Watsco Inc (WSO.B) 2005 Q2 法說會逐字稿

Good morning. My name is Jessica, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Watsco Second Quarter Earnings Release 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. his is Al Nahmad, and with me is Barry Logan, our Senior Vice President. We're going to cover the second quarter and year-to-date performance of Watsco.

Before we start, let me read a cautionary statement, as I always do. Please remember that this conference call has forward-looking 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.

Once again, Watsco achieved record level performance, as we followed a strong first quarter with record levels of sales, earning and earnings per share in the second quarter. These results are especially satisfying for me given the soft market conditions that are evident in recently published industry data. From what I know, the industry published distributor and manufacturer shipments in April and May were soft. And June, we don't have those numbers yet, but in both of those months as well as in June, Watsco had growth. So that's an indication to me that we're doing very well. Our solid performance in the first half of the year is expected to continue, and we do expect the results of the full year to be another record-breaking year.

I'd like to go over the numbers for the second quarter. Diluted earnings per share was up 12% to a record $0.81. That compares to $0.72 last year. Net income was up 16% to a record $22.4 million and that compares to $19.4 million last year. Revenues for the quarter rose 19% to $443 million. In that figure is the sales increase of 3% and a $57 million contribution from East Coast, which continues to produce double digit revenue growth rates. The transaction was completed at the beginning of January.

Looking at gross profits, they increased 16% to $112 million with a gross profit margin of 25.2. The change in gross margins year-over-year primarily results from the addition of East Coast, which historically has operated lower profit margins than the rest of the Watsco businesses.

Looking at SG&A, we continue to actively manage that and as a percentage of sales that decreased by 30 basis points. Our operating profit for the quarter was $37.1 million with operating margins of 8.4% on the same store basis. Let me say that again. It was 8.4% for the quarter and on a same store basis it was 8.7% which is consistent with the prior year.

Regarding cash flows for the quarter, they were strong as the company was able to generate $23.5 million in operating cash flow versus $12.1 million a year ago. Now, as you know, the cash flows generally substantially increase the remaining of the calendar year, and I think we'll achieve our annual goal of having cash flow exceed net income.

Year-to-date, earnings per share were up 18% to a record 1.14 versus $0.97 cents in 2004. Net income has risen 21% to an all time high of $31.6 million from $26 million last year. Operating profit increased $8.9 million or 20% to a record $52.9 million with operating margins on a same store basis expanding by 10 basis points to 6.9%.

Revenues during the first half of 2005 were up by more than $138 million or 21% to $789 million. And that includes a 5% same store sales growth and east coast contribution of approximately $100 million for that revenue.

Gross profit increased 19% to $199 million for gross margins of 25.2%. Again, the change in gross margin year-over-year primarily resulted from the addition of East Coast, which historically has had lower gross profit margins than our other business units.

Operating expenses were $146 million for the first six months, as the percentage of revenues decreased 50 basis points to 18.5% from 19% last year.

Regarding Watsco's balance sheet, compared to June 30th, 2004, debt has been reduced by 17%, and we are now at a debt to cap ratio of 10%. I always like to point out that the strength of this Watsco balance sheet helps us as we develop strategies that our competitors can't and help us compete in the marketplace.

Moving right along with the outlook, we've had, as I said earlier, we've had a very strong start the first half of this year. We are confident we'll have another record year for the full 2005. In terms of guidance, we continue feeling we can sustain 20% growth which is in line with had our historical 10 year growth rate of 20% in earnings per share.

And lastly I'd like to once again reiterate that the Company's goal is to build a national network of locations that provide the finest service and product availability for HVAC contractors that assist and support them as they serve the country's homeowners and businesses.

With that, we'd be happy to take questions.

[OPERATOR INSTRUCTIONS] We'll pause for just a moment to compile the question and answer roster. Your first question comes from David Manthey with Robert W. Baird.

Good morning, David.

Good morning, guys. Question on the environment being weak here, clearly in April and May. I think it was better in your markets, just based on some weather patterns we've looked at. I was wondering if you could talk about given that the industry has been so weak, have there there been any opportunities to take advantage of deals? It seems like your inventory turns are very solid and your inventories didn't go up very much. Within that was there the opportunity to get some lower-priced product?

The OEM?

Right.

I would say that business as usual was conducted during the second quarter.

All right. And in terms of linearity, on the last call you said that March was weak and that April had picked up. Based on the numbers, should we assume that May was also weak and that June got better? And I don't know if you can comment on July.

Well, I will, David. First let me tell you that April and May and June, all three months in Watsco's case showed same store sales growth, which I think differentiates us from the industry data I've seen, which all showed at least April and May were down as much as 9 to 10% at the distributor level.

And in terms of growth rates, should we -- I mean, did things accelerate through the period? I guess the daily sales numbers wouldn't accelerate.

In the first quarter, our same store sales growth rate was 7%. In the second quarter that came down to 3%. What we're seeing now in the beginning of the third quarter is an increasing sales growth rate . So that I think that whatever happened in the second quarter, even though we powered through it and made -- performed at record levels, I think that we're starting to see recovery of our growth rate. I cannot tell you what the industry did in June or what they may be doing in July, but we are increasing our growth rate in July.

All right. Great. And then one last question on the acquisition environment and competitors. One of your larger competitors recently bought about $60 million in HVAC acquisitions. I'm just wondering are you finding the environment any tougher, does it slow down given that sellers would want to sell on 13th SEER results as opposed to selling on the current results?

