Watsco Inc (WSO.B) 2011 Q1 法說會逐字稿

Good morning, ladies and gentlemen, my name is Shawn and I will be your conference operator today. At this time, I would like to welcome everyone to the first quarter earnings conference call. (Operator Instructions). Mr. Albert Nahmad, CEO, you may begin your conference call.

Good morning everyone, and welcome to our first quarter conference call. This is Albert Nahmad, President and CEO; with me is Barry Logan, Senior Vice President and Paul Johnston, Vice President. First, our regular cautionary statement. 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. Alternate results may differ materially from the forward-looking statements.

During the quarter, we delivered record sales and significantly higher margins and more than doubled the earnings per share of a year ago. We produced revenue growth on the heels of phenomenal fourth quarter. This growth was driven by sales of replacement HVA systems with a consistent mix of higher-efficiency units in the strong commercial market which generally leads the economic recovery in our industry.

Operating margins improved dramatically as we had higher gross profit and maintained control of our SG&A. The first quarter represents the lowest seasonal time of the year for sales, so we are satisfied that we're off to a good start and to what should be a great year for Watsco. In fact, I think it's going to be a record year for Watsco.

Now the detailed performance for the first quarter. Revenues grew 5% to a record $534 million. HVAC equipment grew 3%, other HVAC product sales grew 4% and sales of commercial refrigeration products were very strong, growing 20% in the quarter.

Gross profit increased 10% to a record $135 million and gross margin improved 120 basis points to 25.3%. SG&A increased 4%, including new branches in acquired costs related to the Carrier Northeast joint venture. Excluding these costs, SG&A increased only 3%, primarily due to higher selling and other performance related costs.

Operating income improved by 88% to $17 million and operating margins expanded 140 basis points to 3.2% during this off-season period. All of Watsco's business units contributed to the sales growth and strong earnings performance during the quarter.

Diluted earnings per share more than doubled to $0.21 per share during the quarter.

Now as for cash flow, we're using our balance sheet to build up inventory for the upcoming selling season. We look to build share again this year and believe we are well positioned to do. We raised our dividend earlier this month by 10% to an annualized rate of $2.28 per share. However, we remain in a net cash position in terms of cash versus long-term debt, and we continue to look for investment opportunities to grow our network.

The Carrier Northeast transaction is on track to close this quarter. This will add 28 locations in 11 states and over $200 million in annual revenues to our network. This is a great organization in one of the most populous markets in the United States and we look forward to getting started.

Now as for providing an outlook for 2011. This is our slowest seasonal quarter of the year. We plan to provide our full year outlook as we get a better view of the selling season. We do expect 2011, however, to be a record year for Watsco.

Now, before I answer questions or we answer questions, a reminder of fundamentals. Our products are significant component in the movement towards high-efficiency, energy conservation and greener solutions. HVA systems account for more than half of the energy use in the US home. Over 74 million systems are over 10 years old and operating at efficiencies well below current federal mandates. Just to put it into prospective, the industry last year produced about 4.5 million systems. So you got 4.5 million now, your production is going to 74 million units that are already installed and ten years old. There is a substantial long-term opportunity to replace these systems that will offer us revenue opportunity and offer cost-savings for consumers.

We also know how to build a company. We'll continue to grow our network by opening locations and by making acquisitions. We believe our entrepreneurial buy and build strategy works and benefits all parties in the marketplace, including our shareholders. We certainly have the capital to invest and we continue to execute our strategy.

Now with that said, Barry, Paul and I will be happy to answer your questions. Shawn?

(Operator Instructions). The first question on the line comes from Robert Barry. You're line is now open.

Hi guys, good morning.

Morning.

Al, I just wanted to ask you a little bit more about your comment about it being a record year for Watsco. In what regard do you mean? Revenue, earnings, margins and what gives you the confidence here?

