Watsco Inc (WSO.B) 2008 Q1 法說會逐字稿

Good morning. I will be your conference operator today. At this time, I would like to welcome everyone to the first quarter earnings 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 session. (OPERATOR INSTRUCTIONS) Thank you. Mr. Nahmad, you may begin your conference.

Thank you. Good morning, everyone. Welcome to our first quarter conference call. This is Albert Nahmad, President and CEO; with me on the phone is Barry Logan, Senior Vice President; and Paul Johnston, Vice President. First, let me read a cautionary statement.

A reminder 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, for the highlights of the first quarter, sales results came in about as expected. The first quarter is a seasonal low point for the replacement market and therefore new housing and the general economy had a disproportionate impact on sales. This normally balances out as we move into the replacement season during the second and third quarters. As we discussed in our February conference call, we have taken action to improve gross margins and reduce SG&A. We estimate approximately $5 million of pretax earnings were contributed during the quarter as a result of these actions and there's an additional 25 million to $35 million of earnings that can potentially be realized during the next several quarters.

We generated record operation -- we generated record operating cash flow of $21 million during the quarter and over the last 12 months, we have generated cash of $122 million. This is well in excess of our established goal of cash flows exceeding net income. In per share terms, this represents cash flow of $4.41 per diluted share over the last 12 months. Gross profit showed further improvement in adverse market conditions, reflecting the success of a number of initiatives to enhance margins. Same-store SG&A declined 5% during the quarter, a sequential improvement over the fourth quarter change in SG&A, indicating our initiatives are also working to lower costs. Watsco's dividend, which we paid at the end of this month, represented 12.5% increase in our dividend rate to $0.45 per share. This shows our confidence in the Company's ability to perform and generate cash flows in the future.

It is also important to note that sales of higher efficiency systems, that is to say products above Montreal continue to grow this quarter, both in absolute dollars and as a percentage of the sales mix. The richer mix helps explain sales and margins and it speaks to the importance and relevance of these products as we moved into the replacement season. We also saw continued growth in sale, sales of systems that are used, that use ozone friendly R410A refrigerants. In 2010, the Montreal protocol will become effective for the equipment manufactured in the United States. This means that 410A products will become the standard of the industry. Their product transition is already under way and we have been actively training our customers on the merits and benefits of replacing systems with the 410A products well before the mandate takes effect.

As we head into the replacement season, these two aspects, high efficiency and concern for the environment, can provide higher price points and margins, margin contributions for us in our contractor customers and deliver long-term value to end users who see an immediate reduction in their electrical bills.

Now, for the specifics of the first quarter performance, sales were $380 million, including $49 million from new locations and on a same-store basis, sales declined 10%. Sales of HVAC equipment and non-equipment HVAC products declined 10% and 13% respectively. Our refrigeration business achieved growth of 2% during the quarter. Gross profit margins improved 10 basis points to 25.8% and on the same-store basis improved 30 basis points to 26%. This represents strong performance out of the overall market conditions. SG&A was down 5% on a same-store basis, a sequential improvement versus the rate of decrease in the fourth quarter of last year. Operating profit was $12.8 million and operating margins of 3.4%. On a same-store basis, operating margin was 3.9%. Earnings per share was $0.28 per diluted share on net income of $7.6 million.

As previously mentioned, cash flow for the quarter was $21 million, our best ever for our first quarter. Debt ended the quarter at $39 million, a $15 million reduction since year end. Our present, our cost of debt is LIBOR plus 37.5 basis points, so we are in a great position to invest and are actively seeking acquisition opportunities. Our updated outlook for 2008 earnings per share is a range of $2.35 to $2.40 per share. With that said, Barry, Paul and I will be happy to answer your questions. Hello?

(OPERATOR INSTRUCTIONS) And your first question comes from the line of Curt Woodworth.

Good morning, Curt.

Good morning, how are you?

Fine, thanks.

In terms of thinking about the revenue outlook for the remainder of the year on a same-store basis, given that this quarter, obviously has a higher proportion of residential new construction and over the next several quarters, the comps get a little easier and obviously the replacement market kicks in, is it pretty logical or fair to assume that this quarter should be your worst in terms of the same-store number for the year?

I would say that's correct.

