Watsco Inc (WSO.B) 2004 Q4 法說會逐字稿

Good morning. My name is Nicole, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the 2004 annual 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. (OPERATOR INSTRUCTIONS).

Thank you. Mr. Nahmad, you may begin your conference.

Good morning, everyone this is Al Nahmad. I am the CEO of Watsco. With me this morning is Barry Logan. He is our Senior Vice President. And today, we are going to cover the fourth-quarter 2004, as well as the full year.

Before getting started, let me read the 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, let me start. In 2004 -- was another great year. And it is especially gratifying to deliver record performance following what was also a record year in 2003. Before we discuss the specific 2004 results, I would like to comment on our overall achievements in 2004.

First, Watsco performed at its highest rate of sales growth in 4 years during the year -- and moved selling margins to the highest level ever, our tenth consecutive year in improvement in selling margins. Once again costs were controlled and by leveraging our infrastructure, the Company enjoyed the biggest jump in operating margins in our history. During the year, we further enhanced asset quality and the quality of our balance sheet and generated cash flow above our stated objective of meeting or exceeding net income. And we did that for the sixth year in a row. And so far as new locations, ones that had been acquired or opened in 2004, they performed well and were accretive during their first year in operation.

Also once again, dividends were raised during 2004. And we have also raised them again at the start of 2005. And lastly, Watsco generated record earnings per share with a 34-percent growth rate last year. And that takes our 10-year earnings per share compounded annual growth rate to 19.6 percent. Let me just say that again -- over the last 10 years, our compounded annual growth rate is approximately 20 percent or exactly 19.6 percent.

Also by the way, we made these very same general comments in our conference call last year when we were describing 2003 performance. And that demonstrates somewhat the consistency of our performance from year-to-year. I also want to remind everyone that we acquired East Coast Metal at the start of 2005. East Coast had 2004 revenues of $180 million and added 27 locations to our network. This is a terrific organization, and performance in the early parts of 2005 is strong.

Now, let's go through the fourth quarter results in detail. Diluted earnings per share increased 35 percent to $0.23. Net income was up 39 percent, setting a new record for the fourth quarter. Operating profits increased 34 percent to $11 million during this seasonally low period with operating margins expanding 70-basis points and marking our eighth consecutive quarter of enhanced operating margins on a year-over-year basis.

Revenues for the quarter grew 7 percent to $306 million. And gross profit increased 8 percent to $77 million with the gross profit margin increasing 30-basis points to a fourth-quarter record of 25.1 percent.

Now, the results for the full year -- diluted earnings per share was up 34 percent to a record $1.79. Net income rose 38 percent to a record $48 million. Operating profit increased 34 percent to $82 million with operating margins expanding by 120-basis points to 6.2 percent -- the best improvement in our history. Revenues were up $82 million or 7 percent to over $1.3 billion with same-store sales of HVAC products growing by 6 percent.

Gross profit margins increased to 25.6 percent, a 90-basis point improvement over the same period in 2003 -- and reflects our ability to get better pricing from our (technical difficulty) due to our service levels and is our tenth consecutive year of improvement. SG&A increased to a slower rate than sales, 3 percent -- I'm sorry, 5 percent versus 7 percent and as a percent of sales decreased by 40-basis points. Cash flow from operations was $57 million, surpassing a net income for the year and our best -- and our debt-to-total cap ratio of year-end was 13 percent, which is the lowest level in recent history.

I just want to remind everyone that an increasing dividend policy is an important objective. To that end, dividends grew 90 percent to $0.38 per share in 2004. And we announced in January 2005, an increase of $0.40 in our quarterly dividend from $0.10 to $0.14 per share.

Now, I would like to comment on our outlook for 2005. Our Company's momentum continues in 2005, and we believe we are in for another year of strong performance in earnings growth. Our earnings per share guidance for 2005 is in the range of $2.10 to $2.20 or about a 20-percent growth rate, which is aligned with our historical 10-year growth rate.

