I have not yet tried to listen to the conference call, but am reading the transcript which seems very carefully done. I've never seen Thom's name spelled that way before and perhaps it just indicates the assumption of the transcriber, but I'll be watching to see if Iacarella prefers it.
The first thing I want to comment on is Dan's noting that the expected long term EPS growth of 10 to 15%, while not impossible to attain in the remainder of this year, will be difficult. That is how I would have expected Moquist to talk and then to surprise. In Rykhus' case, I'd say it's more a statement of acknowledged fact and a warning.
I expect to be in Austin, TX and will look in on this new "state of the art R&D center". That is for ATD but the one N. of Sioux Falls is also ATD's for the most part, though EFD also has a facility or two up there. It is becoming confusing but I believe the two are comparable and I saw an ad for an engineer in Austin last time which indicated that the hiree could work either in Sioux Falls or Austin. So part of the justification for two R&D facilities is that they can hire more talent which wishes to live in either place, but at the expense of additional administrative difficulty. I'm guessing it's easier to hire out of work engineers in Austin than in SF.
Thom has improved our insights lately by carefully telling us where new investment is being made--usually in terms of manpower I think, but also space and equipment perhaps. I'll post a quote from his prepared comments to begin my next post. But I note that he justifies the increase in overhead by saying that he (and the company) believe that former constraint in headquarters support restrained results in the divisions. I would say that comment reconfirms my understanding of what Dan felt was necessary in order to create his own exceptional leadership results at Raven. Thom is supporting Dan's orientation (as I would expect a good CFO to do).
What I take from the summary in the preceding post is that Dan and Thom continue to believe that they have the right strategy and are not too scared of overdoing the addition of overhead yet to keep building more of it. From that I rather expect an even larger corporate overhead number next quarter and I question how much more sales will be available to cover those expenses. For my investment dollars, I think I'm coming to the conclusion that we are apt to be entering a period of unpredictable EPS comparisons or even negative ones. There is just too much change going on at Raven to be assimilated easily or efficiently.
Again, I'm not saying it is wrong--just that I cannot predict earnings levels as I used to because the overhead won't stay down. Or maybe I really believe EPS will be weak for a few years. I can live with that though I suppose I wish I'd postponed that purchase this morning which did not replace shares previously sold at higher prices. $30 is the highest price I've ever paid for Raven stock except when explicitly replacing shares sold higher--in fact it is nearly twice what I've ever paid before. It may well be a mistake.
And now I need to go back and read more of the transcript or go back to bed. Probably the latter. Oh, I might note that the report of 27% of sales coming from overseas and the particular success in Brazil and Canada is welcome news. And the success in Brazil points to the fallibility of my own analyses which predicted a lot of wasted money there. Since we always see percentage growth figures for sales and operating earnings by division, it might be worthwhile to point out the succession of corporate expenses listed in Q2 since 2010: $2.0mm, Q2-2011: $2.6mm (up 30%), Q2-2012: $3.2mm (up 23%), Q2-2013: $4.6mm (up 44%).
In my opinion Thom is telling me that it will be higher yet next year. They remained in the range of $1.6 to $2.1mm for the 5 previous years as Moquist kept them tightly reined in. It will take a lot of growth in sales to justify the new higher overhead which we are now locked in to. It's much easier to spend that kind of money than it is to reduce it. Yet I don't suppose 4.6% or thereabouts of total sales for all corporate functions would be regarded as all that high if compared to other conglomerate type structures. I've not checked that assertion anyplace and just suspect it to be true. And it's also important to realize that part of the increase may be due to managements reduced resistance to showing that much overhead as it is simply people and effort being moved out of the divisions and into the corporate accounting. Like Mr West who may well be doing mostly the same things he did at Aerostar but now is corporate expense instead of Aerostar expense.
Despite the above qualification, I am concerned about the level in investment mitigated by the obvious success of increased spending at Mr Rykhus' former division (Applied technology; nee, flow controls).
