Griffon Corp (GFF) 2005 Q3 法說會逐字稿

Welcome to Griffon Corporation's third quarter 2005 earnings conference call. With us today we have Harvey Blau, Griffin's Chairman and Chief Executive Officer; and Eric Edelstein, Executive Vice President and Chief Financial Officer. (Operator instructions) I would now like to turn the call over to Mr. Blau. Please go ahead, sir.

Good afternoon, I'm Harvey Blau, Chairman of Griffon Corporation. With me is Griffin's Executive Vice President and Chief Financial Officer, Eric Edelstein. I will discuss the overall results for the quarter and then Eric will provide some further detail.

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

I will start by noting that we are very pleased with our progress in the third quarter, as we have successfully addressed a number of the issues that our businesses were facing. Consolidated net sales for the quarter were $351 million compared to $368 million in last year’s third quarter, and pre-tax income was $19.9 million compared to $24.8 million last year.

Net income was $12.9 million for the quarter, resulting in diluted earnings per share of $0.41 compared to $0.42 last year. Our third quarter financial results show a nice improvement over the first six months of the year and three of our four businesses are operating at levels consistent with the second half of fiscal 2004 in which we achieved record results. Third quarter results benefited from higher selling prices and moderating raw material costs in both the garage door and specialty plastics film segment.

Profitability in the third quarter continued to be impacted by reductions in sales volume for our major customer in our specialty plastic film division. The sales volume reduction was caused by a diaper redesign process which is now complete, and the fact that we have not achieved the market share growth we anticipated at this point.

In films, resin prices declined during the quarter by approximately 10%. We estimate that this resin cost decline produced a positive impact on operating results of approximately $1-2 million.

In the garage door segment, coil and hardware steel prices have moderated and the selling price increases, which became effective in the second and third quarters enabled us to recover more of our steel cost increases.

Specialty plastic films for the quarter had sales of $91 million compared to $100 million last year, and operating income was $6 million compared to $10.8 million last year. As previously noted, the reduction in unit sales volumes from our major customer significantly impacted sales and operating income.

Sales in garage doors for the quarter were $137 million compared to $121 million last year. This segment had operating income of $10.7 million for the quarter, compared to operating income of $9.6 million the prior year. Our service and installation operation had sales in the quarter of $77 million compared to $80 million in the prior year and operating income was $2.6 million compared to $3.5 million last year.

Telephonics, our electronic information and communications systems segment had sales in the quarter of $51 million compared to $73 million last year, and operating income of $2.8 million compared to $6.2 million last year. The difference between the results is due to significant shipments in the third quarter of 2004 of a $35 million contract for ground surveillance radar providing perimeter protection of U.S. Air Force bases.

Consolidated operating cash flow in the quarter was $12 million and we continue to support the growth of our businesses with capital expenditures in the quarter of $9 million, purchases of share for Treasury of $7 million and debt repayment of $12 million.

Our balance sheet at June 30th remains strong with cash in excess of $88 million, working capital of $283 million and total indebtedness representing 30% of capitalization.

Previously we announced the completion of the purchase of the 40% minority interest of Finotech in the first week of July. The purchase price was $82 million and was funded with available cash of $22 million and borrowings of $60 million. Eric will now provide some details on operations and on outlook.

Thank you, Harvey. I will start by addressing the specialty plastic films. As Harvey noted, sales in our films business were lower by $9.5 million in the quarter, and operating income was down by $4.7 million. The lower sales are primarily attributable to lower sales to our major customers to our European operations. The overall volume impact resulted in a sales reduction of approximately $15 million for the quarter, offset by approximately $6 million of price increases. The reduction in sales volume was also the primary reason for the reduction in the operating profit.

In plastic film, we are continuing to execute our capital expansion program. Our expansion project in Germany is essentially complete and we are in the process of selling that additional capacity. Our expansion in Brazil is moving forward and we would expect to add added production capability toward the end of the year. We are also considering the addition of new production capability in North America to address a specific new product program for our customers. The final decision on this project should be made in a few months.

Summarizing our primary initiatives to increase the volume in our specialty plastic film division, they include the addition of more capacity in Germany, Brazil and North America; aggressive sales efforts with potential new customers in the hygienic, health care and industrial markets and ongoing discussions with our primary customers about new opportunities.

Recently, resin prices have declined and stabilized and we believe that although prices will continue to be volatile, we do not foresee a run-up in prices similar to that which we experienced in the last one-and-a-half years.

Moving now to garage doors, sales of the garage doors segment increased by $17 million compared to last year. This included higher selling prices at $14 million with the balance primarily from the sale of higher-priced product. Operating profit of the garage door segment increased $1 million compared to last year, principally due to improved selling prices and product mix differences. The general business environment for garage doors remains very positive and we believe we are well positioned, both in our retail and dealer distribution channels.