Finally, I want to repeat something stated in our press release. We feel very strongly that we're succeeding because we work hard and with a great deal of professionalism to develop profitable market share growth for our manufacturers' products. It is really a great partnership that we have with our manufacturers. We invest whatever it takes in capital and talent to accomplish this goal. Furthermore, we also feel equally as strong about our contractor customers. We spare nothing to constantly improve our service levels. Educational programs, marketing assistance, credit assistance, and anything it takes now and in the future to assist these professional contractors as they serve homeowners and businesses.

And with that, Barry and I are prepared to take your questions.

(OPERATOR INSTRUCTIONS). David Manthey.

Couple of things -- first of all, I was wondering if you could talk about price increases -- what you are seeing from OEM's today? What type of realization you're getting from that? And how long do you think that can continue?

Sure, that's a good question. OEM's have been increasing prices due to commodity cost increases. So late last year and some early this year -- and the market is absorbing those price increases without much problem. Because all of them are doing it.

And the magnitude for you -- I guess if you could talk about just what the impact would be on the equipment side?

Well, we have not calculated the magnitude on overall sales. But price increases are running, I would say on average, of 3 percent. Is that correct, Barry?

Yes.

On the equipment side.

Okay. And then in terms of the margin improvement here -- you guys have done a great job of moving gross margins up year-after-year and driving that down. In terms of SG&A going forward though, we're hearing -- what about 19.5-percent SG&A. Last cycle, it was -- it got down as low as 16. I'm not sure if there is an impact from EITF 218 in there or what. But if you could just talk about where you think that SG&A number can go? Where is the opportunity over the next 3 to 5 years?

Sure, Dave. Don't forget this is a seasonally low period, the fourth quarter, so that is probably why you see a change like that. But we are operating already in certain subsidiaries as low as 16.5 percent. And when I look about what is possible, I take what we have already accomplished and say, well, why -- it's possible in certain of our subsidiaries. We should have that as the overall goal for all of the subsidiaries. So I would say in the area of 16.5 is our ultimate goal. And when we get there, we will probably look and see again how far we can drop that.

Okay. And then final question on the East Coast Metal Distributors -- how is that acquisition going so far? And then beyond that, what other acquisition opportunities do you see out there? Who's going to be -- 2005 is going to be a more acquisitive year for Watsco?

Well, I am glad that you asked the first part of the question anyhow. I have to say that the more time I spend with East Coast organization, the more terrific I think they are. It is a highly motivated business. Its performance speaks for itself. These are people that are used to being on top, and I see more of that continuing. They are just on top of their game. And I think just based on what I have seen since the beginning of the year when this transaction was completed, they are very, very strong and will make a contribution -- an important contribution to our overall performance.

So far as additional transactions -- yes, we're always in the market. We have a reputation for buying and building businesses. We don't have a reputation for buying and destroying businesses. And that seems to attract quality companies to us. And we're always in discussions with some -- that David, you know the answer to that question -- is we cannot predict when they will occur. But we are in the market. And we are well capitalized and have the funds to take advantage of anything, of any size, that might come along.

Kurt Wuhlber (ph).

I just have a quick question on your strategy with regards to 13 SEER. As that evolves, are you planning to move all of your inventory to 13 SEER? Or are you planning to maintain some below 13 SEER product? Also, could you talk about how that migration is going to affect your private label business?

13 SEER is a federal mandate that manufactures beginning January of '06 -- will not be permitted to manufacture a lower efficiency than 13 SEER. And that's because of energy conservation. 13 SEER will conserve power when you compare it to the -- what is presently the federal mandate of 10 SEER, so there is a 30-percent improvement in efficiency.