Well I'm principally speaking to the revenues and earnings per share. What gives us the confidence is the trends that we see, the performance of the first quarter, the performance of the last quarter, fourth quarter. I just like the trends and I like what the pent up demand is going to start to continue to come in to the rest of the year.

Do you think that we're going to start seeing more of that pent up demand come unleashed?

Well we'll have a better handle on it as the selling season enters the segment of the third quarter, but we feel very confident we're going have a record year.

Could you just please be a little bit more specific about what's giving you that confidence? Is that consumer data? Is it what you're seeing in the field?

It's what we see in our own business. The mix of high-efficiency continues to be strong. It's all the things we stated.

Could you perhaps help us reconcile the very strong topline growth in the fourth quarter that you alluded to a good but much softer number this quarter?

Sure. I'm going to call on Paul to respond to that.

Yes. We had a very strong fourth quarter last year and I think a lot of that was reflected in the closeout of the $1,500 tax credit that did occur. I think the questions we had at the last conference call related to is that going to be a pull forward and actually deteriorate in the first quarter of this year, and I think we answered that we didn't feel it would and it didn't. We still had a 5% sales growth in the first quarter, so it's strong. We feel very good about it.

But if you just look at the equipment side of the business, I think in the last quarter it grew 23%, in this quarter it grew 3%.

Right.

Assume there's some pricing benefit in there, it implies almost no volume growth, so that 23% to 3% seems like a pretty dramatic change in two seasonally weak quarters.

Actually there wasn't much pricing impact in the equipment side. We had price increases that were announced but most of those are just taking effect now as far as being rolled out into the field. So on our unit basis, our unit sales we're pretty much inline with our dollar sales growth.

Not only that, we can't come off of a 22% increase in December, and then in January as we reported in the last conference call it was soft, but the trend -- I keep talking about trends. A soft January, less soft in February and a strong March, so I like what's going on.

Okay. Then just the last one. Maybe you can comment on the strong growth margin performance especially given it sounds like there wasn't a whole lot of pricing benefit in the quarter.

Go ahead, Barry or Paul.

Sure. There's not a lot that can happen in our gross profit other than what we call selling margin which is the spread of how we merchandise what we sell to customers, and that accounts for the lion's share of this. It would be a price discipline, a margin discipline within our network.

One of the statistics that you see in the numbers and what we talked about in the script is gross profit is up 10% for the quarter, and gross profit is how we pay our sales people in terms of performance-based compensation. It's how their commission is calculated. So you've got 800 sales people pushing that number and, Robert, just to give my own editorial on your question.

The first quarter is not the heating season. The first quarter is not the cooling season. I wouldn't want to extrapolate too greatly in this conversation on your question. Al's comments were specific in terms of how the quarter went and what we saw in March is probably more relevant to our confidence.

Yes. Okay. Fair enough. Thank you.

Your next question comes from the line of Ryan Merkel from William Blair. Your line is now open.

Good morning, Ryan.

Good morning, everyone. So my first question is, it sounds like the mix of high-efficiency equipment remains consistent despite the lower tax credit. Can you maybe give us a sense of the growth right there versus the base units?

Paul, you want to take that?

Yes. We have continued to experience a growth rate in the very high-efficiency product. We saw a slight dampening in the mid-efficiency products. Some of the reasons I guess when we poll our people and ask them what's causing this? A lot of it still relies upon when we have utility rebates. We still continue to have manufacture's support as far as incentives for consumers. And the third thing is something that is more nebulous and that is that we think our contractors have gained a confidence as far as being able to sell up and sell to the higher-efficiency which was gained through the tax credit that was available to them last year.

And it's a good deal for the homeowner in terms of energy conservation and energy efficiency.

Yes, I mean it's good to see that trend continue as it's pretty important to your business.

I agree with you. Yes and I agree with you that we blew right by that $1,500 tax credit issued.

And then my second question is on the gross margin that was up 120 basis points year-over-year. Do you think that can continue for the rest of 2011? That trend?

