Watsco Inc (WSO.B) 2004 Q1 法說會逐字稿

Good morning. My name is Chasity and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Watsco, Inc first quarter 2004 earnings release conference call. All lines have been placed on mute to prevent any background noise.

After the speaker's 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 one on your telephone keypad. If you would like to withdraw your question, press the pound key.

Thank you. I will turn the conference over to Mr. Nahmad, CEO. Sir, you may begin.

Good morning. As Chasity mentioned, my name is Al Nahmad. I'm the CEO. With me is Senior Vice President, Barry Logan.

Before we get started on this conference call, let me read a cautionary statement. Please remember that this conference call has forward-looking statements as defined by SEC laws and regulations, and are made pursuant to the safe harbor provisions of these various laws. Ultimate results may differ materially from the forward-looking statements.

Now on to our conference call. Watsco had a a great first quarter, and the Company continues to operate at record levels of performance. Even though the first quarter's traditionally the low point in revenues for the year, we're excited about the prospects of the full year, and we'll talk about the outlook at the end of this short report.

Let's look at the numbers. Earnings per share on a diluted basis was up 67 cents, to a record 25 cents, versus 15 cents last year. Net income was up 74% to a record $6.6 million, from $3.8 million last year. Our operating profit was up 56%, to a record $11.8 million, with operating margins expanding 130 basis points.

Revenues for the quarter were $279 million, an increase of 8% over 2003. This increase is attributed to new locations that were acquired in the second quarter last year, and to a same-store sales increase of 5% in our core HVAC operations.

Gross profit increased 12% to $71.4 million, as gross margins increase 80 basis points to 25.6%, from 24.8% a year ago.

We expect to continue to improve selling margins, but perhaps not at the same pace as we have experienced the first quarter of this year. We're also leveraging our cost structure. SG&A increased at a slower rate than sales, which is 6%, versus our sales increase of 8%, and as a percentage of sales, SG&A decreased 40 basis points.

On a same-store basis, SG&A increased 2%, versus a 5% increase in same-store sales in the core business, providing further evidence that we are leveraging costs.

I also want to provide a reminder that our dividend rate increased 25% this quarter to an annualized rate of 40 cents a share, something we're happy to continue to deliver to our stockholders. As I mentioned earlier, we go into the outlook. Now, this first start in the first quarter has increased our confidence that we're going to have another record year. And we still remain in the 15 to 20% EPS growth rate in terms of our comfort level.

And with that, we'll be happy to take any questions.

If you would like to ask a question at this time, please press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q and A roster.

The first question comes from the line of a David Manthey with Robert W. Baird.

Hey, guys. Good morning.

Good morning, David.

Nice quarter.

Thank you.

Could you talk about the margin improvement here and maybe just touch on a couple of things that are leading to the margin improvement? Is it mix? Is it just leverage, or what are issues here?

Well, David, this is old news. We've been increasing margin now for -- quarter after quarter for some time, and it's part of what we do with our fundamental strategy that we are accelerating our services levels to the contractor, trying to outcompete on the basis of service, which gives us an opportunity to raise prices here and there.

In addition to that, because we've grown to be the size that we are, we're able to work with our vendors, and where we might have had 10 or 15 vendors for a single product item, as we consolidate that, we get incentives from the vendors, and that reflects itself in lower cost of goods. And so the combination of the two, I would say, principally are leading -- have led in the past to higher margins, and I think will continue to lead to higher margins in the future.

Right. Okay. And you said that the SG&A in the core HVAC business grew at a slower rate than same-store sales growth. Does it follow that SG&A in the rest of the business was above the sales growth, and if that's the case, could you just discuss that?

Well, the SG&A, we believe, is growing at a lower rate overall as compared to our overall revenue growth rate. But when you look more closely at the core business, there's even a more favorable reflection. That's what you heard me say earlier. But when you move away from the core business, you're into manufactured housing and you're into the staffing business. Those businesses somewhat flattened. I think the worst is over. So I suppose that that continues to be a bit of a drag, David, but in the overall picture, I don't think it's meaningful.

Could you touch on the two that you just mentioned: the manufacturing housing and the staffing? If you would flush those out for us slightly. As far as the manufactured housing division goes, is that -- you said it's bottomed. Do you feel that you can you make some headway there, and then also for the staffing division, seems like you're break-even now. Will we ever see 3 to 5% EBIT there again?

I hope we see 3 to 5%, but once again, regardless of what we see there in the staffing, it's not material to the overall performance of the Company. But it has bottomed. It is breaking even on the manufactured housing. The revenues seem to have flattened, and we're actually earning money compared to the prior year, so that's why I say that's bottomed out.

