Watsco Inc (WSO.B) 2002 Q1 法說會逐字稿

Good morning. My name is [_______________], and I will be your conference facilitator today. At this time, I would like to welcome everyone to the first quarter 2002 results 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. If you would like to ask a question during this time, simply press “*” then the number “1” on your telephone keypad and questions will be taken in the order they are received. If you would like to withdraw your question, press the “#” key. Thank you. Mr. Nahmad, you may begin your conference.

Good morning. As the operator said, this is Al Nahmad. I am the CEO at Watsco and today I will conduct this conference call with Barry Logan, Watsco's Chief Financial Officer. We will cover four topics. The first is the first quarter results and for those you who don’t know it, we issued a press release this morning on the first quarter results. The second topic is the bank refinancing for which we also issued a press release yesterday which was concluded last Friday. The third topic will be an update on the Whirlpool initiative, which those of you who follow Watsco know is a very exciting thing in our future, and fourth we will present our view of an outlook, but first let me read a cautionary statement. Please remember that this conference call has forward-looking statements as defined by a SEC laws and regulations and are made pursuant to the safe harbor provisions of those various laws and regulations. Ultimate results may defer from forward-looking statements. Now, with that behind us, let me first set the parameters for this. I want to remind all of you that the first quarter is always Watsco’s seasonal low point for the year. We are in between seasons that is we are between the air conditioning and the furnace selling seasons. Now on to the quarter. We are pleased about the first quarter results for three reasons. First, we’ve overcome once again on favorable weather and economic conditions. Second, you will see if you have already not seen, the efforts to improve efficiency of the company are working, and third, our cash flow continues to be very strong, in fact, we reduced debt by $56 million over the last 12 months and I am very pleased with that. Lets move on to the revenues. Revenues for the quarter were $257 million that seems to be in line with the industry. I understand that Carrier has reported a 9% decline in revenues and ICP, which is a subsidiary of Carrier at 11%. There is no question that the first quarter for the industry, we believe, is soft. Dunhill is still operating in a soft staffing market and also just to remind you, we have 12 fewer of distribution locations and 6 fewer staffing locations this year than we did last year. Moving on gross profit dollars were at $63 million and gross margins were at 24.5% versus 24.7% last year. We took a closer look at that and we realized that this year because of the environment that we are in, we had fewer preseason orders and rebates. Now, if you perform at those two things, preseason orders and rebates took them out of both years, we actually have a gross profit margin improvement of 20 basis points for the quarter, which is in line with what we seem to be doing quarter after quarter improving our margins. SG&A expenses were down to $5.8 million or 9% as cost continued to come down, and the overall profit margins for the quarter was $6.6 million. Taking a little closer at the overall number, we look at distribution operating margins and they were up 40 basis points to 3.7% and we are pleased with that performance for this time of the year. Dunhill losses cost us a penny during the quarter, and one more thing I want to make sure you understand that the results for this year include $600,000 after-tax benefit from goodwill accounting change under FASB 142. Interest expenses were down $1 million on 37% lower borrowings, and on cash flow, the first quarter is always a period when we build up inventories in anticipation of the summer selling season that takes cash flow, but as I said earlier, we are very focused on operations and improving our efficiencies, and this year we had a positive impact on cash flow of about $16 million. Enough to be said that I expect 2002 is going to be another strong year for cash flow. Moving on to the bank credit agreement - we completed the refinancing of our revolver last Friday, and the details are in the press release that we issued yesterday. Just to touch on some high points here is for $225 million which is down from $315 million because we do not need this much given our cash flow. It is a three-year agreement and pricing is based on LIBOR rates. Our debt at the moment stands at $100 million, $70 million onto the revolver, and $30 million onto the private placement with prudential. So, we have plenty of capacity to make acquisitions and to finance our growth. Moving on to the Whirlpool initiative, just a reminder, we have signed with them a long-term agreement to be the exclusive user of their brand in the HVAC industry. We have found as time goes on that Whirlpool and their people are just wonderful people to work with. They are very enthusiastic about this initiative and engaged very well with us. What we are presently doing is contacting and getting proposals from manufacturers who are going to make the product for us under the Whirlpool brand. There are seven OEMs of manufacturers in this industry, five of which have made proposals and are being evaluated. So I am very pleased that manufacturers want to participate in this initiative. Following the selection of the manufacturer, we will go ahead and develop our sales and marketing strategy, and as we said earlier, we are going to roll this product out sometime in 2003, and not to be said we think this is very exciting for Watsco as it will give us a national brand for the first time that we can sell it throughout the United States. Lastly, on our outlook, we will continue during the rest of the year to focus on operations. We still think we can get much more efficient, and I also believe that the softness in the industry in the first quarter will not repeat itself in season during the next two quarters, which is whenever in the season the second and third quarter. Our guidance remains the same at $1.18 to $1.22 for the year and that includes 8 cents from the FASB 142. In terms of cash flow, we expect that we will equal our net income or beat net income in terms of positive cash flow. With that information in background, we will open it up for questions and Barry and I will be happy to answer them as best we can.

