Griffon Corporation
Q2 2008 Earnings Call Transcript

Published: 15 May 2008

[Operator:]

Good afternoon. My name is Rose and I will be your conference operator today. At this time, I would like to welcome everyone to the Griffon Corporation's second quarter fiscal 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator instructions) Thank you. It is now my pleasure to turn the floor over to your host, Mr. Ron Kramer, Chief Executive Officer of Griffon Corporation.

[Ron Kramer:]

Good afternoon. Welcome to an overview of our second quarter. With me today are Frank Smith, our Chief Operating Officer; Pat Alesia, our Chief Financial Officer. I'll discuss the overall results of the quarter and then we'll answer your questions and we'll get an overview on where we are headed with the business. Before we begin, I should point out that to the extent that matters discussed in this 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. This is my first chance to talk to you as CEO and I do so at a very difficult time for our company. We continue to experience the adverse effects of the crisis in the U.S. residential housing markets, which has resulted in a decline in our installation services companies and our garage door business. Earlier today, our Board of Directors approved management's plan to exit the installation services business in 2008. As a result, we estimate the aggregate exit cost, including the operating and intangible asset write-offs, would range between $30 million to $40 million for the remainder of 2008, of which $25 million to $35 million is estimated to be non-cash. This action was taken after consideration of many factors, all in the interest of increasing shareholder value. Last quarter, we announced plans to address the most serious issues associated with the downturn. As a consequence, we focused on our weakest market positions while taking actions to maintain our historically strong operations. We discontinued operations in several markets, Atlanta, Fort Myers and Fresno, and we restructured several others in the second quarter. During this time, we continued to weigh the severity of this downturn, the likelihood and timing of market recovery and the strengths of our restructured operations. We believe the time is right to pursue selling the remaining locations, exit the business and focus on our core manufacturing-based businesses. I'd like to acknowledge the dedication of the installation services employees, the loyalty of their customers, and we're confident that the location teams will continue to provide industry-leading service. But for us, this is the right time to exit the business. Our Clopay garage door business, sales were – in this, our weakest seasonal quarter, were $84 million compared to $105 million last year. Garage doors reported an operating loss of $8.6 million this quarter compared to $4.6 million last year. Segment has been and will continue to focus on cost-reduction programs. I would like to say that we have every confidence in Gene Colleran and the management team of what we think is a terrific business in a very bad business cycle. We'll do all the things to protect our position as the number one brand for the inevitable upturn. In our plastic films business, sales for the quarter were $115 million compared to $100 million last year. The operating income of $5.2 million compared to $4.9 million last year. Higher sales resulted primarily from a favorable product mix and the impact of foreign exchange. However, operating income was unfavorably affected by lower unit volumes, higher revenue costs. It is estimated the negative effect of resin was $5 million to $6 million. Gary Abyad and his team have performed well in what we think is a very difficult environment, but we still have room for improvement in our international operations in Germany and Brazil. Finally, telephonics had sales in the quarter of $98 million compared to $124 million last year. Telephonics operating income was $7.1 million compared to $12.4 million last year, but the year-over-year, quarter-to-quarter comparison doesn't tell the story. Our business continues to perform quite well. The strong prior year results of telephonics were driven by the substantial contracts we had with Syracuse Research Corporation, which just were at a lesser level this year. Excluding the impact of the SRC contract in the respective second quarter periods, telephonics' core business sales grew by approximately $8.2 million or 11%. Joe Battaglia and his team have built this business as a preferred provider and have delivered solid growth. Our technology advantage is acknowledged by our customers and widely recognized by our industry competitors. Telephonics is celebrating its 75th anniversary and I think its brightest days are ahead. Our balance sheet on March 31 remained strong to meet both the operating challenges in our existing businesses and to reposition Griffon for future growth. There's much work to be done, but we have the ability and the desire to build shareholder value in the years ahead. With that, we'll take the questions.

[Operator:]

(Operator instructions) Mr. Kramer, your first question comes from the line of James Greeter [ph] of MVL Company.

[Ron Kramer:]

Hello?

[James Greeter:]

Hi, thanks for taking my question. I had a few questions. I guess the first was just with respect to steel costs. It moved up rather rapidly during the quarter and just wondering if, as that inventory flows through the garage door business, if you'll be able to pass that on to the customers in the residential industry, especially through Home Depot? And if not, how that might impact margins in the current quarter and the next quarter?