Okay. And just one last clarification here. Historically, you've talked to us about the swing factor for both of those divisions, as far as what the year-to-year impact was. Could you talk about that this quarter?

Well, there's obviously improvement because they were not doing well last year. But, again, I don't think it's material to the performance of the quarter. And we have not broken that down because it isn't significant.

Great. Okay. Thanks.

Your next question comes from the line of Steve Tusa with J.P. Morgan.

Morning, Steve.

Morning, guys. A great quarter.

I just wanted to get a sense of how the markets were in March and April. The ARI data from the distributor side was very strong in January and February, and, you know, you guys put up a very decent 5% same-store sales number. So I'm just wondering how the comp was in March, and then what you're seeing in April, and maybe a bit of an early read on -- I know it's still early, but an early read on --

Well, March -- see if I can take a crack at it. March we had a very slow start. We were not showing any growth, and then by the end of the quarter, we showed growth.

April, I would say, starting much the same. We had a slow start, and it's now coming back. I think -- I would hold, Steve, that we're probably going to be in the -- when you look at it over the rest of the year, when the year is over we're going to be in the mid-single-digit growth rates in terms of the industry, at the distributor level. Now the manufacturer shipments, which, I think is what you've been looking at, that's a different story. Because that's more dependent on inventory changes.

On that 50 -- I guess this leads into the next question. On the 15% to 20% EPS growth, considering that you guys did put out such a solid first quarter, and I realize that first quarter isn't a huge percentage of earning, so it's still too early to tell, can you just talk about maybe some of the puts and takes, and what you see as maybe the biggest risk on both downside and upside. Obviously, weather is one, but what else out there that you see, and how conservative would you say that 15 to 20% growth is?

Well, we deliberately try not to overstate outlook. But I think you've nailed it. I think it is a weather issue. Although we have diversified the geography of our company to the point where maybe we've taken weather out of the equation, when it's all said and done, if the industry does grow at the mid-single digits, we will readily achieve our EPS growth rates. In terms of any upside beyond that, I'd rather this not travel in that, Steve.

Okay. It was worth a try. Lastly, acquisition pipeline? How's it looking these days, and what's your sense?

It's -- you know, we are the Company that people like to sell their business to when they get ready to sell. We preserve the traditions and the culture of the selling company. We know there are several out there that feel that way about us. And we're always in touch with them. What we've said, it's just so impossible to predict when some of these companies may decide that the time has come.

What we do feel comfortable with is that when they do come to that point, we'll get the call because we would pay more than anyone else for the business because it's worth more to us. And we also, as I said earlier, we just build on the culture and the organization that comes with the company that we buy. But it's unpredictable, and we continue to hold to our 15 to 20% without any acquisition, in terms of 15% to 20% EPS growth rate, without any major acquisitions.

So no change in sellers' attitudes recently?

Well, if there was, we'd be announcing some transactions. Maybe you can go persuade them for us. The ones we want are obviously the best, I'm talking about when we get into some size, and we have to be patient, and we think that our reputation will help us when that time comes.

Okay. And lastly, on the -- you mentioned, you know, the gross is up, so you're obviously not really seeing any of these price increases that maybe the manufacturers are trying to pass through on -- related to raw materials. Is that a safe assumption, or are you just making --

That's an interesting issue, Steve. What we are seeing is that commodity prices are increasing at all -- particularly in steel and other metals. And sure, those price increases are coming into our distribution network and some of this profit increase is because we are able to pass on those increases without any problems at all. And, of course, some of the inventory that we have is just priced at the -- is valued at the prior -- before the increase in new prices was announced. That's why we said earlier that while we see a substantial increase in gross profit margin in first quarter, and we think we can continue to increase gross profit margin the rest of the year, we don't think it's at the same pace as we did in the first quarter.

But you think that they will continue to kind of show nice little upticks?

I think the manufacturers will pass on price increases, and they are doing it because of steel and other metals. And I think that we continue to pass it on to the customer.

Okay. Thank you very much.

You bet.

Your next question comes from the line of David Mitchell with William Blair.

Hi, good morning guys. Most of my questions have been answered, but I wanted to talk about Whirlpool for a second. Can you just give us an update there?

Sure Whirlpool -- a full line of Whirlpool is just coming on to the distribution market. I know that we launched it last year, but it was partial, in terms of product offering, and we're continuing to fill the line. It did not contribute to any earnings -- has not contributed to any earnings since the initiative. Our expectations are that this is a slow and deliberate process, and eventually -- again, our principle is that we don't want to displace brands that we already sell. We want to use Whirlpool or any other private label that we come up with to have incremental revenues. This is a slower process, but it's a deliberate one, and I think it's an excellent part of the overall strategy to broaden our participation in the marketplace.

