Watsco Inc (WSO.B) 2004 Q3 法說會逐字稿

Good afternoon, my name in Lory and I will be your conference facilitator today. At this time I would like to welcome everyone to the Watsco third quarter earnings 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 and the number one on your telephone key pad. If you would like to withdraw your question, press the pound key. Thank you, I will now turn the call over to Albert Nahmad, CEO of Watsco. Mr. Nahmad you may begin your conference.

Good morning everyone. As Lory has said, welcome to our conference call. We are going to cover the third quarter as well as the nine months for this year. My name is Al Nahmad as she said and with me is Barry Logan, the company’s Sr. Vice President. Let me first read our 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. On to the quarter, Watsco continues to operate at record pace during the third quarter even though key markets in the company were struck by four hurricanes during this period. Let’s take a look at the numbers. Diluted earnings per share increased 16% to 59 cents compared to 51 cents in 2003. The estimated loss sales due to the hurricanes in the south-east were estimated to have cost the company 3 cents in the quarter. Net income was up 20% to a third quarter record $15.9m from $13.2m last year. Profitability also continues to be strong with operating margins at 7.5%. That’s a 110 basis point improvement and our best ever for our third quarter. This also marks a seventh consecutive quarter of advanced operating margins on a year-over-year basis. Same store sales on our core HVAC business increased 3% to $357m despite an estimated $8m of loss sales ahead of 2% impact on the same store sales business that was caused by the four hurricanes that struck in Florida, our largest market and also destructed operations in Alabama, Georgia and the Carolinas. Gross profit increased 8% to $93m for the gross profit margin increasing 130 basis points to a record 25.9% from 24.6% a year ago. Operating cash flow for the quarter was strong and the company was able to generate $18.6m in cash from operations. We expect cash flow to grow substantially during the last three months of 2004 as the fourth quarter has traditionally been the strong seasonal period for cash flow. Now the results for the first nine months of 2004 -- diluted earnings per share was up 32% to a record $1.56 that compares to $1.18 in 2003. Net income rose 38% to a record $41.9m. Operating profit increased 34% to $70.7m with operating margins expanding by 140 basis points to 7% and that’s an all time high. Revenues were up $62m or 7% to over $1 billion for the same store sales in our core HVAC operations growing by 5%. Gross profit margins increased to 25.8%, a 110 basis point improvement over the same period in 2003. SG&A on the other hand increased at a slower rate in sales, growing only 4% versus the 7% sales increase and as the percentage of sales decreased by 30 basis points. Another thing I would like to point out is the de-leveraging of our balance sheet. Throughout 2004 Watsco has been able to reduce its debt loan. At September 30th, our debt to total capitalization ratio was 13%, the lowest level in recent history. The increase in our inventory level on September 30th deserves mention. During the quarter we made purchasing decisions with certain vendors to take advantage of current pricing and ahead of announced price increases. Also we have added stock for certain product lines to maintain high levels of customer service in light of slower lag times by certain of our key vendors. We believe these are effective uses of our capital and something that our competition is generally unable to do as well as we can. Inventory levels are, however, expected to decrease in the fourth quarter. In so far as our outlook goes, we announced at the end of the second quarter that our 2004 earnings per share growth rate is expected to be in the 25- 30% range or $1.68- $1.74 per share. To be consistent and conservative, we continue to feel comfortable with that guidance. And with that, Barry and I will be happy to take questions.

At this time I would like to remind everyone in order to ask a question please press star and the number one on your telephone key pad. We will pause for just a moment to compile the Q and A roster. The first question comes from David Mandy of Robert W. Baird

Hi good morning.

Morning David.

Just a couple of questions. First on the sales line…even excluding the $8m in hurricanes, the top line seems a little bit light this quarter. Was there anything else, I mean it seemed like it was a little wetter than normal, but overall temperatures were pretty much in line? Anything thoughts on just beyond the $8m, what impacted sales in the quarter?

With the $8m, we would have had a 5% same store sales increase, which is pretty much our growth rate for the year, David. I wouldn’t say that we witnessed any abnormal weather patterns. I just think that we are continuing to show gains in share and growing a little faster than market as an overall in the markets that we serve.

Ok. In terms of the SG&A then, given that even if you pull out the hurricane, that number on an absolute basis in dollar terms seems to be slightly higher than it would be normally. It was actually up sequentially. It would normally be about flat. And given that sales were about in line with what you expected, what was the thought there given that especially the percentage of SG&A as percentage of sales seems relatively high?

Barry you want to take that?

