Griffon Corp (GFF) 2007 Q2 法說會逐字稿

Hello, everyone, and welcome to Griffon Corporation's second quarter 2007 earnings call. With us today we have Harvey Blau, Griffon's Chairman and CEO, and Eric Edelstein, EVP and CFO. After the prepared remarks, there will be a Q&A session. [Operator instructions] Thank you. All participants will be placed in a listen-only mode. This call is also being recorded, and your participation implies consent to our recording 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. Blau. Please go ahead, sir.

Good afternoon, and welcome to a financial overview of our second quarter of fiscal 2007, which ended on March 31st, 2007. I am Harvey Blau, Chairman of Griffon Corporation's board, and with me is Griffon's EVP and CFO, Eric Edelstein. I will discuss the overall results of the quarter, and then Eric will answer questions with respect to operations and financial results.

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

We're very pleased with Telephonics' results, and our Specialty Plastic Films segment continues to make progress. However, the severe slowdown in the building products market has had an impact on our Garage Door and Service and Installation businesses beyond which we anticipated. Needless to say, today we will discuss steps being taken to improve the operating results for these businesses while waiting for the business environment to strengthen.

Consolidated net sales for the quarter were $387 million, up from $366 million for the second quarter of fiscal 2006. Pre-tax income was $700,000, compared to $11.5 million last year. Net income of $300,000 for the quarter, compared to $7.2 million, resulted in diluted earnings per share of $0.01, compared to $0.23 last year.

Telephonics, our Electronics Information and Communication Systems segment, had sales in the quarter of $124 million, compared to $72 million last year, a 72% increase. Telephonics' operating income was $12.4 million, compared to $4.8 million last year. Overall, Telephonics had an outstanding quarter, driven by increased revenue from the Syracuse Research Corporation contract and the MH60 helicopter program. The $52 million sales increase in the quarter reflects increased SRC contract revenue of $36 million and MH60 revenue of $11 million. To date, Telephonics has received contract awards of approximately $345 million from SRC.

The United States Navy has placed orders for next-generation counter-ID device to increased suppliers other than Syracuse Research. Nevertheless, the possibility still exists that Telephonics and Syracuse Research will continue to receive orders of the currently specified devices from the ultimate customer, the U.S. Army.

The MH60 program continues to ramp up, as projected. The production range is expected to continue to increase, with an annual run rate of $100 million per year being reached in approximately 12 months. Based on the Navy's current plans, that range should be achieved for at least the next eight years.

Telephonics' other programs are also doing well. Customer expectations are being met, and opportunities to expand programs are numerous. Our backlog at March 31st, 2007 continues to run near an all-time high of $371 million.

Our building products operation had very disappointing results for the quarter. Traditionally, the second quarter is our weakest quarter for this segment. Seasonality, along with the declining market for new home construction and the home resale market resulted in weak operating results. Sales in Garage Doors for the quarter were $105 million, compared to $122 million last year, and had an operating loss of $4.6 million, compared to the prior year's income of $3.6 million. Garage Door sales in the quarter decreased approximately 13%, primarily as a result of sales volume decrease, partially offset by a more favorable product mix to more premium line doors.

The operating income decline was primarily attributable to the decrease in sales volume. Volume levels were approximately 20% lower than the prior year. Based on market intelligence, we believe our decline is in line with the overall market decline. It is not clear to us, or others, when the business environment will improve for our Garage Door business.

We did not anticipate the severity of the decline in new home construction in certain markets, and we did not foresee the slowdown in the repair and the renovate business. As these conditions have had a significant impact on operating results, we have taken steps to resize our operations for lower volume, including the substantial workforce reduction last week. In addition, we are [inaudible] other programs that we expect to lower operating expenses without detracting from customer service.

Our Service and Installation operation had sales in the quarter of $62 million, a decrease of $19 million over last year, and an operating loss of $4.8 million, compared to $1.2 million of income last year. The decrease in revenue is primarily attributable to decreased volume resulting from the weak national new home construction market and customer losses in our Las Vegas market.