Okay. And then in terms of the $5 million cost reduction achieved this quarter, was that mostly in the gross profit area, and if you could kind of delineate where that was achieved?

Barry?

It's really equally spread and you can see the gross profit is up 30 basis points and can kind of do some of the math there with the quarter and the run rate you saw in SG&A in the fourth quarter, which was down 1% same-store is now down 5% same-store. So, again, you get a sense of some of the two sides of that equation.

Okay. I mean if your same-store revenues are down 10 and your SG&A is down 5, I mean that, I mean that under normal scenario, that's probably what it should look like, right, on SG&A?

Well, this time of year, Curt, is when the fixed costs are also at their highest level.

Okay.

So they, for instance, there were -- it didn't happen January 1. It happened during the course of the quarter, but there are 10 fewer branches at the end of March than there were at the end of the year.

Right.

So it is a fixed cost achievement, not simply adjusting to sales.

Okay, and the incremental 25 to 35, which you seem to have -- can you comment on how the breakout of that is going to look and where, kind of where the conviction lies in giving that number the next couple of quarters?

Well, this is what we discussed in the last conference call. This is a series of action taken by each of the individual subsidiaries and it's very difficult to group them into generally speaking things. These are specific actions, specific subsidiaries and so we are unable to give you general guidelines as to where they are coming from. Other than we're pushing to improve gross profit margin and reduce SG&A.

Great, and just last question, on commercial refrigeration, the growth rate has been slowing there. Do you think that that market can continue to stay positive for the remainder of this year?

Yes.

Do you see any evidence of--?

Yes, we believe -- we like what we're doing there and we believe we can continue growth in it.

And there is certainly a large component of replacement there, which is seasonal also, Curt, so I wouldn't think the trend should be any different in refrigeration as we get into the replacement season.

And what's the replacement percentage for commercial fridge?

That's the hardest number to give you, but it's primarily an after-market business.

Okay.

It would probably look like our air conditioning business.

Okay, great. Thank you very much.

You're welcome.

Your next question comes from the line of Matt Duncan.

Hi, Matt.

Good morning, everybody. A couple of questions. We talked a little bit about the first quarter cost savings. I'm wondering if you could comment where those came in versus your expectation in the quarter. Was $5 million kind of what you expected to get this quarter? Or kind of talk about that.

Well, we've said that our goal is to achieve an aggregate amount, 25 million to $30 million over a period of quarters, sometime through the first quarter of next year and we didn't make it -- didn't design it to happen quarter by quarter. These are not things that just happen periodically. These are initiatives that are taken, many, many initiatives are taken at the subsidiary level, and our goal is to achieve the 25 to 30.

And if I look at the branch closings, I guess is that a net 10 branches, Barry?

That is -- there are also two openings, so net is eight.

So net is 8. What was the impact of those closings on revenue? Is there any way to look at how much revenue you forego by closing those branches in the quarter?

Matt, most of those activities were nearby branches, basically taking over customer bases, taking over service to customers, so it's not something that is that cut and dried and spliced like that.

Okay, fair enough. Barry, looking at the gross margin for a minute, I know last year the high watermark for the year in gross margin was the first quarter. That was the highest quarterly gross margin you had for the year. It sounds like from your guidance, is that the same expectation you would have for this year as well, or kind of what should we think about with these cost cutting programs, how your gross margins should progress throughout the year?

I think there's 20, 30, 40 basis point improvement that is kind of inherent in the numbers if you were to extrapolate what you saw in the first quarter out towards the year, is the goal for the year. It really is a -- not something that you can calendarize. It's something that happens every day at the sales counter. But in terms of the goal, if you will, what you see in the first quarter is what we want to see for the rest of the year.

Okay. Fair enough. Can you comment at all about the replacement market, do you feel like your sales to replacements were up and the same-store sales being down was really a commentary on new construction?

Yes, the stats say in our markets, new housing is down about 40%.

Okay.

And that would certainly explain the same-store sales decline for the quarter and replacement is probably fairly neutral looking in what is an off-season quarter.

So it was probably roughly flat year-over-year, probably the right way to think about that, then?

That is correct.