Barry, you got an answer?

Of course I have an answer. We would like it to, Ryan, but it can't be considered to be obtainable at that level of improvement. Again, this is the time of year when I think good sales people show themselves and when it's not the season, and I think they did an exceptional job this quarter.

Okay. Fair enough. (inaudible - multiple speakers) --

The higher-efficiency does bring by itself a higher gross profit margin.

Thanks, guys.

Yes.

Your next question comes from the line of Matt Duncan from Stephens Inc. Your line is now open.

Good morning, Matt.

Good morning, guys. This is Jack Atkins on for Matt. My first question is with regard to your new joint venture with Carrier. You said that you expected to close in the second quarter. Could you give us any more specifics on when in the quarter you expect it to close, and then how accretive do you think it will be to earnings this year?

Barry?

Jack, we do expect it to close certainly in the next 30 days. I'll categorize it that way. As far as the accretiveness, what you can see in the contract that we filed is the price we're paying which is right around $36 million in cash. Would you have to consider your own (inaudible - multiple speakers) --

That's a contribution of homes. That is $36 million net of contribution of homes.

That's correct. But you would have to consider your own estimate of earnings off of that type of price and then compute that obviously for about a half a year this year. We have not publicly disclosed the relative earnings that we're acquiring.

Okay. And then was there an impact to the first quarter results from transactional related expenses?

Yes, about $300,000. Just short $0.01 a share.

Okay. And then secondly, could you maybe comment on the M&A landscape right now and what's your appetite like for additional transactions at the moment? Do you think there's a potential for further joint ventures with Carrier?

Well, we do believe that we have a balance sheet and a desire to substantially focus on M&A. You know we're always hungry for transactions and I think we've completed well over 60 now. It's always hard to call any specific transaction that might come to bear, but we're well-known and well-regarded in this industry, and if there are distributors, whether they're owned by Carrier or anyone else, we think we're the place go to and we're relentless in our pursuit of such acquisitions because they add to our network and because we really can deliver to the OEMs post acquisition. So it's a general statement because we never know for sure what's going to happen.

Sure. Okay. Well great. Thank you for that color. Barry, could you maybe provide us with a breakout of your sales growth between replacement and the new construction, and also commercial in the quarter?

Sure. Jack, I can't resist, by the way, another editorial on your last question about acquisitions. For 18 years I've said we cannot measure the timing or quantity of acquisitions, and I finally get to say this very specifically in the next year in July we'll obviously have the opportunity to invest in another 10% bump in our investment in Carrier Enterprise, so that's something for next year on the acquisition front per se.

On your residential, it's certainly under 10% at this point would be our estimate of residential new construction just given the relative insignificance of that to the mix right now. And on the commercial side, you can see in our press release we talked about commercial refrigeration is about 8% of sales, a good estimate of commercial air conditioning if I added to it would be about the same size, so 15% or so would be our commercial component these days.

Okay. Great, and one last question here. On the inventory they were up over $110 million sequentially this quarter which is a little bit more than the typical seasonal build. Could you maybe walk through in a little bit more detail the reasons behind the build? Such a significant build this year.

If you look at it from the end of the year to the end of the first quarter, yes, it was a significant build. We did, however, take -- inventories were unusually low at the end of the fourth quarter. We had the high demand that we had in December really depleted a lot of the inventoried balances that we had and we had to replenish those back up. If you look at it on a year-over-year basis, the inventory is up roughly $40 million to $45 million which is pretty much is in line where we were last year. It's up roughly 8% or 9%.

Okay. Great. Thank you, guys.

Next question comes from Keith Hughes from SunTrust. Your line is now open.

Good morning, Keith.

Hi. How are you? Just a quick question on refrigeration. What kind of venues or markets are the most robust that are leading to this big 20% number? And back to the equipment question on inventories in the channel. Do you feel like inventories in the channel, have they been elevated by any of this price increase? Where do we stand on that?