Sure, Dave. Well, the…obviously the expenses…the run rate of expenses during the quarter are very consistent in terms of the level of people and head count, and so on, that we had out in the field. We also probably had some measure of extra expenses because of the hurricane activities and getting, you know frankly, the businesses safe and secure. But there were some bigger ticket items in there.

First, we are incurring some costs that hit the quarter for Sarbanes Oxley in terms of getting our project done and complete. And some of that expense did hit the quarter. Not enough to go out and highlight on it in a paragraph in a press release, but it is something that impact the quarter. We also had a disposition on a corporate aircraft that the company had owed. We see the change in fixed assets in there is about a penny or so, half a million dollars or so of expenses that you can see in the corporate expense detail that we have given in the press release.

I think it’s a good question, Dave. I think that we feel that we are still getting more efficient as a percentage of sales, the trend is that that will drop in the future.

Right. Ok. In the inventories, you touched on it earlier Al. Is there any change in your expectations for inventory metrics, turns, or inventory-to-sales?

Another good question. I think that what we as a company have as a goal is to constantly improve inventory turns. And we were making progress until this third quarter and then we decided that we would lay that goal aside for the moment because of some unusual opportunities that occurred. The commodity prices increases going on. The OEM is letting us know that prices are going to go up. And that if we wanted to take advantage of current pricing and if we had all the wear with all to do so where others do not have the wear with all we took in large amounts of inventory.

Furthermore we had some vendors that during the second quarter, as you know, was very heated industry-wide as it was for us. And they were having trouble delivering goods so we just thought, let’s use our strength. Let’s use our power. Nobody else can do it as well as we can. Let’s take the goods in. And we have. And I think all of that will work to the benefit of our customers as well as to our shareholders. And I think you will see that inventory decline in the fourth quarter and through the first quarter. And you will see that we will back again on the trend of increasing inventory turn. That is our goal and that is what we work towards, increasing inventory turns.

Ok. Thanks. And just one more and then I will get back into line. In terms of the price increases, what are the percentages that you are hearing from your OEM’s and was the majority of the inventory increase?

Due to the price increase?

Yes.

I think it’s due to both reasons. Slower vendor times of one particular vendor that we do a lot of business with, as well as, what I would articulate as 3-5% in terms of price increases.

And that should be good for you. You should be able to pass that along.

Absolutely correct. Absolutely correct. Price increases are, with our strength in the market place, is something that we can easily pass on to customers.

Three to five, is that across all the equipment?

It now becomes…you know we doing business with most of these…I would say five out the seven equipment makers, not to mention the hundreds of non-equipment makers and I would say that in terms of the equipment guys which easier for me to get our hands on. I think that is going to hold. I think enough of them are coming in. I think only one has not announced a price increase. I don’t know how long that will stay in terms of the equipment manufacturers.

Alright that is good news. Alright. Thank you.

Once again, if you would like to ask a question, please press star then the number one on your telephone key pad. Your next question comes from Kurt Woodworth of J.P. Morgan.

Good morning, Kurt.

Hi. Good morning. I have just some more questions relating to some of the vendor buying with news that there is some excess inventory at the vendor level. You know, is the three to five percent sort of a total increase in prices that you are going to see sort of near term? And do you have expectations for ’05? Because it seems like you have been benefiting recently from sort of the price spread where the market price is going up and you have lower priced inventory still flowing through. So if you kind of talk around those dynamics al little bit?

Well, Ill take a shot at it and then Ill let Barry develop it the way he does. But my sense of it that we are just now, it is now when you get price increases, I think will hold, Kurt, I think throughout the year they have not, some have tried and some have pulled back and I can only deal with the equipment guys because there are too many manufacturers of non- equipment to try to summarize for you.

But I think these price increases if I am right will hold, I think you will see a benefit for us ahead of us, as distinct from behind us. So I think that’s the good news for our company and I think again because of our strength in the marketplace as OEMS regardless whether equipment or non-equipment increase prices we can handle, are able to pass those increases on to our contractors, they understand we compete not on price mostly but on service levels. Barry.

Yeah Kurt, one of those score card items that is easy to see, is that if you look at eight to ten years worth of gross profit, it has been a – for our company about a 20 to 30 basis point pretty steady improvement in gross profit and this year it that improvement is up over 100 basis points, so we certainly have been able this year to be a good merchant at getting some pricing given the market conditions and that has come primarily through the parts and supplies. A lot of the steel products, a lot of the commodity type products that we do sell, have helped our gross profit this year.

The equipment side, the OEMS, did not get a lot of price increases accomplished and I am sure you are educated on their stuff they are all saying now that they expect to not just have price increases but have ones that stick. So that is an opportunity for us and it is something that will play itself out between now and next year.

