Griffon Corp (GFF) 2005 Q1 法說會逐字稿

Hello, everyone, and welcome to Griffon Corporation's first-quarter 2005 earnings call. With us today we have Robert Balemian, President and Chief Financial Officer. After the prepared remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) All participants will be placed in a listen-only mode. This call is being recorded. Your participation implies consent to our recording of this call. If you do not agree to these terms, simply drop off the line.

I would now like to turn the call over to Mr. Balemian.

Good afternoon welcome to our financial overview of our first-quarter of fiscal 2005, which ended on December 31, 2004. I am Bob Balemian, President and CEO of Griffon. Harvey Blau, our CEO, is out of town today and I will be handling the call myself. I will discuss the overall results of the quarter and provide some further detail on the outlook.

First I should point out that to the extent that matters in the call include forward-looking statements. They involve certain risks and uncertainties that could cause the Company's actual results to differ materially from those in the forward-looking statements.

For the first time in quite awhile we experienced a reduction in quarterly earnings compared to the prior year. Net sales were $340 million compared to 339 million last year. Pretax income was 19.6 million compared to 25.7 million last year. Net income was $10.5 million versus 13.1 million in 2004. And diluted earnings per share for the quarter was 34 cents compared to 41 cents last year.

Profitability in the first quarter was negatively impacted by continued higher raw material costs in both the Garage Doors and Specialty Plastic Films segments. Higher selling prices in both segments partially offset the effect of the raw material cost increases. In films, resin costs escalated substantially in North America and Europe. Resin prices increased by close to 20 percent for the quarter and by approximately 40 percent compared to last year. We estimate that resin costs movement produced a negative impact on operating results of approximately 3 to $4 million in the quarter.

In the Garage Doors segment, higher steel costs negatively impacted operating results by approximately $1 million. Specialty Plastic Films also experienced lower unit volume due primarily to product design changes by its major customer. As we have discussed, the customer will be using a narrower, printed film product designed to meet its changing needs instead of the film laminate product previously supplied by the segment. The conversion to the new printed film began in 2004 initially in North America and more recently in Europe and is expected to be completed in the middle of 2005.

The service and installation operation reflected reduced sales and operating income for the quarter. This performance was a result of a weaker construction environment in certain markets, increased competition especially in the Atlanta market, and higher cost to product with significant steel content such as garage doors and fireplaces.

Telephonics and the Defense and Electronics operation had improved results in the quarter as a result of some recently awarded programs. Their markets continue to be active as evidenced by the new Coast Guard radar contracts mentioned in our news release. These contracts are especially important because it’s the beginning of a relationship with the Coast Guard and for the first time, Telephonics has equipment on board an unmanned aerial vehicle. This application has some additional growth opportunities for us.

Now some further detail relating to the quarter. Sales in Films declined by $12.7 million to 91.3 million. This reduction was due to lower unit volume of $20 million partly offset by $4 million of price increases and 4 million from exchange rates. Operating earnings in Films were down 4.3 million reflecting the lower unit sales and the negative effect of higher raw material costs. These factors were probably offset by the positive effect of exchange rates and lower operating expenses.

The major reduction in sales and earnings in the Film's business occurred in our joint venture operation in Europe. The new diaper product is phased in first in North America and we felt some of that volume impact at the end of fiscal 2004. As we have become more efficient in producing the newly designed diaper product, our earnings in North America improved slightly in the quarter compared to last year. In Europe the effect of the product transition is just being felt, resulting in a negative effect on operating results. Resin costs clearly had an effect on our business. Not only have they had a negative impact on earnings but as the increased prices they have an impact on our customers. It has become very difficult to project resin prices. In addition to the increases at the end of fiscal '04 and into 2005, there was a 5 cent per pound increase posted for January and a 4 cent per pound increase for February. The January increase was then delayed to February and there is some talk that it will be further delayed.

The February increase may have gone away. The bottom line is there seems to be a slight softening but we're not aware of any predictions of a dramatic (technical difficulty) in prices.

The Film's business continued to execute its capital expansion program. Additional expenditures in connection with capacity additions (ph) in Europe and Brazil will be made throughout this year. These investments are expected to provide for future geographic expansion and development of new markets and customers. In addition, we are considering the addition of a new plant in Europe to address a specific new product program for a major customer. A decision on this project should be made in the next 3 to 6 months and we anticipate sharing further details with you next quarter.

