively, compared to the prior-year periods.

Gross margin decrease. For the three- and six-month periods, margins decreased about six and seven percentage points, respectively. The current year periods were impacted by substantially higher resin costs combined with market conditions that did not allow pass-through cost, as well as reduced manufacturing efficiencies due to new line start-up costs.

Operating expenses. Second quarter operating expenses as a percentage of net sales was 4.0% compared to 3.9% in the prior three-month period. Year-to-date operating expenses of $3.1 million were up $0.3 million, or 12%, over the prior year due to higher R&D spending for new product development on lower sales volume.

Aerostar
Aerostar designs and manufactures surveillance technology and specialty-sewn and sealed products including tethered aerostats, high-altitude scientific balloons, protective wear, parachutes, military decoys and marine navigation equipment. Aerostar also provides electronics manufacturing services (EMS) with a focus on high-mix, low-volume production. Assemblies manufactured by the Aerostar segment include avionics, communication, environmental controls and other products where high quality is critical.

Aerostar acquired Vista Research, Inc. (Vista) at the end of fiscal 2012. Vista's smart-sensing radar systems (SSRS) use sophisticated signal processing algorithms and are employed in a host of detection and tracking applications, including wide-area surveillance for border patrol and the military.

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                                       Three Months Ended                                    Six Months Ended
                         July 31,     July 31,                               July 31,     July 31,
(dollars in thousands)     2013         2012       $ Change     % Change       2013         2012       $ Change      % Change
Net sales               $ 20,722     $ 26,845     $ (6,123 )     (23 )%     $ 42,437     $ 52,480     $ (10,043 )     (19 )%
Gross profit               2,839        3,879       (1,040 )     (27 )%        6,610        7,241          (631 )      (9 )%
Gross margins               13.7 %       14.4 %                                 15.6 %       13.8 %
Operating expenses      $  1,875     $  1,570     $    305        19  %     $  3,840     $  3,490     $     350        10  %
Operating expenses as %
of sales                     9.0 %        5.8 %                                  9.0 %        6.7 %
Operating income        $    964     $  2,309     $ (1,345 )     (58 )%     $  2,770     $  3,751     $    (981 )     (26 )%
Operating margins            4.7 %        8.6 %                                  6.5 %        7.1 %

The following factors were the primary drivers of the year-over-year changes for the three- and six-month periods:

Market conditions. Certain of Aerostar's markets are subject to significant variability due to U.S. federal spending. Uncertainty and sluggish demand in these markets continued throughout fiscal 2013 and into fiscal 2014. In collaboration with Google on a pilot program to provide high-speed wireless Internet accessibility to rural, remote and underserved areas of the world, Aerostar is pioneering leading-edge applications of its high-altitude balloons. While in its early stages, this program positions Aerostar for significant growth potential, albeit with a higher risk of uncertainty.

Sales volumes. Net sales for the current quarter did not reach last year's second quarter levels, declining 23% from $26.8 million to $20.7 million. Year-to-date sales of $42.4 million were down $10.0 million, a year-over-year decrease of 19%. The primary drivers of the quarter and year-to-date sales declines were reduced demand from U.S. government customers resulting in lower sales of parachutes and planned declines in avionics sales. These decreases were partially offset by additional high altitude balloon sales to Google, higher Vista net sales of support activities under existing contracts and increased intercompany sourcing to Applied Technology.

Gross margin change. For the six-month period ended July 31, 2013, margins increased about two percentage points compared to the six-month period ended July 31, 2012 due to increased sales of higher-margin product lines and increased sales at Vista.

Operating expenses. Second quarter operating expense of $1.9 million, or 9.0% of net sales, increased from 5.8% of net sales in the second quarter of fiscal 2013. Year-to-date operating expense as a percentage of net sales was also 9.0%, up from 6.7% in the prior year period. Increased R&D spending on product development and selling expense associated with product demonstration over lower sales volumes drove the percentage higher in the current year.

Corporate Expenses (administrative expenses; other (expense), net; and income

taxes)
                                           Three Months Ended          Six Months Ended
                                          July 31,      July 31,     July 31,     July 31,
(dollars in thousands)                      2013          2012         2013         2012
Administrative expenses                 $   5,019      $  4,647     $  9,781     $  8,807
Administrative expenses as a % of sales       5.4 %         4.6 %        5.0 %        4.0 %
Other (expense), net                    $    (219 )    $    (96 )   $   (417 )   $   (148 )
Effective tax rate                           32.5 %        33.2 %       32.5 %       33.0 %

Administrative expenses for the three- and six-month periods ended July 31, 2013 increased $0.4 million, or 8%, and $1.0 million, or 11%, respectively, compared to the three-and six-month periods ended July 31, 2012. This increase is due to the Company's investments in additional finance, legal, human resources and information technology personnel to support current and future growth strategies through a strengthened corporate infrastructure. This growth has been tempered over the last two quarters and the number of employees in these roles has remained relatively consistent.