At this time I would like to remind everyone in order to ask a question, please press “*” then the number “1” on your telephone keypad. Your first question comes from Martin Sankey.

Good morning Martin.

Actually it’s [_______________] sitting in for Martin. How are you?

Hi [_______________].

Can you talk about what you are seeing in terms of inventories?

I think there’s been a reduction of inventory in the distribution channel everywhere. We are certainly one of those. We reduced our inventory double digits. I think part of that is based on softness last year and softness this first quarter in the industry, but I also think corporations especially Watsco is getting better in inventory management, and we can anticipate a slow industry as well as expanding industries, so to answer your question, I think it’s just down everywhere. Barry?

I would agree with that [_______________]. I think it’s not just being conservative running into the season and playing it close to the rest on simply [_______________]. I think the distribution channel is better at managing inventories. I know that we are and also the OEMs are getting better and have got better at that lead times which helps takes some of the inventory out of the channels, so I would expect inventories to be down and believe that they are.

And moving on to cost reduction, can you give us an update on what’s going on there in improving efficiency?

Well, our overall goal as we have stated it earlier in our discussions is to reach 8% operating margin from something like 5% and that focus is on a number of initiatives which is to first eliminate branches that were because of acquisition programs superfluous to our infrastructure. We pretty much got that behind us in the elimination of also on profitable branches, and then we move right down all the different cost items, we are the largest in the business, and we are able to take advantage of size when we deal with our vendors and we think from people that supplies, with product, for resale to people who supply with services, insurance, telephone, and all the rest of it, so that is why G&A and selling was done 9%, and I think we still have a lot more to go as we continue to take advantage of our size and our focus on operations, so once again we would like to get the 8%, we think we can from the rest subsidiaries are operating at over 8%, and some of course are operating below 8%. Barry?

Yes, something I have looked carefully at is how much of our SG&A savings have come from simply having closed branches, and how much from, what I would just term heavy lifting in our businesses and actually most of the savings are coming from heavy lifting in the subsidiaries, so that tells our existing businesses are being well managed and closed branches have helped the picture but actually most of it is coming from simply better management on the field, and we know they are not done yet. .

Okay. And in manufactured housing, can you tell us what you are seeing there?

Manufactured housing, as you know, [_______________] because I know you listen to these quarterly conference calls, we thought had bottomed out in the fourth quarter of last year. We actually showed a little bit of same-store sales gain. In this quarter, we showed a same-store sales decline and we are the largest in that segment distribution of air conditioning to manufactured housing, and as best as we can determine it’s directly a result of lenders quitting the consumer financing of manufactured housing, more lenders I should say quitting in the first quarter. So there is a period of adjustment going on there. The yields to lenders are increasing because there are fewer lenders there, so we expect that lending capacity will catch up sometime during this year and in fact we will have bottomed out, and after a long decline, I think it’s over two years now, we start climbing back.