Our service levels remain extremely high. We believe we have the highest in the industry, and we continue to get good acceptance on new products introductions. Our expectation is that operating results in garage doors for the fourth quarter will be very strong, as our business needs to be operating at levels comparable to last year.

In our service and installation segment, the sales decrease of $3 million was primarily attributable to lower sales in Atlanta. In addition, service has received substantial cost increases, primarily for garage doors and fireplaces, which due to the economic climate was difficult to pass on. This has had a negative impact on operating margins. Market conditions have improved in Phoenix and Las Vegas, two of our main markets and therefore we anticipate a strong fourth quarter for this segment.

Telephonics once again had a good quarter, with both ongoing programs and newer programs contributing to sales and profitability. We had previously announced a very important new contract award from General Dynamics Canada for various work on the Canadian Maritime Helicopter Program. We have a high level of business development activities around new and existing programs, especially for radar equipment, and our backlog at June 30th, 2005 is at an all-time high of $236 million.

Telephonics best quarter is typically the fourth quarter. We are anticipating that this will also be true this year as there are a number of contracts and projects with significant milestones and deliverables scheduled for the next few months.

Finally on a consolidated basis the third quarter includes a $3.7 million gain on the sale of land and buildings, and the reduced provision for income taxes as a result of lower projected annual effective tax rate and the resolution of other income tax matters.

That completes our prepared remarks, and we are now ready for questions.

Thank you. (Operator instructions) Our first question is coming from Larry Baker with Legg Mason.

Good afternoon.

Hi.

Eric, could you go back over the real estate gain and give that on an after-tax basis?

Yes, the real estate gain, as I said, is $3.7 million. Approximately $2.2 million after-tax, EPS in tax of $0.07.

And then can you talk about the lower tax rate effect in the quarter?

I can give you the numbers. In the quarter the rate, if you compute it, you can see it is 28% and for the nine months, approximately 30%. The so-called normalized or effective rate for us, and that would include federal, foreign and state, at this point it is probably closer to 34%, but as I just noted in the prepared remarks, in this year we have had a number of items that have been resolved in our favor where we have provided reserves in the past. Those reserves are no longer needed and under the accounting requirements, they therefore come back in the form of reducing tax provisions both for the quarter and for year to date.

And what does that imply for the fourth quarter tax rate?

It implies probably something along the lines of the run rate so far this year.

Okay, which is what? 31%?

Around 30%.

30%, okay. And then can you talk about next year’s tax rate?

Well indirectly I just did, Larry. I put our typical normal rate without these items is 34%.

Okay. And then can you talk about the timing for the revenues of the Canadian contract and any other contracts on the horizon for Telephonics?

The Canadian contract we announced as a contract value of $50 million. It is a long-term contract. You want to think in terms of eight, nine, ten years for the majority of that revenue.

Okay, thank you.

Thank you. Our next question is coming from Bob Labick with CJS Securities.

Good afternoon.

Hi.

Hi. I wanted to follow up with some questions regarding the films division. Was there a change in terms of I guess number of units and diapers sold to your major customer, or what other change could have caused – you alluded to lower volume again. I thought we had already anniversaried or reached the point where we had already, a year ago, reached lower volumes. So why was it lower again in this quarter? If you could help us understand that.

There was a change. Most of the impact relative to the redesign had flushed through in the quarter that we just finished up, but we had shortfalls in Germany at Finotech for the product that, the printed film product, that we are producing for them and it is something that we are talking to them regularly about. They are aware of the shortfall and it is over each of the quarters, it has gotten a little bit worse with each quarter, and we are working with them to see what we can do to improve it.

Are they getting supply from another customer or are they selling less diapers? What is causing the shortfall?

We are not sure. It is probably a little bit of both, but we are not completely sure.

Okay. And I guess you cited that as the reason that margins were lower than expected, at least from my perspective, because if resin came in 10%, generally you would expect margins to be higher. Your 6.5% margins on a business that normally does 12-14% in your own words, what is the driver there?

I think part of the driver is the volume and the fixed costs being spread over less volume.

Does any of the impact have to do with the qualifying for Finotech or where do we stand in that process?

It shouldn’t have had that much of an impact. Finotech did get qualified in this quarter, so therefore we did expend money to get it qualified, but probably not quite as much in this quarter as in prior quarters.

One of the things, Bob, is that we are trying to replace the business that we are taking away from some of our machines and going on Finotech for our biggest customer with private label customers and we have made inroads in that area, but they are not going to happen overnight and it is going to take some time for us to be able to put on the additional volume that is necessary from the capacity we have added with the private label customers. So we are working now to get a bigger amount of private label customers into the Finotech operation, which our people believe will work out over the next few months.