Maybe more later. L.
"...Turning to SG&A and R&D, we continued to invest in our research & development capabilities and corporate finance, information technology, and human resource developments to lay the foundation for long-term growth. Spending in all these areas continues to increase over the prior year. Substantially all the F2Q increase in R&D was in the Applied Technology and Engineered Films Divisions. We’re investing in the growth pipelines they require for future success.
We believe the historically low level of corporate support has been at times a growth constraint to our divisional initiatives. We continue to see the need to bring on new talent. Examples include resources to help us move forward on key competitive elements, identify and integrate acquisitions, find new talent and improve the service level of our information technology...."
I note that Thom continues the Raven tradition of speaking carefully, especially in prepared comments. So he has listed several areas where spending is continuing to increase. I gather from that we will see even more than the $4.6mm corporate overhead number in future quarters, and that he approves of it.
He notes R&D spend is increasing and that clearly includes new buildings in both Austin and SF. But I gather also new people. He also lists corporate finance (his own department has invested in more software, hardware, and or people), Information Technology (the newer employee whose name I can never remember has an increased budget), human resources (also getting bigger).
In the next paragraph he specifies people being added in "key competitive elements" which I take to be new R&D people, he adds more people for acquisition identification and integration, and in IT.
Last year more than half the operating earnings in the second quarter came from Applied Technology Division. ($12.1mm vs $9.8mm for the other 3 divisions). And op income at AT was up dramatically from Q2-11 when it was $5.5mm on half again as much revenue. ($32.3 vs $21.0mm). And with overhead expenses being deliberately expanded, I have decided that even at $.50 my November calls at $37.50 are safe enough from exercise. I do notice that someone else bought back their calls for $.50 and there is apparently only one other sold batch outstanding.
I would not be terribly surprised if Raven again surprised us to the upside. Aerostar has perhaps the most possibility for surprise though AT might very well perform better than expected. Most sales are in the field preparatory or early tending activities IMO, which makes this quarter smaller than the first. And the non irrigating farmers must be scared though even in dry years Raven's precision ag should be desireable for a marginal farm.
Really, I expect a rather lackluster report tomorrow with no great surprises but more likely a bit on the light side than on the blowout side.
And, of course, I'm happy to buy more shares if they get down to $30 or so.
And I did buy those shares this morning. The report was weak and Raven's price justifiably sank. Engineered films was the standout performer for the quarter though not quite as amazing at it was in Q1. $6.8mm operating income is easily a record for the second quarter as are sales of $36.8mm. However, they are both weaker than Q-1 and that is not a typical reduction in the second quarter of the year. EF sales are normally stable or increasing slightly from Q1 to Q2. Margins seem to be stable also between the two quarters though recently they had been increasing in Q2. So, while EF showed an outstanding quarter, it was rather weak compared to an even more outstanding Q1-13 and could not carry the rest of the company.
AT was somewhat the same story. A good quarter, but not as good as Q1. Sales were down to $35mm or so (neglecting the $5mm estimated from electronic systems) which would have been a good quarter for last year, but after $50.5mm in Q1, looks a little wan. Margins held up well.
Aerostar continues to be weak though sales appear to be up a bit assuming that 75% of ES sales went to them. But margins are poor, aerostats were the great hope for the division and seem to be dead (though I seem to remember that the competitors have been seeing even worse results) so our diversified business model seems to be carrying that division for the moment. Could continue to be a drag or could break out at any time. Government contracts are fickle.
And now the corporate expense is really beginning to show what I've been anticipating. $4.6mm after many years held below $2mm by Moquist. I'm not complaining--Rykhus had to do something different and did--but we are now going to see just how smart he was and what kind of people he hired. It was a relatively good job market as he invested so much in manpower and facilities, so I hope he made good buys. But now we see how they are able to coordinate and perform. This quarter makes one wonder.