Okay, and then last couple of things here and I'll jump back in the queue. Can you talk about the acquisition landscape a little bit, kind of what you guys are seeing out there? Obviously your cost of borrowing is pretty low right now. You would like to take advantage of that. Are you close to anything, is there anything we should expect to see in the next quarter or two?

Well, I'm pretty excited. I think that some of these companies that we've been pursuing for sometime are, and because we've created such a positive reputation for what happens after acquisition, we seem to be having a larger number of conversations, but nothing that you should bet on or that I can report to. I just like the atmosphere.

And then last thing, just couple housekeeping items, what was depreciation and amortization in the quarter, Barry, and then also CapEx?

Hang on one second. G&A was 1.8 and CapEx was six hundred thousand point six.

Okay.

Your next question comes from the line of Jeff Hammond.

Good morning, Jeff.

Hi, good morning, guys. Just wanted to get a better sense of in terms of demand trends what you saw in terms of progression in the quarter, and just maybe just demand landscape and the more important March, as you kind of segue into the selling season.

Well, I would comment on March as being industry-wide a pretty weak month.

Okay, so I guess back to your earlier comment, what gives you confidence that 1Q is kind of the low mark in terms of the same-store sales?

Because of the seasonality. As you know, Jeff, we enjoy increasing demands as the weather warms up and the air conditioners require -- they start them up and they require either repair or replacement. Plus you have these very high efficiency products that we're selling now and they conserve energy and reduce electrical bills, so these kind of forces are out there in addition to the weather. And that's why I'm pretty positive about the replacement market.

Jeff, another comment I would add is that we saw pricing in the quarter and especially in your unitary business up 5% and that's both price increase and sales mix. So really in a competitive environment, in an off-season environment to have positive pricing like that, and we're getting into the meat of the season, I think that's a nice positive as well.

And maybe just further comment on that, what are you seeing from the OEMs in terms of price increases, given, given the inflationary environment?

Paul, let's get you into the call.

We've seen a couple of, we've had a couple of announcements of price increases to date. I know Train published theirs that they were going up 4 to 6%. A couple other manufacturers have moved, but what's announced and what's actually being realized in the marketplace has been two different things. I think a lot of it, a lot of the pricing that Barry references is actually a mix change that we're seeing as we move into more 410 and above 13 SEER product sales, which continue to accelerate. I think -- we haven't seen a lot of the flow-through from some of the commodity spikes I think that you are all familiar with copper going above $4, aluminum moving up. We haven't really seen a lot of that roll back down into distribution as far as pricing increases.

On equipment.

On equipment.

Yes.

Okay, good. And then shifting gears back to the cost savings, can -- and I think in the recent presentation you laid out some of the initiatives. Can you maybe just speak to what, in your mind, is maybe working out particularly well or getting better traction, what's been maybe a little more of a challenge, if anything?

Barry, do you want to take a shot?

Sure. Well, Jeff, again, there are really three kind of pictures that need to be painted. First is variable costs that obviously is compensation and commission programs, things like that, and those are -- adjust themselves accordingly. There's no -- that's just something that is tied to sales. In a presentation, I said that the kind of fun phrase of greater discretion over discretionary costs, and culturally throughout the organization, there is a very intense focus on spending, and of course there always should be, but in planning this year and in getting through this year culturally, it's that much more intense and we're seeing the benefit of that. The hardest thing obviously is pricing, which is a day to day discipline, branch by branch, counter by counter. When Al talks about this is a very local business and a very local initiative, pricing ultimately is at a very disaggregated point of view, but we are seeing the benefits of it. It's something that's been more systematic and is probably the greatest variable still, but we certainly did see progress in both the fourth and the first quarter, and so far, so good.

And then just final question, I don't know if this is a nuance, but it looks like in the fourth quarter, parts on a same-store sales decline was much more challenging. Equipment was a little more stable, and that seemed to even out a little bit more, and you saw a bigger equipment decline. Anything, anything to read out of that?

Yes, I'll take a stab at that. That -- it seems like in the fourth quarter we still had some run-off of some of the new construction projects, which had started earlier, and I think a lot of that tapered off in first quarter this year. That would be my estimate of what happened.

Okay. Thanks, guys.

Your next question comes from the line of Michael Cox.

Good morning.

Thanks for taking my call. My first question, if I heard you correctly, it sounds like that--?