And can you give us just a ballpark of the potential range of the private label capacity? Is it $40-60 million? Some ballpark like that.

That is a pretty good ballpark.

You believe that can be added in the next few months?

Well we have the capacity now we have to get the customers. We haven’t been able to get the customers because we did not have the capacity and that is one of the reasons we added Finotech. This will give us the opportunity now of going out and getting customers by building availability that we have. You can’t get the customers until you have availability. So until we put Finotech in and it was qualified, we did not have the ability to go out looking for new customers. We are now out bidding and trying to get sourcing for new customers. How fast that comes on will determine, to some extent, how fast the turnaround will be in this business. Plus we are pushing our main customer to give us additional business in other areas.

Got it. Now in terms of getting the margins back to the 12-14%, do you need to fill that capacity or is there a way to shut off say line 1, run 2, 3 and 4 full and you will get back to the 12-14% margin, and then as you get capacity add it on line 1? Or, do we have to wait until you get the extra $60 million in sales until you can get capacity higher? Until you can get margins higher?

We need to be at close to full capacity to get the margins up at that level. Keep in mind when we achieve that in ’04 we were at 100% plus capacity.

Okay, great. I think I understand that now. And if you can give us, I know you alluded to Brazil, when would you expect that to be I guess go into qualifying or anything along those lines?

We are targeting the end of the year, the end of the calendar year.

Okay, end of calendar year for qualifying. And will there be a similar impact once Brazil comes up in terms of margins down there, until you get the capacity built?

If by similar impact you mean decline in margins, no, not necessarily. There will be similarity in terms of the amount of time necessary to sell out the capacity.

Right, okay. I did mean the margins. And this won’t affect the margins because you are not pushing the customer over, you are not going to be running all of the lines – this will be a totally incremental line.

Correct.

Okay, got it. And then you will sell it when you sell it and it should ramp up from there. All right, I think those are my questions, thank you very much.

Okay.

Thank you. Our next question is coming from Rudy Muller with Winchester Group.

Yes, two of my questions were already asked by Larry Baker and answered. The third is, the outlook for resin prices, are they set to fall further or what is your general take here for the next three to 12 months?

I will kind of expand a little bit on what I said in the prepared remarks. First let me emphasis that at this point I don’t believe anybody truly knows where they are going. What we think is we are not anticipating a significant run up from here like we experienced over the last year-and-a-half. On the other hand, we do foresee the possibility of what I referenced as volatility. By volatility, I mean that in a given month it can still go up 5-8% and then obviously perhaps the following month go the other way.

So we are looking, we believe short-term volatility and long-term no significant movement one way or the other, but that is, as I said before just aren’t in –

And to what extent and how far forward are you price protected?

We are not price protected very significantly at all. We get price protection, so to speak, in terms of obviously the inventory we are carrying, that which we pay for, but wherever there is a bulky material you can store it in rail car and silos, which everybody does, but we are not price protected two, three, four, five months out.

Our price protection runs from our ability to pass on costs to our customers, as the prices go up.

Thanks.

Thank you. Our next question is coming from Marty Pollack; NWQ Investment.

Yes, hi. A couple of questions. On the telephonics, just from the point of view of timing, it seems that sales year to year are very weak, I forget what was the accounting for that, I know you are looking for what would be a stronger finish for the fiscal year. Are the sales being pushed off into the fourth quarter that were not booked, that did not show up this June one?

The sales from year to year are not overly weak. We have to take out the $35 million one-time contract in this quarter and you will see that we did have significant growth in sales and in earnings in the quarter compared to last year.

Okay, I appreciate the clarification, okay.

The problem is that we had a contract that was $35 million that was all delivered in the quarter and was all off-the-shelf items with no R&D whatsoever, it is a product that we had developed, we had it on the shelf. The customer bought it and we had to make it and deliver it all within a very short period of time. So we increased our sales, it was wonderful last year, by $35 million and increased our earnings substantially because there was no R&D expense. So on a comparable basis, Telephonics is doing very, very, very well. They have won a whole bunch of contracts this year. The main program they have which is the MH-60 helicopters going into early production, which means it is going to increase the sales. We have a very, very big backlog of very good programs and we think that the fourth quarter is going to show how well we are really doing this year, because you won’t have the comparison with last year on the one-time contract and you will see how well we are doing in the Company this year.

Nevertheless, you would expect sales to bump up from that nominal dollar value here in June, right? I mean, effectively September will be up?

Yes.

Secondly on the specialty chemicals side, I guess in a sense looking forward with the Finotech JV now folded in, and obviously you have these margin issues at the moment, we understand all of that. Is there anything on costs that would provide you some ability here to really have a little bit more control on that? Obviously with more flexibility, can you in fact focus more aggressively on cost reduction, at least get the margins back up that way? I recognize that maybe ultimately you get back to 12-13% when you replace the volume. But can, on the cost side of the equation, you accomplish some of the same?