In previous conference calls, we have spoken about customer change programs and the potential for revenue declines in Las Vegas. As we have not been successful in replacing this business with old and new customers, revenue has declined in this market. Approximately 60% of the sales came from flooring, with about 15% each attributable to fireplace and garage door sales. The decrease in operating profit is primarily the result of the decline in revenue and gross profit, along with operational inefficiencies in our cabinets business.

In Specialty Plastic Films, sales for the quarter were $100 million, compared to $96 million last year. Operating income was $4.9 million, compared to $8.9 million last year. Sales in the second quarter were positively impacted by higher volume in Europe and the effect of a weaker U.S. dollar in translated sales somewhat offset by lower selling prices for our major customer and an unfavorable product mix. The $4 million decrease in operating income was primarily the result of low selling prices somewhat offset by the favorable impact of the payout of the resin cost increase. We are continuing to roll out our new elastics product. The timing for the ramp-up in volume has been somewhat delayed.

On a positive note, we have made excellent strides in improving our operating efficiency. Also, our strategy to diversify and grow our Films business with new products and customers and enter geographic regions with higher growth is working. The cost of resin increased approximately 10% in the quarter, primarily in the months of February and March, and there is pressure to move the price of resin upward in May and June.

With the continued pressure on operating margins, we are taking steps to optimize our Specialty Plastic Films, and we anticipate actions that will significantly reduce operating costs. Consolidated cash flow user operations was $14.7 million, and we continue to support the growth of our businesses with capital expenditures in the quarter of $9.4 million and $17.1 million user fund acquisition, all of which was funded by available cash balances and the proceeds from the issuances of long-term debt.

Our balance sheet at March 31st remains strong, with working capital of $348 million and total indebtedness representing 30% of capital. We continue to fund our common stock purchase program. We used $1.2 million in the quarter to acquire 50,000 shares of stock.

In addition to the operating actions being undertaken by the company to address the current challenging market environment in the building products segment, the company has retained Goldman Sachs & Company to assist the company to evaluate the components of our business, our capital structure and other potential strategic alternatives. No decision has been made by the company to pursue any specific course of action at this time.

We would now like to take questions.

Thank you. [Operating instructions] We will pause for just a moment to compile the Q&A roster. [Operator instructions] Thank you. Your first question is coming from Bob Labick with CJS Securities.

Good afternoon.

Hi.

Hi. I had a couple questions. First, just starting with Doors, if you could, hopefully, just elaborate a little bit on two things. I guess you said obviously it's difficult to see the longer-term outlook on the top line on the sales. You're partially through the quarter. What are your views on the rest of the year in terms of generally where sales should turn out? And then the second part is you mentioned some examples of cost cutting and savings on SG&A; can you give us a sense of the annual savings that you may get from the actions already taken?

Firstly, let me say this to you, Bob, because I know you know the business pretty well. This is not a backlog business, so it's very difficult to project what sales are going to be. Also, when you think in the beginning of the year what your sales are going to be and then the sales do not come through, they have, obviously, an immediate effect on your operation. This is not, as I said, a backlog business. It's hard for us to project what's going to happen as the year unfolds. We are hopeful that the second half of the year is going to be significantly better than the first half, and that's going to depend on some help by the economy and by the housing business and also weather and other related items. We are prepared to deliver and install and service, and what we want to do is see if there's a market that comes back and a demand for the doors. Now, as far as the cutbacks, they were significant, of personnel, and we are continuing with other consolidations of machinery and plants, and we're looking at every aspect of the business to make it the most efficient, lowest-cost producer so that we can maintain gross profit margins.

Okay. Moving to Films. Your operating profit was pretty good in this quarter, certainly relative to even last quarter. It improved a little bit, so you're getting the gradual improvement there. Sales were down, however, sequentially. Could you just give us a sense of the change there and your private label sales coming on and just the outlook for the top line there?

