Watsco Inc (WSO.B) 2003 Q4 法說會逐字稿

Good morning, my name is Wes, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Watsco, Incorporated fourth quarter and year end 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. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad.

If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the conference over to Mr. Al Nahmad. Please go ahead, sir.

Good morning, this is Al Nahmad. I am the President of Watsco. And with me, as always, is Barry Logan, the company's Senior Vice President.

Before we get started on our conference call this morning, let me just read a reminder. This conference call has forward-looking statements as defined by SEC laws and regulations that are made pursuant to the Safe Harbor provisions of these various laws. Ultimate results may differ materially from the forward-looking statements.

Watsco had a great year in 2003. Our best ever. Profit margins expanded, setting new records. Revenue grew at a nice rate. Cash flow exceeded net income again. We paid off more debt. We increased our cash dividends. We expanded our footprint, particularly in Texas, which is the industry's largest market, where we added a large number of new branches.

Our employees are receiving more training than ever before, and are motivated to provide excellent service to the 38,000 contractor customers that we serve.

Our vendors are pleased with our performance and are seeking new ways to to enhance ours and theirs revenue growth. 2003 certainly was one for the record books.

Now for the specifics. First, the fourth quarter. During the quarter, revenues increased 7% with our core business growing at 5%.

This is the highest rate of growth on a same store basis in the last 10 quarters. Selling margins increased 120 basis points to a record 24.8% during the quarter; while operating expenses were up 4% in aggregate, but declined 1% on a same store basis.

Operating margins in the fourth quarter, which is seasonably low -- which is a seasonably-low period, along with the first quarter -- climbed to 3%.

Interest expense during the quarter declined 32% on lower borrowings. Net income rose to a new high of $4.4 million for the quarter, and EPS more than tripled to a record 17 cents. Obviously, it was an excellent quarter.

For the full year 2003, revenues increased 4% on a same store basis in our core business. Newly acquired or opened locations contributed $41 million in sales, and were slightly accretive to earnings per share.

Selling margins increased to a record 24.7% versus 24.3% last year. Operating expenses increased 3% in aggregate, but remained flat on the same store basis.

Operating profits climbed 20% to a record $61.2 million, with operating margins expanding 70 basis points to 8 -- to 5%, which is the largest advance in our history. Due to lower volumes, interest expenses declined 22%.

The new record was set for net income of approximately $35 million. This performance led to a 25% increase in EPS to $1.34, setting a new record for Watsco.

Cash flow for the year was $60 million, exceeding our goal, and reducing our debt to a total cap ratio of 14%, our lowest in recent history.

With such strength in our financial position and confidence in our future, the Board of Directors announced a 25% increase in cash dividends to 10 cents a quarter.

Once again, this was our best year ever. Now looking to this year, we expect recent trends in growth and profitability to continue. Watsco is strong and has excellent position in the markets it serves.

With this in mind, we hope to achieve an EPS growth rate in the 15 to 20% range. This concludes my comments; and at this time, Barry and I would be pleased to answer your questions.

At this time, I would like to remind everyone, in order to ask a question, please press star, then the number 1 on your telephone key pad. We will pause for just a moment to compile the Q&A roster.

Your first question comes from Martin Sankey of Neuberger Berman.

Martin!

Hello, Al, how is it going?

Wonderful.

Okay. I guess, first, why don't we -- it's clear that 2003 was a great year, and you expect great things for 2004.

Could you, first of all, elaborate on what goes into your expectation for a 15 to 20% EPS increase? In other words, what you expect the markets to be doing, your initiatives, and cost reductions, perhaps?

Well, I will give you a broad view, and then Barry may want to be a little more detailed, but he may not. Let me see what he says.

In terms of the industry, the industry, from what we hear, in 2004, is expected to show single-digit -- low single-digit growth rates. Although that's not a unanimous point of view. In spite of what the industry may do, we think that we will continue revenue growth.

We are gaining share, we believe, and you combined revenue growth with our increasing margins, due to our ability to manage our assets much better and our ability to manage our operating expenses much better.

I think that is what we have confidence in that we will be providing double-digit EPS growth rates in 2004, and I think beyond that .

Okay. Barry, are you going to say anything in addition?

Well, Martin, if we just look at some of the trends that I think have been consistent trends, and therefore, trends that we see, you know, continuing would be, as Al suggested, revenue this year. If you look at all four quarters, have been in the 3 to 5% range, and I think those trends, you know, should continue consistent with what Al had mentioned.

