Watsco Inc (WSO.B) 2006 Q1 法說會逐字稿

Good morning. My name is Lewana and I will be your conference operator today. At this time I would like to welcome everyone to the first quarter earnings release conference call. All lines have been place on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) Mr. Nahmad, you may begin your conference.

Good morning, everyone. This is Al Nahmad. I'm the President and with me on this call is Barry Logan, who is the Company's Senior Vice President. This morning we will be discussing Watsco's first quarter that ended on March 31 this year. First a cautionary statement. This is the reminder that 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.

As you can tell by the press release, we had a great quarter. We feel confident this will be another great year. We participate in a very large market and have plenty to do serving our contractor customers at work tirelessly to maintain the heating and cooling systems in almost 120 million homes in the United States. These are exciting times in the industry as new and more efficient equipment is introduced at the same time that energy costs are escalating. There is also growing focus on indoor air quality and the industry is moving to meet demand for these products as well. Watsco as the largest distributor of course is well positioned to benefit from these developments and we are focused on increasing our 7% market shake.

In the first quarter this year, our revenues and margins expanded resulting in a 42% increase in earnings per share to a record $0.47. Revenues and gross profit dollars for the quarter increased 14% with gross profit margins increasing 10 basis points. Operating expenses were up 9% versus a 14% increase in revenues and as a percentage of sales, operating expenses declined 80 basis points to 90.9%. This resulted in operating margins increasing 90 basis points in the quarter.

Interest expense declined 24% on lower borrowings and higher interest income and net income reached a record $13 million. $22 million in cash was used in the quarter compared to $30 million last year, reflecting the seasonal buildup of inventory and the transition to new higher efficiency systems. Average daily borrowings declined 17% and our debt to total capital ratio remains at 10%. With this healthy performance we once again increased cash dividends to a quarterly rate of $0.25. This represents a 25% increase in cash dividends. We also repurchased $3.7 million of Watsco common shares during the quarter.

Finally we thought it would be interesting to note in the recently published Fortune 1000 list for 2005 Watsco moved up to number 903. Even more important, we ranked number 26 out of the 1000 companies when it came to total compounded return to shareholders over the last ten years. We earned that ranking by providing our shareholders with a 29% compounded rate of return over that period of time. We understand that Fortune calculates return by adding stock appreciation and dividends.

That concludes my comments and at this time Barry and I will be pleased to answer your questions.

(OPERATOR INSTRUCTIONS) Curt Woodworth, JPMorgan.

Congratulations on another great quarter. The question on the gross margins. If you look at the gross margins for the Company going back about three to four years, they have only risen 50 basis points compared to the EBIT margin for the Company, which was about up I think 300 basis points since '02 -- this is just looking at the first quarter. My question is do you feel like you have a lot more opportunity to improve the gross margin today at the Company than you did three years ago? Can you maybe talk about some of the drivers there? Or do you feel like the majority of the margin improvement going forward is going to be sort of a similar mix of a lot of the SG&A leverage continuing to benefit the Company?

My crystal ball on that is that we think we're going to deleveraging SG&A more, that revenues will grow at a faster rate than operating expenses. Gross profit margin is a competitive -- it is somewhat limited by competition. We do feel that we are getting more efficient in our procurement and sourcing programs, but nevertheless it is more of a competitively driven margin as the strength from what we can do with operating margins given our ability to do something with our operating expenses. So I think as you have experienced -- as we continue experience in the last few years we will see it in the future revenue growth rates at a higher growth rate than operating expenses and that will be the main driver for EBIT.

Okay. So then in terms of the 13 SEER transition, you really wouldn't see any gross margin benefits or negatives then?

I'm one that doesn't like to add to the hype about this transition of higher equipment. I think that there is a possibility like you just said, Curt, occurring, but I'd rather wait and see that develop before commenting on that. I think that there is that possibility though of higher gross profit margins on the higher efficiency systems but I've got a wait-and-see attitude about that.

Okay. Then in terms of the organic growth this quarter of 14%, if you break it out what was the equipment growth and what was the mix benefit? Could you tell us what your -- the mix of below 13 SEER product was this quarter?

Let me first say generally speaking that the first quarter was a 10 and 12 SEER on the equipment side market. There was some 13 SEER but not enough to really get too excited about at this moment. In terms of equipment, the equipment business was up 19% during the quarter; 3% of that was price increases while 16% of that was units. And the non-equipment was up 11% and the mix of that gives you the revenue increase of 14%

Great, thank you very much.

Holden Lewis, BB&T.