Ok. And then in terms of parts and supplies and your sourcing of vendor consolidations, can you talk about weakness there and are you increasing your low cost sourcing, do you think that is going to be a benefit coming forward?

Well I guess I summarize it in my mind as size – being of size is very significant advantage, and of course now we are the largest. And we still have been covering advantages of size, in that specific arena that you have mentioned, the vendor pricing, we still have huge opportunities ahead of us because we are only, we have been at this for such a short period of time, the way that works is that we may have some of our subsidiaries buying from different vendors the same, more or less the same product and as we offer to the subsidiaries programs that we negotiate nationally with vendors and we do that, that as the corp and then offer to the subsidiaries so that they can buy into what essentially will be a margin improvement if they buy into the program because their cost goes down. That process is by – still has an enormous amount of ahead of it. I think there is more ahead than we have already accomplished, so I think that it’s – if it’s not only in the vendor program, it is the safety program, it’s in the information technology, there are certain things that our size will enhance our posture in the market place that other just can’t get there.

Sure

And as long as we keep our decentralized mode, which keeps us in terms of the revenue generation and the sales at the local level and not at a centralized level I think we are just going to be very prosperous. Are being and will continue to be, I don’t think I have ever been more optimistic than I am now. Not only for the rest of this year, but you know, going forward.

Ok great. And then if you can just touch on the private label growth and what you are seeing --

That is consistent with what I was just saying about our size, because of our size we can and are introducing a private label, which is our own brands into the marketplace and we are doing it, starting just to do it on parts and supplies, but the biggest impact is that the two labels that we have in the equipment side, one is -- we called one GrandAir and the other is the Whirlpool. GrandAir was started soon and it is a very large and growing business, very profitable business.

Whirlpool has started recently and is still very slow, cause you don’t want to displace other businesses because you didn’t have manufacturing delays with the product offering that we had and eventually we think that it will also become large like GrandAir is and then there are other labels that we’re just starting to introduce which published earlier is only out there 60 days. We’re introducing still other labels in the equipment line. So, I just think that the private label thing is huge for Watsco to go. I mean, we shouldn’t say huge now but it will be huge for Watsco and it’s something that we can do better than anyone else because of our size.

Great. Thank you very much.

That’s - - Dave I think you did a piece on 13 SEER. We’ll find out just what our private label could do when 13 SEER comes along in ‘06 because if there is - - if we do have a successful private label program and we’re able to private label 13 SEER, we’ll be able to offer that on a national basis regardless of what brands we’ve been granted to specific territories.

Your next question comes from Martin Sanky [ph] of Newburger Burman.

Hi Martin.

Hi Al. I guess, two questions. First a follow-up on the discussion of some of the initiatives. You’ve always prided yourself on running a really really lean ship at corporate level. Does implementing some of these initiatives might mean you’re - - you might have to add some people at the corporate level, which I guess, will mean over time that perhaps a little bit higher SG&A but better gross margin?

Well I don’t think so because what we did - -what we did for example at the - -when we introduced Whirlpool is that we did start with a team from the corporate level and we’ve now switched back to the subsidiary and there are other programs that we’re kicking off which I hadn’t mentioned earlier for example the Chinese manufacturers are very anxious and they’re coming to us and we’re gradually introducing those products and they’re operating at the subsidiary level. But what we do is we take the best subsidiary that we think can do the particular function and then they operate and offer whatever they are doing to the other subsidiaries. So, I do not see a larger corporate payroll. I’d frankly like to see over time, a smaller corporate payroll, Martin because I think the subsidiaries, even though we may initiate the idea, as long as they like it they approve of it - -they buy into it, then they can implement it throughout our network.

Okay. Maybe it might not be seen to people in the corporate payroll but they will be - -

Oh yes it’s correct - -

What it means - - it means that there is an SG&A dollar that is spent?

Yes. That’s correct.

So we will see - -so it will be fair to say that we will see perhaps maybe an acceleration in SG&A?

No, I don’t want to - - I don’t think that’s correct. I think that our revenue gross rate will exceed any SG&A gross rates. I do think that SG&A as a percentage of our revenue will decline. There has been a blip and Barry’s explained the reasons why. But I think the trend has been for a lower SG&A growth rate than revenue growth rate and I think that trend will continue for some time.

Okay. Alright. Second question is capital allocation. As you pointed out in your formal remarks, your effective capital is running at an all time low. You really haven’t done a major deal for five years and you’ve been increasing the dividends pretty aggressively, which as shareholders we all appreciate. I guess, what are your thoughts regarding the capital allocation? And what kind of acquisition opportunities do you see out there?