Sales of the Garage Doors segment increased by $13.8 million compared to last year. This included higher selling prices of 10 million with the balance primarily attributable to the sale of higher priced product. Operating profit of the Garage Doors segment decreased $600,000 compared to last year principally due to the net effect of higher raw material costs of $1 million. We are relatively comfortable with the outlook for Garage Doors. We've done a pretty good job of minimizing the effect of the substantial steel price increases received over the last 6 to 9 months. Most of our competition has also increased selling prices but a leveling off or reduction in steel prices would certainly help the industry.

In our Service and Installation segment, the sales decrease was primarily attributable to a slowdown in business in the Phoenix market and increased competition in Atlanta. In addition, Service has received substantial price increases primarily for Garage Doors and fireplaces which due to the economic climate are difficult to pass on. This has had a negative impact on operating margins. We expect that our second-quarter results in Service and Installation will not be strong but we do see some improvement later in the year.

Telephonics had a good, solid quarter due primarily to the effect of recent contract awards such as the CP 140 radar program in Canada. Sales increased to 46.4 million from 41.6 million. Operating income was $2.5 million, up from 2 million last year. In addition to the two new Coast Guard contracts, we have a number of other potential programs that are in the procurement phase which we are hopeful we will be successful on and will be able to share with you in the near term.

The radar program for the Navy's MH-60R helicopter, formerly known as Lance is making good progress. That program is transitioning from development into low-rate initial production and then into full production. We should see substantial order growth at the end of 2005 on this program and continuing for a number of years.

With respect to our stock buyback program, in the quarter we purchased approximately 300,000 shares for $7 million. In November the Board increased the stock buyback authorization by 1 million shares. The acquisition of Griffon stock continues to be viewed by us as a good use of corporate funds and our intention is to continue to make meaningful additional purchases in the future.

The Company also continues to make investments to support an expansion in each of our businesses. Capital expenditures in the quarter were $17 million, the major portion of which relates to the Plastic Films business. These investments provide meaningful opportunities to resume growing businesses.

The balance sheet remains healthy. Cash is $80 million; working capital is 269 million; and long-term debt, most of which is convertible subordinated notes, represents approximately 35 percent of capital. Our financial position provides a foundation to fund future growth opportunities.

At this time, I will take questions.

(OPERATOR INSTRUCTIONS) Bob Labick of CJS Securities.

Good afternoon, Bob. Nice of Harvey to leave you for this quarter. I actually got dropped off the line for a second. I had a quick question to try to understand the product transition, you said it is happening in Europe for the first this quarter. I had bought in the Films business we got to like a run rate of about 100 million and then was that transition in Europe responsible for the reduction in sales? And is this a new run rate until we get through the transition for a few more quarters or how should we look at it going forward?

The transition started in North America. We felt that at the end of '04. It started also a little bit later at the end of '04 in Europe and that has continued and we see the major effect on us this quarter from Europe. I think I was asked the question last quarter about the volume in Films. I said we could do $100 million a quarter. That is still doable and I think in the near term. I clearly feel that volume as we get through this transition in this timeframe will start to improve.

We had a couple of other usual factors with regard to volume in Europe. I think there was probably some overordering early on to make sure we got through the transition correctly. And we may have seen some effect of that in the beginning of the first quarter. But I think in terms of overall volume for the year in the Films business we should be in the $400 million range.

Great and then in that you may have touched on this -- I apologize -- but could you just tell us the expected timing of the launch of the new Finotech line and then the Brazil capacity? Should we see any effect of those in fiscal '05?

The Finotech line is near at the installation, near a completion. There's a substantial period time for qualification after that and making sure it's running correctly. We anticipate it operating sometime in the middle of '05 and the question in terms of volume clearly is how much or how soon we can sell some of that product out. The major direction for that piece of equipment is for our existing customer base so the idea is we will transition some product from Finotech 1, 2 and 3, the first 3 lines, to the fourth line and we will retrofit some of the existing equipment to be able to make product for additional customers.

Overall we've talked about a pretty substantial increase in capacity in Finotech and I think the fourth line gives us someplace additional capacity of someplace in the range of 70 to $80 million.