Also, if you look at selling margins -- gross profit margins over the last, really, 8 to 10 years, you see really a progression of of anywhere from 20, 30,40 basis points, depending on the year, virtually every year. So about the same type of trend that we are shooting for for next year.

SG&A has always been in our focus. It's in the numbers this year, and also, you know, under constant management, obviously, and so we do not see SG&A trending along with the rest of the business, because that's been a major focus to keep those costs in line as revenues grow, so that would be some coloration that I would add to it.

Our interest expense line at this point is fixed rate debt for 2004, so the interest trends that have been benefited by, frankly, lower borrowing over the last several years, that trend is going to probably flatten out in 2004, simply because we have fixed rates on the books until next year when some slots and fixed rate debt begins to amortize. So those would be some thoughts.

Okay. I guess, what of a couple of businesses -- first, I guess, what has been an albatross in recent years of manufactured housing.

What does that do in the fourth quarter, and what is the outlook there and the Whirlpool initiative?

Well, manufactured housing is a market that we serve, our traditional HVAC products to, and that industry has been hard hit.

As you stated in the past, it's -- it has cost us something, and in 2003, it cost us 9 cents per share. But in the fourth quarter, the manufacturing house business actually was accretive. In other words, we lost less money in the fourth quarter of '03 versus fourth quarter '02.

Now in terms of the industry, it has not, to my knowledge -- we can't see any -- any flattening, any bottom. It seems to be flattening, and, you know, Fannie Mae is jumping in there to provide with help with financing in sales of new manufactured houses.

But the way we look at it, our basic fundamental business, sales to residential and commercial, is so strong -- strongest in the country -- it's our position that the materiality of manufactured housing, one way or the other, is not as significant as it used to be. And what was the second part?

Okay, the Whirlpool initiative.

Whirlpool is part of our private label brand. We are constantly looking at brand -- brands that manufacturers already have, plus what we can do to supplement our growth rate, and Whirlpool is, as I have said earlier, was a very slow, careful introduction into the market in '03.

We don't want to disrupt revenue growth rates for existing brands, and it is not of consequence in '03, and we don't even want to raise expectations for '04, but we certainly think over the long term, it will be very productive.

Uh-huh. Okay, and I guess lastly, how are any prospects for acquisitions in the near term?

Well, it's always part of our game plan. We have a very strong balance sheet. We certainly could afford, with ease, anything that -- any of the companies that we are in contact with, and it's just a matter of timing.

But we are building, as you know, our company on the basis of internal growth.

Uh-huh.

We have, we are the largest in the industry, and we use our size to penetrate new product groups, as well as penetrate new territories.

For example, in Texas last year, we acquired over 30 branches, and Texas is the largest market in the United States.

So acquisitions, should they come -- and we think they ultimately will -- will just be accretive to what we were doing internally.

Okay. I guess, looking at it, you have been very disciplined over the last couple of years in the face of the industry down turn.

But now that you have the balance sheet and that business is turning up, are you tempted to, perhaps, maybe pay higher multiples today than you might have a year or two years ago to get deals done?

Do you want all these targets that we are talking to hear the answer to that question? Martin, you know, we -- I don't want to get into valuation on the line.

Right.

But we have a history of being very fair to sellers of distribution companies.

Our reputation with the 30-plus acquisitions we have made is very high. People come to us to sell their companies from time to time, and because of our reputation, we keep companies -- when we acquire them, we build them, they know that, we provide opportunities for their employees.

Owners seem very happy with what we have done in the past. So let me leave it at that. But it's our reputation that helps us with our acquisitions more than anything else.

Your next question comes from David Manthey of Robert W. Baird.

Good morning, David.

Hello, good morning. This is actually Adam Drake for David Manthey.

That's okay.

Sure, sure. Just a couple of quick questions here. What was the EPS impact of Dunhill in the quarter?

Dunhill in the quarter was accretive by one cent.

By one cent. Okay.

Do you have the full year then too? Or if -- I can go back and do the math here.

Adam, for the year it was diluted by3 cents.

3 cents, okay.

When I say accretive, it means the fourth quarter lost less money in '03 than they did in '02.

Right, right. Okay. I was wondering if you could talk a little bit about the pricing environment for the year and where you see that now going forward?

Barry touched on that. Our selling margins, gross profit margins, continued to improve. Pat of that is our ability to provide high levels of service to our contractors, and where we can, we pass on price -- price increases from manufacturers, which we seem to be able to do with ease because of our high service levels. So I expect that's going to continue.