What firm are you with, Michael?

I'm with Piper Jaffray.

Thank you.

Yes, thank you. If I heard you correctly, it sounds like the high end of your earnings guidance was brought down a little bit. I'm just trying to reconcile this change with the comments that sales were basically in line with your expectations? It sounds like the margin enhancement initiatives are tracking to plan. So if you could provide a little color on that, that would be helpful.

Barry?

Sure, Mike. How are you?

I'm good.

Just wanting to be a little smarter about going through the process that we go through each quarter when we do our guidance and something we do from the ground-up and just wanted to refine the range. There is not a hidden message or hidden agenda. It's simply wanting to refine what's probably a bit of a broad range when we started the year.

That's helpful. And should we expect further branch closures through the balance of the year, and if so, or even looking at the first quarter? And were those ACR branches versus the, your existing legacy branches?

Well, there are a few ACR branches, a few meaning three that were in the plan as we started the year. The rest are throughout Watsco. Most of the heavy lifting is done for new branches and it's not something we wanted to worry about as we got into the season and disrupt the day to day activities of what's a much busier time of year. So the heavy lifting at closing is finished.

Okay, thank you. Then my last question, you had mentioned that March was overall a tough month and I would imagine that had something to do with the cool weather. I'm curious if April has bounced back, if you're seeing any uptick--?

That's a very good question. I would say it's early to tell, but no.

Okay, thanks.

Your next question comes from the line of Holden Lewis, with BB&T.

Good morning, Holden.

Good morning, thank you. Can you give a little bit more clarity in terms of this price mix. I mean kind of what I've heard is on the one hand, it's not largely been price. It's mostly because of this mix, but you keep using the comment about capturing pricing, that sort of thing. So maybe we're just sort of muddling terms, but I mean are you getting actual price, or is that 5% you're referring to primarily just mix? How should we be looking at that?

You're getting actual price. I can't split out how much of it is price and how much of it is mix. But we are -- in certain parts of the country, our subsidiaries are actually working hard to change their price matrixes in order to get actual pricing into the marketplace. The mix change is certainly there, which we've seen with the higher efficiency equipment and the 410 A equipment. So I think it's still a combination. I don't want to muddle it up any more, but I think that it's a combination of both still.

Holden, when we talk specifically about pricing of the Unitary products being up 5%, that's only equipment. And when we talk about our initiatives throughout the Company, it's all of our business, all of our lines of products across the whole board. Unitary equipment is only about 40% of what we do, so I'm really speaking a little bit to the OEM side of our business when we speak that way and the initiatives are throughout Watsco and there certainly are price increases and better margins in all the other product lines.

Okay, and then can you give a little bit of color also about the impact of both the mix, as well as the R410A? I mean what's the mix of 13% in better machine now versus where it was a year ago? And what's the mix of sort of R410 sales now versus a year ago and what's the margin discrepancy between those categories?

That's about seven questions in one question, I think.

They are all good ones.

I'll take a simple shot at it. In 2007, the trend above 13 SEER was around 10% of our Unitary sales. It's tracking now about 15%. And in absolute dollars, it's up quarter over quarter about 25%, if I look at a year-over-year trend from last year to this year. So 25% growth obviously is meaningful in terms of a real trend. 410A is a much smaller percentage. It only really entered the mix as we got out of 2007. It's populating our inventory now and it's not a -- I wouldn't throw out numbers to you yet, other than to say it's more than doubled to impress you, but it's still a small percentage.

Okay, okay. And, again, as the mix shifts towards the 13 SEER plus and the 410A, is that a margin-positive event, and to what extent?

Primarily it's a unit price event. The equipment costs more on average. I think it's difficult to tell you. I don't think the margin will get any worse. And if I was to -- we're just starting on these trends. That is to say it's probably going to be a positive.

Okay.

I would say more so, Holden, on the above 13 SEER. It is for the--.

End of 410.

For the industry, it's a higher margin. It's not just Watsco.

It's industry-wide, right.

410A tends to be the same -- relatively the same margin, but a slightly higher price. And the reason for that, is the higher efficiency does produce a better result for the end customer in terms of energy conservation, so the market will pay more for the equipment.

Okay. Okay, great. Thank you.

Your next question comes from the line of David Manthey.