[Ron Kramer:]

What we're experiencing is the inflationary impact of steel in the garage door business and obviously, of oil and natural gas and its flow through into resin in our plastics business. The answer to your question is that, yes, the cost of our raw materials are going up. It hurts our margin. We intend to be able to pass through prices but, ultimately, the end consumer is under pressure and the ability for that to pass through to the consumer market still remains somewhat in doubt. But there's no question that we, like others, are going to have increased cost of production and we'll be passing that through to our retailers.

[James Greeter:]

I see. That applies on the polyethylene prices, I was going to ask you?

[Ron Kramer:]

When the price of oil is going up, you can expect the price of resin to follow, and vice versa.

[James Greeter:]

I see. Another question with respect to the garage business, it seems you will be closing the installation business. How will that affect sales in terms of your ability to push products through that channel?

[Ron Kramer:]

Good question. We've been very sensitive as we've explored how to go about selling and exiting the installation business to protect the intercompany sales that we have between Clopay Garage Doors and for service companies. The plan that we've developed will protect the approximately $20 million of intercompany sales from Clopay Garage Doors. So, we believe that we'll roll out some of the locations directly under Clopay Garage Doors' management, while exiting others into third-party hands with supply agreements.

[James Greeter:]

Okay. And just one last one on the pension. Are you planning on funding that this year? Or is the goal to keep it unfunded for another year?

[Ron Kramer:]

I'm sorry. What was the question?

[James Greeter:]

With respect to the pension, the company's pension plan, I noticed there is an unfunded pension program and I wasn't sure if that can be maintained or if there's a need to fund that.

[Ron Kramer:]

No plans to fund the pension plan.

[James Greeter:]

I see. All right, that's all I had. Thank you.

[Ron Kramer:]

Okay.

[Operator:]

Your next question comes from Bob Labick of CJS Securities.

[Arnie Ursaner:]

Hi, Ron. It's actually Arnie Ursaner. Not Bob today. How are you? Welcome. A quick question actually on specialty plastic films. Obviously, you were impacted by dramatically higher resin costs in the quarter. It doesn't look like you were able to fully recover those at all.

[Ron Kramer:]

We think we had a very good quarter in plastics. We would have had a better quarter if resin prices were lower. But the reality is, we're subject to the same cost pressures that others are.

[Arnie Ursaner:]

But the relationship –

[Ron Kramer:]

The lag effect of the resin increase is going to continue to have an impact both positively and negatively.

[Arnie Ursaner:]

My understanding though with your relationship with your customers is that you were generally able to recover higher costs with some modest lag. Is it something we are likely to see in the next quarter or two?

[Ron Kramer:]

As resin prices continue to go up, you're never going to catch up the lag. And the outlook for resin prices is murky at the moment.

[Arnie Ursaner:]

And the refinancing you have with Clopay, how do you intend to perhaps use those funds? Can you give us a feel for what you hope to gain with the refinancing with Clopay?

[Ron Kramer:]

Yes, what we're doing is to be able to tip [ph] the – what was $175 million of Griffon parent company debt, which we've successfully put $100 million at the telephonics subsidiary at the end of March, so in the second quarter. We're in the process of discussing an asset-backed loan on Clopay. What that would be doing is replacing the credit facility that we previously had at the parent company level. So, the use of proceeds is to fund the development of our businesses directly secured by the assets of the subsidiary, and to provide the liquidity for what could be future events both in our capital structure and as we look to grow in the next few years.

[Arnie Ursaner:]

And final question from me. I know at least a partner you've been involved with in the aerospace side. I think you've partnered up with someone who has a fairly sizable program that's just rolling out – Lockheed, I believe it is. Can you perhaps comment on some of the opportunity that may present to you for the next year or two?

[Ron Kramer:]

Could you repeat that question?

[Arnie Ursaner:]

It's either Rockwell or Northrop. You have a pretty sizable relationship –

[Ron Kramer:]

Are you talking about the VIS-X Program?

[Arnie Ursaner:]

Yes.

[Ron Kramer:]

Okay. Yes, we've a teaming agreement with Rockwell Collins for a sizable program that's in process, where we expect to be one of the competitors on a $3 billion program that will go for selection later this year sometime and expect it July or August.

[Arnie Ursaner:]

To the extent you are the winner, can you give us any feel for the possible revenue contribution over the next 18 or 24 months?