There's talk about commodity price increases, whatever. If that occurs, and we are starting to see a little bit of that, I think we should be able to pass those increases on with some ease. Again, because of our high service level.

All right. That's helpful. Thank you.

And just, lastly, is there anything, one off in the quarter that changed anything here?

Is there anything that what?

Any one offs that we haven't talked about yet?

No, no, Adam.

Okay, great. That should do it for me thank you.

Sure.

Your next question comes from Michael Hagen of BB&T Capital Markets.

Good morning, Michael.

Good morning, guys. Barry, did you guys provide a same store figure?

We did.

What was that number?

For the year?

For the quarter.

For the quarter it was 5%.

5%. All right, and how is the newly acquired [INAUDIBLE] business.

Is that -- you know, what are the margins you are seeing out of that?

It is not contributing much to EPS in '03 -- did not contribute -- and probably won't until the summer season begins, which is in the second and third quarter.

Okay. Has that been kind of a cash burn in terms of stocking the shelves?

Yes, yes. I think, Barry, what is the number, $20 million went in there to stock the shelves and provide receivable assets as well?

That's correct.

Was that in the quarter, or since acquired?

The year.

Acquired in April. Of 2003.

So you spent 20 million on inventory? Another question I had, how do you guys assess the credit environment of your customers? Are you seeing an increase in bad debt expense, are you seeing that come down? What is the general feel of that?

Go ahead, Barry.

It has come down to some extent, and it's been, you know, a very -- probably a long-term tightening of our own credit posture with our customers that started three or four years ago.

It's not a trend in the marketplace. I would say it's an achievement of our -- of our asset management in terms of what we have been doing in the last several years, and managing -- managing very deliberately and conservatively, you know, over a long period of time.

It's not something you wake up tomorrow and flip the switch on, and your credit posture changes. It is something that is -- that is -- that has been executed over a period of time.

So, yeah, through some -- through those initiatives, bad debt is less. In terms of what the marketplace is, I can't necessarily speak to that, but our own performance has been certainly better.

Let me just follow on on that, we were running 40 basis points in bad debt in 2003. 40 basis points of sales, and I think that will even get better in 2004.

That's actually helpful. What was the other question I had? I guess, just in general, you know, EBIT margins year over year in the quarter was up 200 basis points.

You know, how should we read that up? I can't imagine that's a sustainable lift in all the quarters going forward to a 100 basis points expansion. You know, how much of this is pure operations?

How much of this might be just true ups and accruals just netting out in your favor, etc? How much -- how much do you get a sense that the operating margin has lifted?

Well, I mean, you have to put this quarter in perspective to what's been going on for the last few years, and almost every quarter we have been reporting increasing operating margins, and that's a trend that we don't think is going to stop.

No, absolutely. But --

But specific to the fourth quarter, there are no so-called true ups. This is just what occurred in operations.

Now, is that 200 basis points going to continue into the next few quarters, which I think is your question, I don't think so. I mean, I don't think we have prepared to quantify the improvements in the next -- in 2004.

We just see trends, and we are working on those trends, and I think that without quantifying, we can just state that we feel very confident that our margins will continue to improve.

Okay. For the first three quarters, you saw a 20 or 30 basis point expansion. Then in Q4, you have this 200 basis point expansion.

So I am just curious if that -- What was -- what had been kind of a steady expansion of 20 or 30 basis points on the EBIT margin, you know, is that kind of accelerating, do you get a sense? Or -- or was this, you know, just a special quarter in terms of that performance?

Michael, the -- well, first, it's a very seasonal quarter. So $1 of extra profit in a quarter like this is going to have -- is going to have an accelerated effect on the math equation of computing the 200 basis points.

So part of it is seasonality. 200 basis points in the summertime is a far different, you know, significant amount than 200 basis points at this point.

So the steadiness that you have seen in the last few quarters and the fourth quarter, we do -- you know, I would look at in terms of year over year trends, and we do see, we do expect those trends to continue to improve, because it's been something we have obviously been focused on -- the performance has been there, and in 2004 we will continue it.

It won't be 200 basis points, obviously, in 2004. I would just look at the year -- the yearly trends, and look at that as achievement for this year.

Okay, great.

But I do think that we will see some acceleration over the 20 or 30 basis points that you are talking about, Mike.

Okay.

It's just hard for us to -- I don't think it's proper for us to give you that number. But we just have a sense of it.