As you pointed out, it was a good quarter relative to margin. On average, our business is stronger in Europe than it was in North America, and North America is probably the key relative to the first quarter in terms of the decline. And the resin for the quarter had an impact, both on revenue and cost, helping to increase the sell price or the pass-through for about $2 to $3 million.

Great. And then, I guess, just moving to the Telephonics. Obviously, it was helped with the MH60. Can you talk a little bit about the overall core business, excluding Syracuse? We've talked plenty about Syracuse and the opportunities we're still, as you said, waiting to see if there's more on CREW 2 or CREW 2.1. But excluding that for the moment, could you discuss the remaining core business outlook there?

Sure. The first thing to start with, as Harvey mentioned, is MH60, the [lands] program. That's moving along nicely, and we do expect that the full rate production schedule will result in us being at an annual run rate of about $100 million a year about 12 months from now. There are also a number of other things involved with that program that haven't been completed yet, but we're working on, and we're hopeful even that program will grow.

Besides the lands program, we continue to both land new awards, new contracts, as well as incremental funding on current contracts. That would be both in our radar and communications business. Some of the customers that are involved are Sikorsky, Boeing for the C-17, [McDonnell Douglas] for the CP140, and in the radar area, [Inaudible].

Okay, thank you. Last question, then I'll get back to the queue. In past calls, you've been really candid with strategic options, with strategic alternatives, mentioning potentially bolstering Telephonics to be able to spin that out or things like that. Could you give us a sense of some of the options you're exploring or thinking about in terms of strategic alternatives? And also, it seems like some of the problems, certainly in the quarter, could also at least appear temporary. Is there any reason you're looking at strategic alternatives now as opposed to waiting until some of these abate to where you could probably get better results out of those divisions?

Let me answer you in this way. We have traditionally had a number of advisors calling on us and speaking to us about simple alternatives that we can do, and we've been looking at a number of them. We've been looking at the tax implications, we've been looking at the [tax leakage] implication, what the company looks like resulting if you do sell something or if you added something. We have now basically gone to the next level on this, and we have hired Goldman Sachs, and we have turned over the job to them to analyze all the different operations of the company, which they are doing, and come back with proposals for us.

Okay. Thank you very much. I'll get back in queue.

Thanks a lot.

Thank you. Your next question is coming from Marty Pollack with NWQ Investment Management.

Yes, just a couple questions. One, back to the Specialty Plastic business. I recall, I think, at the previous conference quarter, the question came up about what are sort of the band of margins longer term, and I think the number was mentioned of 8 to 13% as sort of a band for that. Is that number still a number that you'd be comfortable with? Clearly, you have -- 13% would be, obviously, during extraordinary times, but it seems like high single digits are still suggested as an opportunity.

Yes, Marty. Actually, my recollection of the way it was posed was, given some of the things that we were talking about three months ago, the question was would 7 to 12 maybe be more in line than 8 to 13, and in some respects we might be splitting hairs here, but I would have to say 7 to 12 probably would make more sense as a range, and I think you are accurate in saying that, yes, there's a high part of the range, and we have to have things working well, and we need to have that part of the cycle where our new products are hot as opposed to things that our competition is also offering.

Secondly, you mentioned SRC, at this point, I guess, has not seen an order for CREW 2.1, but there have been three others -- I believe EDO is one of them -- that have received some significant orders. Can you just comment about the issues there? Is there any particular reason why SRC has been more, say, in front of the line? And it's probably possible, as you say, we'll still get an order, but would you describe this as a little disappointing at this point?