With respect to Brazil, a little bit later than the Finotech 4 program. Brazil is in the construction phase of putting a building up. We've ordered the equipment. That line should be installed by the end of 2005 and we should have capacity from that line in the beginning of 2006. We have had some very important discussions with additional customers in the Brazil market and we think we have some real good opportunities to sell most of that business out pretty soon after it is installed.

Great. And this is my last question. You mentioned heightened competition I believe in Atlanta, which seems to be continuing I guess in Q2 but you think it will improve or services in general will improve in the Q3 and Q4. Could you just give us more color on what is going on in services and what you can do to improve margins?

We have been impacted by basically two markets this quarter in the service company. Phoenix has been a little weak, weaker than we expected frankly. And we think that is going to come back sooner. We actually think that Phoenix is still a strong market. There's been some factors that affected some of our customer base in this quarter which we think will be cleaned up towards the latter part of this year. And we think the Phoenix market will come around and we will tend to do better toward the end of the year.

Atlanta was a little bit of a different issue. We do have some increased competition, new competition that has impacted our business somewhat. They have gone after some of our good customers and have had an impact of our business and this one is a little more difficult to really pin down and tell you exactly the direction it’s going to go in. But we have some plans to improve the operation down there and both internally and to try to win some of this business back, but it is going to probably take some time.

I will get back in queue. Thank you very much.

Larry Baker of Legg Mason.

Good afternoon, Bob. Can you give the debt outstanding? You gave the percentage but could you give the number of debt, actual number?

We have about $160 million in long-term debt.

Okay.

That's 161 (ph). We have $130 million of subordinated debt and the balance is a bunch of small pieces around mortgages and some debt in Europe to finance some of the equipment, that type of thing.

Okay, and can you talk about pass-through of resin costs going into the percentage you can pass through going into next quarter and what that will do to margin potential in the Specialty Plastic Films segment?

As we've said, resin is quite high and going frankly in a bad direction. When you have high resin prices and increasing resin prices, it is a negative for the business. We do have a substantial portion of our business where we're allowed to pass resin costs on. It probably amounts to about 80 percent of our business. There is a lag probably averages about 3 months -- in some cases even longer than that. It depends on when the increase gets folded into an index but as resin prices are increasing, there is basically a sharing of the costs by our customers and by us. And this quarter it has been a very substantial amount. It has an impact on us.

We've seen some increases in the first quarter which we folded into our price to our customers, some of it in the beginning of the second quarter, some as late as April of this year. So there will continue to be an impact on us as resin stays high and as it continues to increase.

The best we can do in terms of the direction of resin prices and we've looked at some trade publications frankly in connection with this call is they expect resin prices to be about where they are now or about where they are at the end of the year, similar to where we are in the beginning of this year. But they do project an increase, a slight increase in the next few months and then I guess a leveling off toward the end of the year. So if that happens we would see some impact on margins in the Films business in our second quarter and that will tend to be then lower, the effect on us will be less in the third and fourth quarters.

Okay and would you expect the effect to be less in the second quarter as well? Less than the first quarter?

Part of that has to do I guess with current price levels. Again there is a posted price increase and we're not sure what's going to happen with that but if that's effective in February, it will have an impact on earnings. If it goes away, it will have less of an impact on us. So an important factor is what happens with the resin price increase that's projected for February. I do not believe the effect on us in the second quarter will be higher than it is in the first quarter.

Okay, thank you, Bob.

Scott Jarod (ph) of National City (ph).

I was hoping to ask some questions around the Garage Doors segment. I was wondering if you could speak to the impact that slower residential housing starts might have on the segment going forward and kind of in tandem with that if there are any opportunities for cost savings from in sourcing some of the related products or components that you currently purchase from outside manufacturers?

In terms of cost, we buy a lot of our hardware that tended to phase some of that down and we are in the process actually of building capacity to make some hardware. We started that program about a year ago. It has done been well for us and we anticipate continued expansion of that program. So our expectation is that over the next few years we will build additional hardware capacity.

With respect to the overall market in the Garage Doors business, again it has been fairly strong. The new construction market has been impacted somewhat by our price increases and may have been substantial. This is in a lot of ways the toughest area of the business to pass along price increases.

In our business we are primarily renovation and remodeling I would expect somewhere around 70 or 75 percent of Clopay building products is for the remodeling market with the balance being for new construction. That said of course, new construction is still an important part of our business. So a weak new construction market would have some negative impact on us but we've done in the past -- we've done pretty well actually in weak construction markets. And frankly we don't see that market slowing down right now. The customer base even in new construction market is quite optimistic about the direction of the business.