Well what we are looking at is cost reduction opportunities and taking your question literally there is an opportunity to improve margins by controlling our costs better than we are doing already. But that is not the answer to get back up to those levels. The resin is the primary cost input to the finished product and that is in there and it is a capital intensive business, there is depreciation which is there. So it is not to say that it is not something we are ignoring, we are focusing on it but it is not the solution to get the margins back up.

One other thing I just didn’t want to let it pass, but we were just talking a minute ago about that airport contract in the third quarter of last year. It was actually $30 million of the $35 million that went through in the third quarter, it was a $35 million contract. Just – the response is the same response, but I just wanted to clarify that.

Just again, unexpected costs on Finotech could solve the problem, but I am wondering, is there some dollar amount that you can see in cost reduction that can help at least margins from here? Is there some significant amount? Obviously not enough to replace volume, but is there some meaningful cost reduction opportunity still?

I don’t think there is a meaningful amount as it relates to impact on the margins. Is there the potential for several million dollars? Sure there is, there always is and as we noted in the press release in announcing Finotech we talked about the fact that this will give us an opportunity to realign, better organize our European and German operations. And in doing that, we have the potential to save some money.

I am referencing the plant we have in Burma as well as the one that was in [inaudible].

Thank you.

Thank you. The next question is from George Nissan; Merrill Lynch.

Hello?

Hello.

A couple of questions. Obviously as we talked about on the call already, raw material costs have been real challenging, especially in the area of resin. I am interested if you can provide some color today on the call, on what some of your strategic initiatives are and is collaborating better and more efficiently with your supplier base to reduce raw material costs and overall improve your entire supply chain efficiency?

You are talking about resin?

Well I mean resins and actually foils. Just general, probably resin is the biggest challenge but most of your raw material costs, and how are you working with your suppliers to reduce raw material costs by collaborating better and just overall improvements to the supply chain efficiency?

It is something we are looking at all the time, ranging all the way from how many suppliers we use or how many are available to us. And speaking about resin, by the way, we have in recent times, especially when resin prices were increasing dramatically, looked at the possibility of hedging and we have done that on our own and with our major customers.

Quite honestly, what we found was the cost of taking the risk out was more of an [inaudible] than eliminating your risk, so we didn’t see an economically viable fee hedge. The production process itself we think we do a pretty good job of controlling in this area. As you might be familiar, the scrap is reused in the extrusion process and we think we do that quite well.

So having said that, it is something that we are looking at all of the time. We are looking at the way we buy, looking at the logistical side of when we take shipments, because all of that has to do with what you actually pay for the resin. On the field side, and really our business was just limited really to – the key things are resin and steel.

On steel, we have the ongoing question of whether we want to buy under contract or in the spot market, and we watch very closely the things that up the cost of four or five or six different types of steel that they are buying on a regular basis, and we are making decisions there, even recently on whether we want to be provisioned by our contract or in the spot market, depending on where we think things are going. We work real hard with our suppliers to keep a good relationship with them, which has to do with they provide us a high level of service, we be a customer that is very easy to deal with, pay on time, things like that.

One of the other things that we did consider in steel procurement is the number of mills that make our product. Depending on what is going on with them, there can be more or less mills that are offering what we want, for sale. Obviously if there are more of then it is to our advantage, and if it is at a point in time where fewer of them are producing this specific type of steel that we need it makes it more difficult.

When you talk about one area that as an example you guys could comment on is the area of quality, because it has always been a top priority, and why you guys are able to beat out some of your competitors in this very challenging market.

In terms of working with the suppliers, how are you making sure that they are living up to your standard? Are you score carding them or meeting with them through global supply forums? How are you making sure that your supplier base is meeting your quality standards?

Well on the resin side, we are doing all of those things. Meeting with them, we also have a lot of input from our own customers as to not only the type and where we are sourcing our resin. Some of it is as simple or complicated as buying from the people that our customers would prefer that we buy from. But testing and things like that are important.

So you are actually score carding to check for quality and making sure they are meeting your quality standards?

Correct.

Okay. And final question, what has been their feedback? Obviously you guys have had a lot going on in the last couple of years, working with the suppliers. Are they open to this new type of partnership? Are they – do you feel like there was any squeeze, go find another supplier? What has been their feedback?

Most of the time they are open to partnering, they are talking the same language we are about working together in the best interest of both parties. So they have been pretty open.

Okay, thank you very much. Good luck down the road.

Thank you.

Thank you. Ladies and gentlemen, this does conclude the question and answer portion. I would now like to turn the floor back to management for any further comments.

Thank you very much, we look forward to the phone conversation after the fourth quarter which we hope is going to be a very, very good and strong period. Bye, bye.

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day.