Hi, David.

Hi, how are you.

Fine, thanks. How's Tampa?

Tampa's nice, but I'm in Milwaukee. Thanks for asking. Can we talk about repair versus replacement on the equipment side.

Yes, yes. Okay.

Any discernible trend you're seeing?

Paul, or Barry, do you want to take that?

That's something that we've been tracking right along, trying to identify what the repair versus replacement is. There's been a lot of noise about the subject for about the last 18 months to 24 months. From what our sense is, yes, there are repairs going on certainly, but I don't think that there's actually the -- this is my opinion. I don't think that there's actually a significant trend away from replacing and consumers repairing their equipment, and the basis of that is we track replacement compressors, sales and warranty compressor sales and movement, and we really haven't seen much of a movement change in those areas for the last 12 months.

Okay. That's encouraging. And in terms of the impact from copper and steel and other commodities prices, you said you're not seeing an impact yet, but given the major--.

No, no, let me give you a little clarity there. We're not seeing too much of an impact at the OEM changing of equipment prices other than the one that Paul mentioned. But in terms of the copper products that we sell directly to the market, we have been reacting to the rising prices of copper and steel and so forth.

As it relates to the equipment, though, do you expect that as we move through the year, prices will gravitate higher? It just seems the moves have been so dramatic that--?

Yes, I understand.

-- trying to get that back through efficiency. At some level, they have to raise prices.

Well, it's probably a better question for the OEMs, there's so much capacity out there, the industry is certainly performing below last year, and whether they want to, if the OEM wants to take that risk, as they try to pass that on, they may lose share. I don't know. But so far we haven't seen too much of that because of the capacity, excess capacity that's around.

Okay, and then final question, I know sometimes seasonally the first quarter is clearly not as relevant. But are there lessons that you learned in the first quarter that tell you anything about 2008 as a whole, or is it just simply too early to tell?

I think it's too early. That's why we haven't really changed much in our outlook. We've gone to the lower end of the outlook, just because we're conservative. But it's too early to tell. I am hopeful that we'll get a normal summer pattern in the weather and replacement business will be strong. And plus, I like what we're looking at in terms of the investment opportunities. And I like the debt market, for us are very good. I mean we have a lower cost of borrowing money and we have a very clean balance sheet and we have lenders that are there to support us if we choose to take on some of these larger acquisitions, which I'm very hopeful for.

Great, thank you very much.

You bet. Tasha, is that it? Hello? Tasha? Barry, are you on?

I am.

Paul?

Yes, sir.

Are we disconnected?

I don't know.

I can still hear you, Al. Can you hear me?

Yes. Who is that.

It's Dave Manthey.

Once you spoke, everybody else was cut off.

I think we lost the moderator.

Isn't that amazing? Let's give it a minute. Tasha? Is that you still, Dave, that I hear in the background?

I'm on mute, but, yes, I'm still here, Al.

Mr. Nahmad.

Yes.

You have a question from Ian Zaffino.

We lost you there.

I do apologize.

Don't go away. Okay. I'm sorry. Who is the question from?

I'm sorry. Ian Zaffino.

And the firm, please?

Oppenheimer and Company, sir.

Sure. Hi, Ian.

How are you doing? I think most my questions have been answered, but I was just wondering if we could get into a little bit more of the ACR kind of action, how that's panning out, any surprises there, or any positive developments or anything else you could allude to?

Very good people waiting for a good market. Should give you a summary on that. Very pleased with it.

Okay. So if you were look at some of the accretion metrics you provided or alluded to initially, were those contingent upon the current conditions you're seeing item now, or conditions gotten worse, or--?

Well, whatever they are, we've got it considered in the estimates, the guidance that we're providing you. We believe that ACR will be accretive and all of that is included in the estimates for the year, the outlook for the year.

Okay, all right. Thank you.

Your next question comes from the line of Keith Hughes, with SunTrust.

Hi, Keith.

Hi. My questions have been answered. Thanks, guys.

Your next question comes from the line of [Ryan Morteo] with William Blair.

Hi, this is actually Jeff Germanotta with William Blair.

I know you're in Chicago or Milwaukee, one or the other.