Other (expense), net consists mainly of activity related to the company's equity investment, interest income and foreign currency transaction gains or losses.

OUTLOOK

Raven continues to become a more technology-focused Company - centered on solving the specific great challenges of hunger, security, energy independence and natural resource preservation and serving our core markets. Raven is transitioning from a company with a strong contract manufacturing orientation to one that is driven by proprietary products and services. During this

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evolution, management anticipates some volatility in our results. And, as expected, the economic headwinds and near-term challenges faced in the fiscal first quarter persisted in our second quarter.
Aerostar in particular continued to be impacted by reduced demand from U.S. agency customers and planned transition away from electronic manufacturing services for avionics customers that do not fit our business model. Management is working to compensate for government uncertainty by focusing on expanding proprietary technology revenues, including advanced radar systems, high altitude research balloons and aerostats to international markets. Over the past three years, the Company has been allocating capital to these three breakout growth drivers, believing that over the course of the next two to three years any one of these more speculative, higher risk growth opportunities could double or triple the size of the division, or any of them could deliver just enough revenue to cover their cost of capital.
As a diversified company, management considers this Aerostar role a benefit, believing that Applied Technology and Engineered Films are well positioned to deliver more incremental growth, and Aerostar provides the potential for strong upside, albeit with a higher risk of uncertainty. Management expects to see strength across each of the divisions during the third quarter. Applied Technology will be driven by sales of new products and improving market conditions. Engineered Films will continue to leverage opportunity in agricultural barrier films and move forward with new film capabilities while working to increase sales in the energy market which management believes is stabilizing. Aerostar will continue to experience reduced demand from Raven's U.S. government customers, but the Company has opportunities to substantially offset this by increasing Vista and other proprietary product sales. The Company's strong balance sheet and technological leadership in its chosen markets gives management confidence for the long-term, despite potentially volatile results as we transition to a more technology-driven company. Management continues to expect a stronger second-half performance on a year-over-year comparative basis, but does not believe that will be enough to deliver profit growth for the full year. Management expects to achieve attractive returns on equity and will continue to deliver strong returns to shareholders through dividends and long-term growth.
LIQUIDITY AND CAPITAL RESOURCES

The Company's balance sheet continues to reflect significant liquidity and a strong capital base. Management focuses on the current cash balance and operating cash flows in considering liquidity, as operating cash flows have historically been Raven's primary source of liquidity. Management expects that current cash, combined with the generation of positive operating cash flows, will be sufficient to fund the Company's normal operating, investing and financing activities. Sufficient borrowing capacity also exists if necessary for a large acquisition or major business expansion.

Raven's cash needs are seasonal, with working capital demands strongest in the first quarter. As a result, the discussion of trends in operating cash flows focuses on the primary drivers of year-over-year variability in working capital. Cash and cash equivalents totaled $55.7 million at July 31, 2013, an increase of $6.3 million from $49.4 million at January 31, 2013. The comparable balance one year earlier was $44.1 million.

Raven has an uncollateralized credit agreement that provides a $10.5 million line of credit and expires November 30, 2013. There is no outstanding balance under the line of credit at July 31, 2013. The line of credit is reduced by outstanding letters of credit totaling $0.9 million as of July 31, 2013.

Operating Activities
Operating cash flows result primarily from cash received from customers, which is offset by cash payments for inventories, services, employee compensation and income taxes. Management evaluates working capital levels through the computation of average days sales outstanding and inventory turnover. Average days sales outstanding is a measure of the Company's efficiency in enforcing its credit policy. The inventory turnover ratio is a metric used to evaluate the effectiveness of inventory management, with further consideration given to balancing the disadvantages of excess inventory with the risk of delayed customer deliveries.

Cash provided by operating activities was $29.7 million for the first six months of fiscal 2014 compared with $44.5 million in the first six months of fiscal 2013. The decrease in operating cash flows is the result of lower company earnings, less cash generated by the change in accounts receivable balances and an increase in cash consumed by inventory changes. These decreases were partially offset by cash generated by the change in operating liabilities, primarily driven by accounts payable.

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Changes in inventory and accounts receivable consumed $1.2 million of cash in the first six months of fiscal 2014 compared to generating $15.2 million one year ago. The Company's inventory turnover rate declined slightly from the prior year despite the higher raw materials inventory levels (trailing 12-month inventory turn of 5.2X in fiscal 2014 versus 5.3X in fiscal 2013). Cash collections continue to be efficient despite the increase in trailing 12 months days sales outstanding of 51 days at July 31, 2013 compared to 48 days at July 31, 2012.

Investing Activities
Cash used in investing activities totaled $14.3 million in the first six months of fiscal 2014 compared to $16.8 million in the first six months of fiscal 2013. . . .

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