We have no indication that 13th SEER is causing owners of businesses to accelerate their decisions to sell. I think that this is a healthy industry, and I think that it's used to taking on challenges. There was a higher SEER mandate a few years ago by the federal government and the distributor segment of the industry did well with that, it adjusted as it had to. I don't see any changes in terms of owners attitudes.

Insofar as the other transactions that you mentioned, I think that we're not unique in this industry. There are always mergers and acquisitions going on. We just happen to have one that's large in scope and it's national, and we have a reputation for what we do after we make the acquisition. Companies that come to be part of Watsco prosper and grow and provide opportunities for employees and customers, and we have that reputation. And I think that helps differentiate us if there is competitive situation we're seeking an acquisition that some other company might also be doing. We have no reason to believe we can't continue to succeed in that in the efforts to grow through acquisitions.

Thanks, Al.

You bet.

Your next question comes from Kurt Woodworth with J.P. Morgan.

Good morning, Kurt.

Good morning. Congratulations on a good quarter.

Thanks very much.

Given that the industry was down on the second quarter, obviously you guys were up, which is very impressive. That being said, given the weather and seasonality and the business and it appears that July is tracking pretty well for the industry, would it be right to assume that the sales levels for the company in the third quarter would be greater than what they were in the second quarter?

Barry, have you got a feel for that?

Well, Kurt, it's a good crystal ball question. We certainly like what's happening in July so far, so if that helps the crystal -- clear the crystal ball in answering you, we're more optimistic. A lot of times it needs to play out. I think the seasonality, which is an objective measurement, I think was tilted last year in such a way that it was nice that we powered through this quarter. I would hope that it makes the third quarter simply a little better comparison than what we've been up against this year in the second quarter.

Can you comment on what type of growth rates you're seeing in July?

Well, it's early. And I'll give you a number. It's 5%.

5?

Yes. From same store.

Okay. In terms of East Coast, can you talk a little bit about -- their sales growth was 20% versus you at 3% on same store basis. Can you talk a little bit about that, how that is being accomplished? And then also touch on the gross margin variance between East Coast and your kind of legacy business. Just because the change in the margin in this quarter of 60 basis points is pretty large. I'm just wondering, the variance must be pretty sizeable. If you can walk me through why that is and those issues, thank you.

We'll share a response for that and I'll start by telling you that East Coast -- once again I want to say that it's a fine organization, and they've had some opportunities in the marketplace since the beginning of the year, and they're just going after it and very excited to do that. I'm just so pleased they're part of Watsco. But they do pursue the value segment of the industry, and that tends to provide a lower gross profit margin. I think that over time -- I hope, and they know that -- we hope as they build the company that their margins will also improve. But I can't complain about anything they're doing. It's just very exciting to watch and see them grow after the transaction was completed in early January.

Barry, you want to add to that?

Sure. The key for us is to see that they are making -- you know -- we really look at it on an operating margin point of view and EBIT percent point of view as, how is their progress? Gross profit is what it is in terms of wanting to get better, but it is lower than the rest of Watsco. But how is the contribution to EBIT? Not only are their sales up but their EBIT margin is up about 50 points from their historical period a year ago. So that encourages us. That's really the key benchmark we're focused on is to know that they're gaining ground ob EBIT margins.

Is their sales growth being driven primarily by new distribution, new outlets? Their same store number wouldn't have been 20%, I assume.

There were no new branches in East Coast, so their growth is same store growth. Part of that growth is coming from some new territory that was granted to them within their marketplace, some additional product lines that's taking hold, and they're building a larger business in their existing market and existing branches.

But they will be adding branches before the end of the year. They feel very confident that adding branches will continue to add to their growth rate.

How many total branches does the Company expect to add this year?

Over the course of the year, it's been about -- the plan has been about 15 branches. It's not something to annualize, so to speak. They come in over the course of the whole year.

Okay. Great. Thank you very much.

[OPERATOR INSTRUCTIONS] Your next question comes from Keith Hughes with Robinson Humphrey.

Thank you. Barry, in response to the last question with the East Coast EBIT being up 50 basis points year-over-year, where does that put it in comparison to the historic Watsco businesses? Is it above, below, about the same?

About 150 basis points behind.

And that's EBIT. Correct?

Correct.

But they all start that way, Keith.

Yeah. That's what I figured.

They start -- it's just very exciting to see, especially when you have a great organization like --

After this year's complete, you've had them in the mix for a year. Is that something you could reasonably expect to narrow in 2006?

Absolutely. I think they want to do that, and I think that's one of their goals.

Is that going to be driven -- is that a cost issue or a mix issue that would push that up?

I think generally speaking Watsco's growth is predicated on revenue growth, not on cost. We do manage cost, but it's mostly about growing the top line.

Final question. I've heard anecdotally some -- at least in my market -- some local tube dealers discounting 12 SEER, 11 SEER product, I assume trying to get rid of it before the end of the year. Is that occurring in your markets now? Is that something that could have an effect on the back half of '05?

I have no reports of any such behavior in any of our business units. I do believe that there will be some judgment calls as we get to year end, how much 10th SEER and 12th SEER distributors will take into inventory that might be sold the first quarter of the following year but I do not see any evidence of discounting in anticipation of that.

Okay, thank you.

At this time, there are no further questions.

That's great. Thanks for listening. Look forward to talking to all of you in the third quarter. Bye.

This concludes today's Watsco conference call. You may now disconnect.