[Ron Kramer:]

We don't give guidance. This is a visible contract. We're always looking at various arrangements. So at this point, I think it's premature to talk about what the impact would be. We're going to do our best to try to win this contract and there's plenty of others in the pipeline.

[Arnie Ursaner:]

Thank you very much.

[Ron Kramer:]

Okay.

[Operator:]

Sir, your next question comes from Marty Pollack of NWQ Investments.

[Marty Pollack:]

Hi. I wonder if, Ron, you could give us an idea of the expectations on the seasonal impact of the garage business because, clearly, this is a point where – in the cycle or in the season that's going to be the worst part. Do you see cost reductions having been impacted by the current environment? I'm just wondering if you look at seasonal pick up and then cost reduction benefits – should we be expecting – can you give us some guidance in terms of what could be the improvement? I recognize that you can't forecast the economy, but at least seasonality, getting a better handle on that?

[Ron Kramer:]

Yes. I guess the second quarter has always been the weakest for garage doors. What I would say is that the visibility of the future upturn in historically the third and fourth quarters is somewhat more difficult because of the economic environment that we are in. There's no question that the management team has been right-sizing the business and we announced previously a cost reduction program, which is impacting throughout the balance of fiscal 2008 of $12 million, $13 million, which is ongoing. We're at the point where we think that the right-sizing activities have happened or are in process of happening, by plant closures and consolidation into our Troy facility. So, the ability to benefit from the upturn really is dependent on the flow-through at the retail level and through our dealer network, which is basically a forecast of what the consumer economy is going to do for the balance of this year. So, I think clearly seasonally this is when it starts to get better. We are optimistic. One month doesn't make a trend, so look at how things evolve over the balance of the quarter.

[Marty Pollack:]

Yes, as far as the cash flow impact – is seasonally or are we approaching a period where you need more – your working capital requirements go up, so that in a sense, do you have a inability to – or in a sense the offset of a pick up is it from a cash point of view, we may still have to wait before we see much improvement?

[Ron Kramer:]

Yes. I think the question is really, is there any working capital problem as we go into the pick up or lack of pick up, and the answer is no.

[Marty Pollack:]

Okay. And just one last question. In a sense, your commentary about specialty suggests that you believe you guys are doing fairly well during these very difficult conditions. Obviously, the lag effect because of resin might continue, so it's not clear that you're going to capture that in the next quarter. Should one assume that if you look at the $6 million, $7 million of penalty that – now that you would add it back necessarily immediately, but in a sense, if you took away that penalty, clearly the margins would look significantly healthier.

[Ron Kramer:]

Yes.

[Marty Pollack:]

In terms of how might you look at it. So I'm just wondering whether – does specialty have the capability therefore in a sense, coming back to the near-teen-type margin if things get normal, or when things get normal?

[Ron Kramer:]

Yes. We're not going to forecast, but what I will say to you is that we think that our Germany and Brazil operations can be more efficient and be better contributors, which would have the impact of improving our overall consolidated margins. So, there is room for improvement both domestically somewhat, but more importantly internationally.

[Marty Pollack:]

Thank you.

[Ron Kramer:]

And that's where our focus is.

[Operator:]

(Operator instructions) Your next question comes from the line of Carlos Berastain [ph] of LCG [ph].

[Ron Kramer:]

Hello?

[Carlos Berastain:]

Hey, guys. I hate to get back to this, but just another question on steel, because the vertical escalation in steel is kind of a relatively new phenomenon, at least in '08. And I just am curious as to if you've actually been able to get that pricing through to Home Depot and just your other customers, just given kind of the weak demand, the troubles that those guys are facing?

[Pat Alesia:]

We have passed this price on to our customers, and I think Ron earlier indicated that it's an open question yet whether these price increases will stick.

[Carlos Berastain:]

Okay. I was just curious if you were talking about to the ultimate consumer or actually just to your customers. So, it's not like there's a little bit of a question if they're going to actually stick with –

[Pat Alesia:]

No. This is an industry-wide phenomenon. And the question is whether the industry is going to stay together or whether we're going to have to react to competitive situations.

[Carlos Berastain:]

Okay, all right. That's great. Thanks, guys.

[Operator:]

There appear to be no further questions. At this time, I would like to turn the floor back to Mr. Ron Kramer for any closing remarks.

[Ron Kramer:]

Okay. We have got a lot to do, as I said. We will look forward to reporting as we make progress on our strategic plan. Thanks for joining us.

[Operator:]

This concludes today's Griffon Corporation conference call. You may now disconnect.