Well, definitely we are disappointed in that. First of all, we're disappointed that they were even talking about CREW 2.1 because the customer seemed very happy with CREW 2, so we didn't think that the CREW 2.1 was even in the cards. Now, you have to understand what's happened here. The original contracts out of the Department of Defense were through the United States Army. The United States Army was the user as well as the acquirer of the equipment, and they have, of course, approximately 17,000 to 20,000 of these units. The Department of Defense decided to turn over the procurement of these units to the Navy, and the Navy made their own evaluations and went along with EDO Corporation, as we understand it, for these contracts and did not give any of the business for CREW 2.1 to either the SRC, which was making them for the Army, and the company making it for the Marine Corps, which was General Dynamics, I believe, and they went with new companies -- not new companies exactly, but whatever new technology they were going to buy from these other companies. The question is going to be -- and we don't know the answer -- whether the Army is going to want to be buying more of these units for their use until the new units come on train or whether or not other awards are going to be made in this area. But right now, they're [inaudible]. Remember, we are not the bidding company. We are subcontracted [inaudible]. They want the competition, and the bottom line of it is, yes, we are disappointed.

I guess is there any technology issue at all to address, or are you comfortable? Do you think that 2.0 was your basic product that was --

The customer was comfortable with the unit and with the way the units were operating in the field and gave us a number of awards for supplying them timely and for the units working in the field. I do not know why they decided to go either with a -- and I don't even know the nature of their technology, but I do not know why they decided to go with another technology when they have all these units out in the field. That was the Navy department's decision.

Thank you.

Thank you. Your next question is coming from [Sahid Fadid] with [Gabelli & Company].

Hi, good afternoon. I have a few questions. One, on the Goldman Sachs involvement. Is there a timeframe that you have in mind?

Well, the timeframe is current. They're working on it. They are analyzing the various alternatives that are available, and they will report back to the board.

Okay, but there's no timeline at this point, that they have to get back by a certain date?

No, but they're on the job, and they're working on it, and they've been retained, and they're working on the problem.

Okay. And then the second question is somewhat related. Why did you choose Goldman at this point, when things have really turned negative? Why did you guys not pick someone, let's say, last year or six months ago, even?

I'm sorry, would you repeat that?

Why did you end up picking up Goldman Sachs at this point, when housing, when garage and installation services have really gotten very weak? Why was picking up Goldman Sachs not done last year?

The answer is that we have been speaking to them for some time, and they've been observing the market and the decline in the industry and have been working with us for some time on this issue and on the related other issues for the company. They have now been officially been on and have made first appearances for the board, and I expect to see them at least at the next board meeting or earlier.

Okay. And then, on Garage Doors, I know that in Q1 your sales fell about 10%, but you still made about $4 million in income, and in this Q2, your sales fell 13%, and now all of a sudden you have gone from $4 million positive to about $5 million negative income. Why such a drop off in the income when the sales are really comparable to Q1 -- slightly worse, but not that much worse? Why such a sharp downfall in the income?

Well, you're comparing sequentially.

Yes, yes.

If you'll compare to the prior year, the relationship will be a lot more in line.

Okay, yeah. I just looked at it; that makes sense.

Now, keep in mind, the second quarter is our toughest quarter, and there is an impact when the sales decline. The ability to absorb our fixed overhead is obviously not as strong and does impact the margin that much more.

Okay. And just a last question, also on Garage Doors. How much of the performance would you quantify as, I guess, market-driven, and how much do you think is execution? Are you able to quantify that, or not?

As you might guess, we've spent a significant amount of time on it. I mean, as Harvey pointed out, we're not happy with the result, and so the obvious question is the one you just posed, and we truly believe the business is off because of the market. You never can say 100%, but from all indications, our volume drop off is in line with what we believe others are experiencing.

Okay, thanks a lot.

Thank you. [Operator instructions] Your next question is coming from Tom Spiro with Spiro Capital Management.

Tom Spiro, Spiro Capital. Good afternoon.

Hi, Tom.

Hi.

Hi. Couple of questions. First, on the Garage Door business, a question about its history. How has it performed in other difficult periods of, say, housing starts at 1.5 million? Has it been able to run in those periods at a profit, or not?