All right. Thank you.

Goodbye.

Your next question comes from David Manthey. +: Hi, good morning guys.

Good morning.

I was wondering if you could help me on a definition here, is that -5% over year over year organic? Is that same store excluding the store closures year over year?

Right. That's correct Dave.

Okay. All right and the, as far as Whirlpool goes you say that you are in track for the 2003 launch, as you move forward here, and if there is sales and marketing and training and inventory build, are there costs that you are bearing or are many of the costs being paid for by either the OEM or Whirlpool or someone else?

Well, this is a developing picture. It's a good question. At the moment we are bearing all of the cost. We have organized a first class team to deal with it, and we are taking senior, seasoned people to be part of that team, and that's a cost we are absorbing. David, I don't think it's a huge cost. I wouldn’t want to misrepresent it, given our, we are over billion dollars in revenues, and as time goes on when we get into the marketing programs and into the inventory issues that you have raised, we will see how that develops. We are finding manufacturers more than interested in helping us in all of those areas. It is just exciting to see, David, how the manufacturers really want to participate in this program, it confirms our idea that this is going to be a big situation for us, big revenue and profit generator for us, just by the enthusiasm of the manufacturer. And also we are getting, not many, but we are getting contractors that are sending letters or contacting us and asking for product availability.

Okay. One last question then on the SG&A. If we look at last years SG&A level by quarter, the first quarter was kind of the peak and things went down from there, and I know there was cost cutting and restructuring and things that may have driven that down, but as we look at this year and we progress through 2002, should we expect that SG&A is flattish or will it at the back half of the year start moving back up?

Well, we hope the selling part of the SG&A goes up, so that’s directly related to revenues.

David, no I would expect because first a good portion of our SG&A is variable. So some of the reflexs there is dependent on sales, but as Al suggested, some of the hard infrastructure costs that are fixed are the ones that are also being, I think, better managed, and we should see declines, we will absolutely see declines. So I think that the notches that we have seen in decreases will continue through the year, and as Al said it would be a nice problem to have if we see some increase in our variable expenses because of the top line.

Alright, let us hope so. All right, thank you very much.

Goodbye.

Your next question comes from Michael Hagan.

Good morning Mike.

Good morning guys. Real quick, in the projections that you gave did you stipulate what you think sales will finish for 2002?

Barry.

Mike I am trying to go back to where we started in the year in terms of our guidance. I don't believe we have given specific guidance on top line really because the, trying to crystal ball it and sorting, seeing how the year will sort out, I think is difficult. I think that we have actually been really flat on any guidance for sales and focused more on what the operating margin picture, cash flow looks like.

We hear a lot, Mike, I hear that a loss in the manufacturers. I don't buy any of that picture. I know that the industry is down in the first quarter, but this is intuition more than it is scientific. This industry has never had three consecutive years of down sales. We are into our third year now. I just think that if weather normalizes, we have a regular summer season, we are going to have growth in the industry, and growth in the industry, certainly we have always grown faster than the industry so I would expect we are participant in that, but that is more as I said, see to the past and if there is any signs out there.

Absolutely. Question on what you are seeing at your vendors, has the impact on steel prices deep down at the early manufacturing level, has that come up in conversations yet?

Mike, we have had no inflationary pressures whatsoever anywhere.

Okay.

In anything we do.

But would you at least admit that that’s very viable possibility?

I don’t know. It’s pretty competitive out there and these manufacturers seem to be dropping prices, not increasing prices even as we speak.

Mike, again that would be a nice problem to have because frankly if there is inflationary pressure on our price, we get to be merchants and have an impact on our price to the market which can actually help the profit picture, and help margins, but there is not a lot of pressure going on.

It could be that the manufacturers, Mike, are observing this for now.