The manufacturers of equipment have different timetables when they plan to introduce 13 SEER. Some of them are talking about third quarter of this year and some of them talking about fourth quarter. Now, in so far as Watsco's policy, we will just have to see when the product is introduced, and we will have to of course take a position in 13 SEER since that is the future. I do not believe we will accumulate large quantities of below 13 SEER, as we get to the end of year. There is no problem in us selling below 13 SEER because the federal mandate is only that you cannot make it below 13 SEER. But because we don't have a clear vision of what 13 SEER might come to, we do not want to get stuck with lower efficiency units that may be priced at or near 13 SEER pricing. So that is something we will be very careful with. But eventually, we will follow -- in '06 for example, I think that we will be -- if not predominantly 13 SEER or more supplier, we will be close to that.

Okay. And is that going to alter your private label strategy at all?

Well, private label follows everything. Private label is nothing more than another brand. We represent every brand. We work very hard at every brand that we represent -- very professionally to grow their share and grow profitably for them. But private label is just another one that follows the same -- as anything that we do with our branded products.

And in terms of the gross margin performance in 2004, if you look at it in terms of a spread benefit from just passing through some of the higher prices in the industry and utilizing your position to buy product at good prices -- can you quantify that at all? Would you expect that kind of spread benefit to improve in '05, as the 3 to 4 percent pricing takes hold?

I'm not sure I understood the question.

Well, part of your strategy in the third quarter was to build -- I think build some inventory. And I think you selectively purchased some --

Do you mean are we going to speculate on price increases or anything like that?

No, just to get a sense of part of the margin improvement this year -- was the ability to kind of pass-through industry-wide price -- some price inflation that you were able to source attractively.

Well, I mean there are two parts to the answer. One is -- we passed manufacturers' price increases onto our customers. And secondly, occasionally, a manufacturer will ask us to take an unusual quantity of products for their own reasons. At that point in time, they may sometimes offer an incentive, which does impact gross margins because we buy -- because we have the capital to buy it. That is one of the great advantages of our size. And that does happen from time to time.

(OPERATOR INSTRUCTIONS). Keith Hughes.

With the acquisition coming in at the beginning of the year, what kind of extra depreciation amortization do you expect during the year?

Barry, do you want to take that?

Well, first in the straight depreciation of the fund East Coast books -- it is about $700,000. We are going through our purchase accounting process now, so I can't tell you what -- if any amortization might be on in terms of the purchase price allocation that we do.

Okay. But when do you think that will be completed?

It is something that we will have to have for our first-quarter release.

First-quarter release, okay. And you had talked earlier about your SG&A goal -- pretty far below where we are right now. Is that part of the initiative of getting some of the lower performing divisions moved up in terms of profitability? I know we consolidated in terms of the number of divisions, is that all part of that?

Yes, but let me give you a little better response. The best way to drop SG&A as a percentage of sales is to grow your revenues. That is how you leverage your infrastructure. That is how -- those subsidiaries that have already gotten to 69 percent have accomplished it. Now, at the same time, you are growing your revenues, you also have to be aware of your -- and control of your SG&A. But as I said earlier -- and maybe you are saying the same thing -- we know that we can get the 16.5 because some of our subsidiaries have already gotten there. So I do not see any reason -- basically, the subsidiaries all do the same thing. And they custom make what they do to the particular market they are selling to. But I believe that should be our goal. And that we can obtain it. I can't tell you when for sure, Keith -- but certainly a goal that is not out of reach, since we have already gotten there with some of our largest subsidiaries.

And what do you expect the share count to be this year? I know you issued a little bit of stock as part of the acquisition.

The share count -- oh, Barry, do you want to take that?

Yes, Keith, the shares in the acquisition were under 200,000 shares. So it is really not a material event, so to speak. But we are using -- adding about 500,000 shares to the year-end shares to account for that acquisition as well as for investing in stock options and so on.

Perfect. And I guess final question -- will East Coast carry some of your private label products this year?

No.

At this time, there are no further questions. Gentlemen, are there any closing remarks?

Yes, so far 2004 was a great year. And I think 2005 will continue the trend. We appreciate your interest in our Company and look forward to our first-quarter conference call. Good-bye for now.

This concludes today's 2004 annual results conference call. You may now disconnect.