Yes. This is the first time, in my memory, that when there's been a downturn in new construction, there hasn't been a maintenance of the rehab part of the marketplace. And actually, if you go back, way back, back to the '90s, early '90, we actually did very, very well in the rehabilitation market, because 80% of our business -- 75 to 80% of our business is in the rehabilitation market, retroactive of existing home starts. This market is the strangest market as far as we're concerned. We cannot exactly figure it out. What's happened is that people are not selling homes. As you know, there's a huge bulk of unsold homes. If they don't sell homes, they don't buy homes. If they don't sell homes, they don't fix up their homes in order to prepare to sell it, or the new person comes in and buys the older house who normally comes in and rehabs the house. So none of that is going on, so for the first time in our business cycle, we have found a huge fall off in the rehabilitation market during the time of a downturn in new construction.

I wonder if there's anything of a structural nature that has changed within the business, for example, or it's a fixed cost as a percentage of total costs immediately higher than a few years ago, or is it basically running with the same fixed versus variable?

Are you talking about us?

Yes.

It's basically the same. There hasn't been any structural change.

Okay. Secondly, on the plastics business, I know we have one significant customer. I think we recently signed a contract with that customer. If you should decide to do something of a strategic nature with that business, is there anything in that customer's contract that might prove difficult?

No.

Okay. And finally, what's the company's capital expenditure and the acquisition spending plans for the balance of the year?

It's consistent with what we've been saying in the past, and that is that overall, we would expect capital expenditures to be about $40 million for the year.

That's before acquisition spending?

Correct.

Do you have any other acquisition spending we need to think about, or are you pretty much done for the year?

We're opportunistic. We certainly don't announce ahead of time. We frequently are looking at opportunities, and we fund them as they come up, and so there is no reserve or plan at this point.

And that's one of the reasons we hired Goldman, is that purpose, to look for situations for us.

Would it be fair to say you're approaching acquisition spending with somewhat more caution today than six months ago?

Absolutely.

Absolutely.

Thanks very much.

Okay.

Thank you. Your next question is coming from Marty Pollack with NWQ Investment Management.

Yes, if I may, just back to what you describe as right-sizing of the businesses, primarily, I guess, Installation and the Garage Door. Could you quantify the number of employees and costs overall that you're taking out of the businesses? And secondly, are there any management changes that are likely to take place or have taken place? It seems that clearly there's a dramatic shift, and that has affected the business. Are you looking for other answers within the organization or some changes on the management side?

Okay, firstly, I cannot answer specifically the number of people or other things that are sort of internally confidential for the company. It would not be helpful to us, and probably wouldn't help you either. But let me say this to you: we have analyzed the marketplace, because we take this very seriously, this downturn, and we believe that when the market does come back -- and we do believe it will come back -- it may not come back as large as it was when it ended in 2006, so we have taken steps to cut down overhead of people, machinery, factories in order to be able to deliver our product and be able to service our customers commensurate with what we think will be a slightly smaller overall market. And there are no changes being made in any of the senior management positions here because we've come to the conclusion that this is a situation in the Garage Door business that is cyclical, that is outside of our control, it affects the entire market, and if you read the newspapers, you'll see that customer reports are coming out by builders and other people in this industry, all showing huge declines.

Yes, just thank you. And then lastly, with regard to cost reduction issues, any action contemplated specifically for the Specialty Plastics business, or essentially things are tracking along your own expectations? Obviously, they're not going to be in the beginning, but possibly later on you're expecting margins to be normalizing higher.

We are looking at the margins in -- we have looked at the margins in the Plastic Films business; we are unhappy with them. It's a competitive business, and so therefore we are reviewing all expenses and all costs that are in the operation, and if we find anyplace that we can make cuts, we will.

Thank you very much.

Thank you. I'd like to turn the floor back over to Mr. Harvey Blau for closing comments.

Thank you very much. If there are any further questions that anybody wants to ask us, you can call us in our office in New York and we'll be happy to speak to you.

Thank you, and this concludes today's Griffon Corporation's second quarter 2007 earnings call. You may now disconnect your lines, and have a pleasant day.