Right, and what I was trying to get out was, is there are any strategic buying opportunities now? Frankly, we are, I mean, the fact that steel prices are firm and are picking up, that’s reality. Number two, you guys are saying, well, we are not most certainly that we are seeing an uptake but we believe that we are going to start recovery and start seeing some growth this year. So I would say that both of those issues suggest that pricing, not only pricing that you will get from vendors, but pricing that you can therefore pass on, should start increasing and so you now have an opportunity to say, hey, let us get in front of that phenomena and stock up on some pretty cheap inventory and then capture better growth coming forward.

No, I understand the concept and trust me, we are always working with manufacturers to see what programs they can offer us to do exactly what you are saying. Some of them participate in a way that does not cost us and some of them are thinking about it, but as the largest buyer of this product. We are on everybody’s radar screen when such an initiative is opted by the manufacturer. But I must say, I don’t see anything currently, may be that will change. Manufacturers have basically, in some cases shutting down capacity and I hope you have read the Carrier they bought ICP and now they are shutting down [_______________] which is a huge plant for ICP and moving their production on to carry facilities and so there is that issue of capacity. I hear what you are saying and I am certainly alert to it and we are certainly the one they are going to come to first because we are capable of doing real numbers for manufacturers.

and Barry I guess I will direct this to you, the 8% long-term goal, A) Have you specified a time range for that? And then B) Where do you think it is easiest to get to that 8%?

Goal time frame, Michael, is always dependent on the team that we have in place and I have said this before and Al said that before that we think that we have the best team in place to push that number higher than we have had, and the first quarter is a decent start, and we will know more as the year goes on. So, we know this, the team is in place time frame wise its going to take some time needless to say. If you have fun with numbers and grow our operating margins just 50 basis points for any period of time it's terrific growth rate. So, time will tell that, but it is there because as Al said we have businesses over 8%. So, the other side of it is where will it come from? Well gross profit is a source, but it is not the source because again the market is efficient in terms of pricing. We think we are better, we can get a higher margin, but most of this is going to come really in leveraging our fixed costs, as well as just the infrastructure we have. More revenue, more products, more growth, better efficiency, cost management, all of that combining really and trying to keep the infrastructure cost as static as possible while the top line is something that we will drive that 8%.

I gotcha. So, at those branches where you do see 8% margins. If their gross margins might be a little bit better than "under performing branches," but it is really that the leveraging that they achieve?

A very specific example as one of our businesses when it was acquired was doing $60 million and is now pushing 200. It's operating profit was under 2% when it was purchased and it has pushed 8% limit at this point, and the reality of that growth curve is that it all happened in the same counties in the same state. It never expanded outside of its original territory. So the prototype, the business model, and the performance can be looked at within our company today, and again it's just a matter of having the right team in place elsewhere to push that kind of performance through. It is achievable.

Okay, all right. Thank you.

Your next question comes from David Mitchell.

Good morning.

Good morning, David.

I've got a couple of questions. Just Al back to your [_______________] forecast there for the second quarter and third quarter pickup, I mean, are you seeing anything now, we are starting from three weeks through April, is there any indication....

Okay. And then I guess the other question is you guys seem to remind us what the loss was in Dunhill last year, both in the first quarter and in the year, and what your action is expected to [________________] in the current year?

David, the segment information is in the press release. You can see the loss in Dunhill for the quarter of about 288,000 and for the year last year, at the top of my head it was just above breakeven, if I remember correctly.

The good thing about that David is that I think this year versus the comp last year is not difficult to meet or be. So, I think the negative impact from Dunhill will be nowhere as near as great this year as it was last year. Eventually, that staffing business strengthens and it contributes, but it is very small, some penny or two either way.

All right, good. Thanks guys.

At this time there are no further questions.

Very good. Thank you again for listening, and we will talk to you in the quarter. Bye-bye now.

This concludes today's Watsco Conference Call. You may now disconnect.