I'm in Chicago and it's a beautiful day. What I wanted to do is drill down a little bit more in the cost saving program. If the bulk of the branch closures are done, does that also mean the bulk of the head count closures are done?

I would say that the bulk of the head count reductions are done.

Okay.

Now, have we had the impact in the first quarter? No, because much of it occurred in March.

But if we take the $5 million that you achieved in the first quarter, we should at least be able to annualize that, so can we say that round numbers, $20 million of that $30 million plus program--?

Oh, I don't know. That's -- same question we sort of got before, but, Barry, do you have a--?

Yes, I would say, Jeff, the trend would be slightly higher than that for the rest of the year, for two reasons that are logical. Not accounting reasons, but logical reasons. First, the gross profit improvement obviously will be in a higher sales base as we get into a much -- being a larger business sales-wise as we get into the season. And secondly, something like closing a branch or reducing head count, as Al said, happened largely late in the first quarter and will be a larger component of the savings going forward. So I, I think what we have felt is most of this activity was a herculean effort during the first quarter and then it slips into--.

Late in the first quarter, yes.

So said another way, a good part of the implementation is done and now the profits will flow through from that, the remainder of the year?

And some into the first quarter obviously.

Well, I would -- I mean they will be implementing these changes and there's so many numerous. I mean we keep a whole record of them. So, there's so many and I think it's an ongoing effort. Except for the head count, I think you nailed that one. I think there will be implementation going on during the year.

And of that $5 million, can you differentiate how much came from ACR versus the core business?

I don't think we want to publish that.

Thanks very much. Keep up the good work.

Next question comes from the line of David Cohen with Midwood Capital.

Hi there. I'm in Boston. Just to clarify the comment in the press release on the incremental cost savings impact over the next several quarters, that does include extending into 2009, is that--?

It does, yes. As best as we could tell, it should go through the first quarter in '09.

Okay. So inclusive in your earnings guidance, what is the area 2008 effect that you guys are incorporating?

Well, that same question that we had gotten before, Barry, do we have an answer--?

I got on a little late. I apologize.

Yes.

Again, I think it's -- it's not something we've given out quarter by quarter because of the cost savings program. Again, I -- you could almost kind of model what we started the year with talking about 35 million, $40 million in total. You can somewhat look at our seasonality and model it that way if you're trying to do a model, first quarter of '09.

I don't even care about the quarters, just sort of an aggregate '08 potential savings is what I was after?

It's somewhere around 80%, I would say, is in '08.

Okay. And the, just doing, I know it's a seasonally slow period, but given the same-store data that you do provide, it looked like your brand new, or the non-same-store branches were just about break-even in the quarter. Is that an accurate reflection of their performance?

Yes, it is.

Okay, and I know you haven't--?

By the way, sequentially an improvement from the fourth quarter.

Yes, I did see that, too. Okay. And then implicit in -- I heard you say that you thought that the 10% same-store sales fall in Q1 would be the low point for the year. Could you give us a ball park without maybe a specific number, but sort of a sense of how much better, in order to drive your earnings forecast, how much better comp sales need to be in the balance of the year than versus the 10% low point?

It's not something we furnish in addition in terms of guidance and I wouldn't want to start today answering your question. We give annual guidance on earnings. It's built on reading and reacting to everything that's going on in the market and we would rather just stick with the earnings guidance.

Okay. Thank you.

You have a follow-up question from Holden Lewis, BB&T.

Hi, Holden.

Hello, thank you. Back to the ACR question, I know that that was I think dilutive by $0.03 in Q4. Was it dilutive in Q1 in the seasonally tough quarter or was it accretive, or how did it play out in Q1?

Similar to the question you just asked, the new branches, which is almost entirely ACR, was mutual to the quarter, Holden.

Okay, fair enough. Then how many -- was there one fewer day this quarter versus last year? How do the days play out?

I think because of leap day, there was the same number of days.

So 64 in both quarters?

Yes.

Okay.

One less day in March, one more day in February.

Okay, and so -- okay. Is it going to be 64? Do you happen to know what the quarterly days are for the year?

No, I don't, but I can tell you. I mean I can get it to you. I don't have it on top of my head.

Okay. Thanks, guys.

At this time, there are no more questions.

Thanks. Thanks, everybody. We'll speak to you next quarter. Bye.

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