I guess you sort of alluded to it. I wanted to get a sense from you on the 13 SEER conversion, you said it was mostly I guess 10 to 12 SEER units this quarter. Is that sort of an inventory overhang issue and where is the industry and where are you in the inventory cycle to clear out the old units and really get more into selling the 13 SEER? Is Q2 going to be 13 SEER heavy?

I don't think of it as a clearance situation. We are pretty accurate in our estimates in the fourth quarter that we thought there would be some transition issues given that manufacturers would be delayed in their deliveries of higher efficiency units, so because of our balance sheet and our strength, we were able to take advantage of that and took inventory in to keep the contractors supplied as the manufacturers caught up with their production of higher efficiency systems. We did that very successfully as you tell by the first quarter.

Now the idea of continuing to have some 10 and 12 SEERs as we enter the replacement market is a good idea because there is going to be a segment of the market homeowners or businesses are going to want some level of demand replacement of their existing condensers, of 10s and 12s. So we're happy that we have the balance sheet to carry that sort of inventory in the replacement market. Not all of the contractors' customers are going to require the 13 SEER but given our unique position in that we have the strength to carry this inventory, we see it as a valuable asset going into the second and third quarter.

Okay and I think the expectation is obviously that because you will be able to sell what should be a more expensive unit over your existing base that there will be sort of a profit step up that occurs once you do shift to primarily 13 SEER. I'm guessing that there really was none of that in Q1, but do you expect that Q2 is where you do begin to see that profit step up?

I would not say there was none of it. I just said that it was primarily a 10 and 12 SEER from the equipment point of view in the first quarter. I think 13 SEER will impact the second quarter, but I think the real impact will come later in the year and I do -- it's the same question that was asked before, you asked. We just don't like to comment on margin expansion at the gross profit level given the higher efficiency systems, but it is possible that that will occur as well with the eventual move to a pure 13 SEER and above market. By the way it's not only 13 SEER. Customers will also the requiring 13 and above, emphasis on above.

Okay. And then last can you just comment on sort of copper prices continue to rise higher. You said 300 basis points of pricing was in the quarter. Plans for new pricing increases to offset those type of costs or what can we expect there?

Yes, the OEMs have announced price increases and we have been able to pass them on without any problems into the marketplace.

Okay, great. Thanks, guys.

Jeff Hammond, KeyBanc Capital.

I guess -- (multiple speakers) -- just, Al, you talked about the gross profit margin and opportunity to expand that, and I think you mentioned your procurement initiatives. Can you just give us a little color on what you are specifically doing there particularly on the global sourcing front and what you think the long-term opportunity is?

I like talking about long-term, Jeff. Thanks for the question. Half our revenues are not equipment and two years ago we started sourcing globally just to test the Waters and we are up to 200 containers a year from China, and that is a very small number given our total revenues. We are importing about $10 million a year. We did see that these items which again I emphasize are not equipment were able to be accepted by the marketplace and at a higher gross profit to our Company. So now we have stepped that up by building a small team around it and we are going to see over a period of time how we can do more of what we have already done in the last couple of years. I don't have any way to quantify that for you. I just wanted tell you what our sentiments are.

Then in terms of the guidance I think you initially mentioned 290 to 295. Any update there or change?

We are conservative people and what I like to say about guidance is that our ten-year record compounded growth rate of earnings per share is 20%, Jeff, and what we like to say is that we think we can sustain what given what we know today.

Okay, then finally you mentioned in the first quarter call some product availability issues. Can you just update us in terms of that issue? Is that fully resolved or are there still some --?

That's a very good question. The product availability issue continues during the entire first quarter and there is still a problem with that. And our performance would have been actually greater if we had had the complete systems that we needed. My guess is that the OEMs will finally catch up to what our needs are sometime in the second quarter but as of April, they are still continuing, although our revenue increases in April are in the double-digit range.

Great. Thanks, Al.

Keith Hughes, SunTrust.

Several years ago you had a bigger business in the manufactured housing market which went through a horrendous decline. Is that business starting to pick back up for you at all?

Yes, Keith. That segment of our business, profits are growing. Of course the tragedies in the Gulf Coast helped in that manufactured houses were placed into that region and we serve that region and it is certainly a much healthier business now than it was in the past.

Is it on a -- besides any benefit from temporary housing in the Gulf -- but is it on a sustained trajectory in your opinion back up?

I think so. It is not a material part of what we do, but we are a player there in that segment. We like to play in that segment and it is healthy and I think it will continue to be healthy.

Okay, thank you.

Jeff Germanotta William Blair & Co.

Congratulations on a great quarter. Regarding the operating margin expansion to 5.5% from 4.6% last year, is that principally volume derived or are there specific SG&A initiatives going on to create greater leverage as well?