I appreciate it. That's helpful. And lastly, I haven't heard you guys kind of talk about the super centers. I know that in Florida -- there is kind of you know, beta testing going on a new concept of store.

Has that kind of petered out, or any update on that initiative?

A super store?

Super centers.

Mike, I think what you are referring to is the idea that -- and in certain markets, we have, you know, multiple price points and multiple brands available to the contractor.

We have never labeled that a super center. I understand, though, the inference you are making with it.

It was really the idea that we want to offer the contractor everything he needs at different price points when he needs it, and that type of execution has been going on. Private label initiatives that we have made has allowed for that to happen as well, so it's something that is an going initiative for us, Michael.

Okay, and have you taken that outside of Florida, then?

Oh, yes. We haven't built out the entire offering that we want to in all 310 locations, but we are building that out to be able to offer the different price points throughout our network, and it has gone out of Florida, but it is not complete.

Okay.

Which, I think, to my way of thinking, presents opportunity.

Of course. All right, great. Well, thank you, guys, and an excellent quarter.

Thank you.

Again, I would like to remind everyone, in order to ask a question, please press star then the number 1 on your telephone key pad.

Your next question comes from Greg Macosko of Lord Abbott.

Yes, thank you. Nice quarter. Could you talk a little bit about the HVAC environment? I realize that is a summer market, but I know that last year there was a -- I think there was significant -- there were some changes of inventory in the previous quarter.

And I just wondered, could you give us a sense of kind of a field inventory in that area and what your general expectations are for that marketplace.

For the industry?

Pardon?

For the industry, you're talking about?

Well, for yourselves and the industry, yes.

Well, we are showing a larger investment in inventory, but much of that is attributable to the private label initiative, as well as the addition of almost 40 branches to our network in '03. And I don't know what the industry is doing, and we don't -- I mean, I can't tell you where I think they are in that.

But I just think that we are going to have another successful year and reach record levels, and we invest in inventory what we think is necessary to satisfy the demand as it comes.

Which is seasonal. It's a seasonal demand.

Barry, do you follow the industry in terms of inventories?

Not as much as I follow Watsco's, I assure you. But the -- you know, one of the initiatives that our industry is taking is to shorten lead times and improve their own productivity and their only ability to deliver products to distribution very quickly, and more quickly.

That is something that we have pressed on, it has helped our inventory turns over the past few years. So, Greg, I don't have a crystal ball for you, but the idea that lead times has been a major mindset for the OEMs -- and you can ask them of their own initiatives in that regard -- but it is something that is helping the industry.

Actually, that reminds me. I can perhaps quantify that for you.

It wasn't too long it would take 60 days lead time for the manufacturer to get our order received and deliver to us. That then dropped to 30 days, and then most recently, it's dropped to two weeks.

That's a huge improvement in lead times; which, of course, means that the distributors, such as ourselves, need to invest less inventory -- in inventory, because the manufacturer is getting much better at deliveries.

So, I guess it's fair to say that inventories are at lower levels relative to kind of your sales expectations year over year? And you don't -- and they are at levels that you feel comfortable with, given -- given the outlook, and obviously there's other issues that you would have?

I would say that's accurate, yes.

Okay, and are you seeing any particular competition within the marketplace from -- or particular programs to -- that are being offered by the manufacturers?

Well, there's always good competition. This is still a fragmented industry, with some 1300 distributors participating in a $20 billion market.

Of course, we -- our share is only 6%, so there's 94% share that we feel we can pursue, and there are always different programs, Greg.

But nothing that -- that, you know, jumps at me and says, this is unusual or this is something that we should be concerned about.

It's a pretty basic business. What we want to do is have convenient locations for the 38,000 contractors that we serve so they don't have to go too far to get what they need, and then once they get into the location, we want to have everything they need, which is not only the equipment, but all the supporting parts and supplies,

And even more important than that is we want to have counter people that are well-trained to help them do their work, which in many cases is a replacement of the system, or in some cases is the repair of a system.

So, those are fundamentals, and we work very hard at that, spend a lot of money training, spend a lot of money in systems to support the over 20,000 SKUs that are required in most of our locations. In terms of promotions or features or products, whatever, whoever has them, we are generally the ones that enjoy them.

Okay, thank you.

At this time, sir, I am showing no further questions.

Well, very good. Thanks for listening in, and we will talk after the end of the first quarter. Have a nice day. Bye.

That concludes the Watsco fourth quarter and year-end earnings conference call. You may now disconnect