Have you subcontracted -- or whatever you would call it in this case --

What, manufacturing?

No, not manufacturing, to -- in markets where you're not present, have you worked out any --

We wanted to first -- that's a good question -- we wanted to first experience it in some of our own distribution outlets. That is our key focus. Although we have put on two additional non-Watsco distributors to see how it would work there. I guess I'm just trying to emphasize that we're just being very careful and very slow. So we're not really offering it to many other places other than to our network for now. And again, only if they can provide incremental revenues, not to replace a brand that they're already representing. We're in the business of growth, we're not in the business of replacing sales.

Alright. Thanks.

Thank you. Your next question comes from the line of Martin Sankey with Neuberger Berman.

Hello, martin.

Hi, Al. Well, my question about Whirlpool was asked and answered. So, can we just go back to the price/cost issue? I think pretty much all the manufacturers have announced price increases, and -- so I guess you're going to see them over the next -- how does it roll, I guess -- how does it roll into your gross margins? Do you -- have you -- does your -- do you -- does your agreements with the various manufacturers lock in price?

No.

Or --

Once title passes, we can do with it whatever we want.

No, I meant your agreement with them, can they push through the price increase automatically?

With contractors, you mean? Or with our customers?

No, with the vendor.

With the vendor, no. Whenever they pass on a price increase, we can do with it as we wish, and we do pass it on. There is -- sometimes we assure a contractor customer that when he's building on a housing project, for example, where they're going to have multiple homes, which is not the main -- our main business is replacement. Some of it is also directed to new construction. We'll hold the price line for a little while. But most of the time in those cases, the factory has also been part of that, so we don't suffer margin, because the factory's part of that -- holding that price line for the time period that we promised the contractor customer.

Right. But at this point, you would say you're actually ahead of the game on passing through price --

Yes. Because of the inventory that we had before the price increases.

Right, but also to you've passed it through to the customers more aggressively than your inventory.

I would say what we do is we pass on the price increase. And we don't have any problems in that. The reason is, I think it's because we have extremely high levels of service. And as long as we continue to prove that, I just don't see any issues with prices either way.

Right. Now, your inventories were up in the March quarter, and I presume that is a seasonal build as opposed to any stockpiling in advance?

You will find it this year, that's a good observation if you compare it to the prior year, our inventory is up some $20 million. That is our subsidiaries, who are the ones who do this, are more optimistic, I suppose, at this time this year than they were last year, so they're taking more inventory in, to the tune of $20 million of aggregate.

So -- but that would also have the serendipitous effect of taking an inventory at the presteel price --

Oh, I see your point. I don't know that it was done for that purpose. I think it's just anticipation of a good season. And sometimes they're right, and sometimes they're not. But the nature of this business is that when they're not, the sale is just deferred there's not a risk of obsolescence or anything in any of these products. So it's a very safe bet.

Sure. Okay. Thanks.

Sure.

Once again, if you would like to ask a question, please press star, 1 on your telephone keypad. You have a follow-up question from the line of David Manthey with Robert W. Baird.

Thanks. Just two quick follow-ups here. When you talk about 15% to 20% EPS growth, is that for the full year only, or are you talking about each quarter of the year?

No, For the full year. Yeah. We do not give in to providing guidance on a quarterly basis.

Got it. And then on the inflation, when you think about the amount of price increase that you've put through, what percentage of your same-store sales growth of 5% was inflation responsible for?

I would say that's not a material percentage because the increases are just going in recently.

Okay. So we haven't seen the impact of that yet. Can you talk about the magnitude --

But the increases in the equipment line are not that great to begin with. I mean, we're talking about 1% or 2%. Now on some of the commodities that we sell, like steel, they're much higher. But as an overall percentage of the revenues that would affect some of our subsidiaries, and particularly I'm thinking of two, but it's not a material part of the overall company.

Okay. But if it adds a percent or two to top-line growth that's somewhat material --

I don't know that that's the case, because half our revenues are not equipment, half our revenues are the supporting accessories and supporting controls and parts and things like that, where we don't see that inflationary change.

Sure. Okay. And then about -- with the GP, is it the same situation that of the 80 basis points this quarter, inflation really didn't have an impact, or is it --

No, I would say it had an impact, and if I had to guess, I would say half of it.

Half of the --

Yeah. Half of the 80.

Okay. Great. Thanks very much.

Sure.

There are no further questions at this time.

Okay. Well, thanks very much for listening, and we'll talk to you at the end of the second quarter. Thank you.

Thank you for joining today's conference call. You may now disconnect.