Great, thanks very much.

(OPERATOR INSTRUCTIONS) Marty Pollack of NWQ Investment Management.

If I may, I don't want to just beat the dead horse here on the specialty resin -- I missed part of the call, so I apologize. Can you define what the nominal amount of resin cost impact was clearly either gross amount or even net amount that you could not pass through? And maybe gross amount that actually you can define for this quarter? In other words, (technical difficulty) people are trying to price -- get some pricing but what was the actual higher level of resin cost impact?

Marty, what I said is that our resin -- the increase in volume in our Films business attributable to increased prices is about $4 million. (multiple speakers) And the cost of unrecouped resin price increase is we've estimated to be between 3 and $4 million.

So effectively would have been, one would assume maybe up to 7 million or 8?

That is correct. We've estimated resin prices from the beginning of our first quarter; the September price through December is up in the high teens, close to 20 percent.

I see. I think I did hear you mention about the JV, major -- what did you -- just repeat if you would on what you said about the JV?

Well, the point here is we have a joint venture in Europe, it's called Finotech and we own 60 percent of Finotech and that business has felt the major impact of the reduction in sales and earnings in the Films business. So if you actually, if you look at the minority interest charge, it's down a disproportionate amount to the reduction in the Films earnings. Simply because Films is making less money in Europe; therefore, the impact on us is not the full amount. It is basically reduced by 40 percent.

I see. And just trying to get a sense of what the recovery potential might be if -- when things get a little bit more to a normal level. The way your businesses and specialties tend to be fairly consistent, 12, 13 percent margins I think back last June you were around 10.8 or so when you did feel again the impact of resin. Is sort of a recovery level at least for the next couple quarters -- I don't know if you could define it but what type of recovery opportunity do you have in terms of margins to get back to double-digit?

There's two major issues facing the Films business. The volume in Europe and resin costs. The resin costs remains to be seen. As I said it's difficult to project where they are going. They are at high levels. No one is saying they are coming down dramatically. If they are at high levels and consistent, it will have a dramatically less impact on us because we will eventually get the higher levels built into our selling price.

In a lot of ways the more important issue is volume. We have to replace the volume that we have lost. We have a number of opportunities to do that. We've talked about additional business in Finotech from the capacity we're building. We have talked about some additional business in South America from the capacity we're building in Brazil. And we have as I mentioned briefly on this call, we've mentioned a new program which we hopefully in next quarter will have more to say about. We actually intend to build a new facility. We have the scope of a project. Someone has to pull the plug yet but we think it's a very important program for us.

So we have some work to do to build the volume back up but this is a very interesting Company. It has done a great job over the past few years as all our companies have. We have exciting potential. We are an important factor in the business and we think that we will be able to replace the volume. It's going to take some time to do that but that's really the key, is replacing the volume. Resin prices I believe we will deal with. I hope at some time to be a little more disciplined in the market and they will start to come down. But the issue, the thing that we have a little more control over is volume and we have some work to do there.

Just one last question with regard to these R&D type expenses associated with the Electronics segment -- with the Electronic segment, the Telephonics area. Some of that spending that you incurred last year, is that being reduced significantly? So is there some net-net lower R&D type spend or development spend?

I guess you are referring to the nanoCell project? (multiple speakers) The answer is that has pretty much gone away. We are continuing a little bit of an effort there. We still have some people on the payroll and we're trying to do some things but the major part of that has gone away.

I think historically that spending in that whole area might have been up to sort of an annual 3, $4 million if I recall?

That is correct.

Is that number now reduced or replaced by some other projects?

Yes. We continue to expand the development effort in Telephonics. It is the key to their future. We have a lot of funded development work where we get contracts to do R&D work and in addition to that we have a lot of internally generated projects that we are spending money on. We think Telephonics has obviously a good future. We've talked about a number of opportunities that we booked recently. We also have some things in the works that are quite exciting for us. And again, remains -- the Lance program which will clearly be the major growth opportunity for Telephonics. We should see some significant growth in that program beginning next year.

Thank you very much.

(OPERATOR INSTRUCTIONS) We have no further questions at this time.

Thank you for sharing your interest in Griffon.

Ladies and gentlemen, this concludes today's conference. You may now disconnect.