We are fortunate as you pointed out. We do have large amounts of cash flow for the size of our company and - - let me just take the question in several parts. Dividends- - I think that for the moment, the board feels that we should be paying out about 1/3 of our earnings per share in dividends. So, since our earnings per share are growing, I think you’ll see dividend increases in keeping with that idea. Now, so far as funding acquisitions is not for lack of trying. We do buy smaller ones, that we sometimes don’t even announce and last year that we bought the forty brands from planeto, [ph] and we are engaged with larger transactions. We just are not able to announce anything because we haven’t consummated them but we are definitely in the acquisition game and we definitely hope to be successful in that and will be a use of cash flow as well as our ability to leverage up the balance sheet if the transactions get that large.

But we are in the fortunate position that we de-leveraged during this period because of cash flow growing in the amounts that it has. And that’s all good news because we should be able to fund anything that comes along the line. Certainly internal growth is fairly easy to fund with our cash flow and I think most acquisitions will be financed that way with out even – perhaps not even turning to further debt.

Okay all that being said Al, do you feel you’re closer to making some significant deals today than you were in let’s say a year or two years ago.

I do.

Okay that’s it for me thanks.

You have a follow up question from David Manthey of Robert W. Baird.

Hi great thank you. In terms of the hurricane impact here if it was a negative impact this year, this quarter is there a potential that turns it into a positive at some point going forward?

Yes we’re seeing it now David. We’re seeing double-digit increases in revenue growth in Florida which is you know 32% of our sales as a corporation, seeing huge gains in revenues in the fourth quarter. I think that – I can’t tell you how long that will continue but we’re certainly witnessing it in October.

Okay and then just some clarity on the point you made earlier about the private label and 13 SEER I’m not sure I quite understood what you said there?

Well you know the whole market the minimum sales level is going to 13 SEER and I think you wrote a piece about that.

Right.

And opportunity, I think you were right on. That is a huge opportunity. Because where as most of the market now is at 10 SEERs as the government has mandated it will be a 13 SEER high efficiency market that will become the minimum SEER and therefore the pricing levels I would expect as you have expected are going to increase if you’re moving from 10, a 30% efficiency gain mandated by the government that equipment is going to be sold at a higher price. So that’s going to help our revenue and I believe our margins, because we’re moving to a higher unit price.

And so far as private labels as these brands come out with the minimum 13 SEER we can only sell the brands that we’re permitted to sell by the OEMs that have granted us those right. But with private label we can have a 13 SEER or anything above that efficiency level. So manufactured for us at our own label and put that anywhere you want to put it. We’re just not restricted by the grants that we did for brand names by the particular OEMs.

So the grant you get by brand name is actually limited by the SEER?

Oh no, no limited by the manufacture for example we’re authorized to sell ---.

(Multiple speakers) --13 SEER in

I’m sorry.

--certain manufacture in an area why is that any different from the situation you have with private label versus the 10 or12 SEERs today?

Well it isn’t versus the 10 and 12 but I’m saying that first you have to take the agreement and I think you are that a 13 SEER minimum market is a positive thing.

Right.

And all I’m saying is lets take one step further and say because it is a positive thing that’s going to further enhance our private label program.

Okay.

Okay that’s all I’m saying.

Alright got it. Thank you.

You have a follow up question from Martin Sanky (ph) of Newburger Burman (ph).

Hi Al, I guess following up on your previous remarks I think the confusion is why would one of your suppliers withhold a mandate for 13 SEER product from you and your base territories.

I think I may be confusing this let me give you a best example. Let’s take the manufacturer Rein (ph) we represent Rein in Florida and what ever he makes 13 SEER or any other efficiency level we can buy and resell in Florida. However we cannot sell Rein in Georgia. We are not authorized to sell Rein in Georgia but with a private label whether it’s BranDeer(ph), Whirlpool or any other label that we’re now starting to introduce we’ll be able to sell that efficiency manufactured for us by Rein or someone else in Florida in Georgia without restriction. Because there is just no – it’s our own label.

So that would have been the case even if --.

And that was David’s case. And I agree with that as I said I – I’ll just say thank God that we have the size to have private labels because we can do that where as most people cannot that compete with us. It is an advantage at today’s efficiency levels and that advantage will continue as the mandate comes in in ’06.

Alright okay.

And I guess if it’s good for us to be selling 13 SEER with a branded product in ’06 then we will also be another positive to be selling 13 SEER in our private label it’s just another positive.

Okay Al thanks.

At this time there are no further questions.

well thanks very much for listening and we’ll speak to you at the next quarter.

Thank you this concludes today’s Watsco Third Quarter Earnings Conference Call. You may now disconnect.