I would characterize it as revenue. We are a revenue-based company. We like to watch our costs, but we are focused on revenue growth. And as I said to the earlier question, I think that our future is the same as our past. We intend to grow revenues at a faster rate than operating expenses. And by the way, we could get a gross profit margin increase as we move into the higher efficiency systems.

Thank you.

Joseph Perrone, Forest Hill Capital.

There's no response from that line. You do have a follow-up question from the line of Curt Woodworth, JPMorgan.

Longer-term question on the buy and build strategy in terms of growing the market share. You have not been -- you have been pretty acquisitive throughout your history but in the last year there has not been an acquisition since East Coast. Do you feel that just by growing your company-owned store base and trying to grow on more of the build way that you can get to the market share level that you wanted to get to, near term? Or do you feel like you're going to have to be more acquisitive looking out the next couple of years to get what to whatever your internal targets are?

That's a good question, Curt. We always would prefer to make acquisitions as we enter new territories because that is our business model and we are very good at executing growth plan post acquisition. But if we can't for whatever the reasons we will build into it organically. We're going to open quite a few branches this year. We are a work in process I like to say. We're only in parts of 31 states and we still have got a lot of locations we can continue to build even in the 31 states and eventually build out all of the territories. So one way or the other we will build a network.

In terms of the acquisition pipeline we are always in contact with great companies. We are -- we have a reputation in the marketplace and it is a very positive one with owners of distribution companies because of what happens after a deal takes place. We are very good with organizations that become part of our Company. They have a lot of growth opportunities and that seems to bode well for these owners. So eventually I think we will do more acquisitions, but we just never can provide any timing on it. It is just very difficult to do. But I think we are the preferred company when it comes to most owners of distribution companies when they're thinking about exiting.

Great. What is a new store count going to be this year? How many new stores are you adding?

Barry, what is it now?

20.

What will the total -- what will that bring the total to?

377.

Thank you.

Clyde Lewis, Citigroup.

Two questions if I may. Firstly in terms of the regional differences in the first quarter, could you maybe say a little bit about how the different regions have performed in the last three months? And second question --.

Where are you, in Australia or Great Britain?

No. I'm in London, so I'm five hours on from you guys. The second question I had was on sort of the market growth. You've obviously done very well in the first quarter with 14% growth. You pointed to 3% sort of inflation in terms of the product. Have you got a best guess as to how much you think the market volumes have improved in the first quarter as well?

The industry does not publish that data yet and when it does distributor data we feel is somewhat unreliable in that it is not a direct reporting, it is sort of a calculation. In terms of regional developments of markets, we don't comment on that for competitive reasons, but generally speaking I think we're doing well everywhere we operate.

Okay, that's great.

A follow up from Jeff Hammond, KeyBanc Capital Markets.

Could you give us sense as you look at your inventory what particularly on the equipment side what is 10 and 12 SEER versus 13 at this point?

Barry, do you have an estimate of that?

Yes, there's about $25 million to $30 in 10 and 12 SEER inventory out of the entire population of inventory, which is again is about half of where it started at the beginning of the year.

(multiple speakers) We are pleased to have that. In fact I think it is going to be a very valuable asset for us at the summer comes and the contractors are called on by homeowners to repair or replace systems. It will be nice to have that inventory for them. And as I said, few distributors have the ability to take the sort of size of inventory in as we have, so I think it is a very valuable asset for us to have for our contractors.

I should say the margin have behaved very nicely with those equipment lines as well and as Al suggests, it is nice to have the advantage of having an inventory and as time goes on, the margins should behave even greater in terms of margins.

Okay, that's helpful. Thanks.

Holden Lewis, BB&T.

Can you comment in terms of any new authorizations either geographically or being able to fill out some more price points on your metrics? Was there any further progress or further newsworthy items that took place during the quarter?

Barry, did you understand that?

Any new product territories or authorizations is the question?

(multiple speakers) Oh. Well, there's always some of that going on. It's nothing that is worth -- nothing of a material nature. We're always negotiating some distribution rights someplace and I would not comment on anything in specific, but that is what we do. We are constantly trying to improve our relationship with our OEMs in being the one that they want to go to when they want somebody to develop a particular market. And again, that something our size gives us. We have the capital in the organization to when asked by a manufacturer to really develop markets that they believe are underperforming.

All right, thanks.

That is sort of a strategic advantage that comes with our size.

Thank you.

(OPERATOR INSTRUCTIONS) At this time, sir, there are no further questions.

Well, it has been a nice time talking with you guys. We will see you at this time at the end of the second quarter. Thanks a bunch.

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