I don't think that the inventories in the channel were really elevated by the price increase as of yet. I think most of the inventory that was put in was put in prior to the price increase, and that's just one way that Watsco would use its balance sheet to be able to offset some of that.

I assume that was done to the rest of the industry though, was it not?

Pardon me?

I assume that would be done through the rest of the industry; correct?

Yes, it is. Generally the OEMs announce price increases and then there is a period, a lag time, before they go into effect where distributors can purchase inventory.

Okay. And then refrigeration, what's driving the big numbers there?

Big numbers that have been driving on that have been on the equipment side for us. It's been on the ice makers and also on the commercial compressor sales. I can't get any more granular than that as far as getting down to customers, but those are the two big areas where we've seen the most growth.

Okay. Thank you.

Your next question comes from the line of Jeff Hammond from KeyBanc Capital. Your line is open.

Good morning, Jeff.

Hi. Good morning, guys. This is [Brett Lindsey] on for Jeff Hammond. How are you guy doing?

Okay.

Just focusing on demand, as you move into the 2Q selling season, what type of momentum are you seeing there? How should we think about comparisons in light of a strong 2Q last year?

Well, as we said earlier, we like what we see and we think we're going to have a growth rate no matter what the comps were last year. We just feel that some of the fundamentals that we've been talking about are actually occurring and that's why we're so optimistic about this year. Paul, you want to add anything to that?

The trends are continuing. The reason why it's tough for us is as you realize the market starts in the South and builds northward. In Florida with the initial trends we saw, in Florida were very strong. Like we say, we like that. Now those trends will continue we hope up through the Carolinas into Virginia, and obviously, into our new territories up in the Northeast. You know there are still some regional weaknesses out there that are iffy for us right now. California is still not recovering and Texas had a tough year last year, and we're hoping to see Texas rebound this year.

But I always like to repeat the basic statistic that I think is the most compelling. The 74 million residential homes using central cooling systems that are ten years old. That's the oldest they've ever been. When the industry is only producing 4.5 million a year that makes for a huge pent up demand and eventually that 74 million units has to be replaced. These are machines that can only be repaired in a certain period of time, and eventually they're going to have to be replaced. We, with the largest network in the country, are going to be the primary beneficiaries of that demand that will come from the replacement of those machines.

Okay, great. Thanks, guys. And then one other one on inventory. As you guys build inventory for this selling season, how were you thinking about high-efficiency mix year-over-year as you enter the quarter?

Each one of our subsidiaries manages their own inventory independently. (inaudible - multiple speakers) --

Depends on the local region they're into. Go on, Paul.

Right. So each one of those has an individual strategy that they work through as far as what they're seeing in their marketplace or their particular market segment, so there really isn't a master plan here at Watsco.

Okay. Great. Thanks. Last one. With R22, we're hearing more about that as an opportunity. What's your tact on the R22 and what's been the impact to date?

The impact to-date is this, Paul, the impact to-date has been relatively minor. There are some industry numbers that would indicate that it's been around 10%. We don't know what happened in March and April when we start seeing more of these units ship.

As far as Watsco, that's the thing I can speak to, for Watsco it really has not been a big event. It's still under 10% of our sales are going to the R22 product and we are hoping like everybody that it keeps in its bucket and that is multi-family replacement which is what a lot of people were using it for. Once again, we'll have to wait till summer to see really what the impact is, if this has an impact on compressor sales trading out for R22 sales, or is it not going to be the impact that everybody else thinks it's going to be.

Okay, great, thanks for the color, guys.

I would like to comment on --

Go ahead.

I was going to comment on inventory in general. Most of our careers, lead times from our factories was 60 days. These days it's down 10, 20, 30 days maximum. So in terms of reading and reacting to the market and balancing inventory and how much R22, how much high-efficiency and so on, it's a very, very nimble process and also very local process as Paul suggested. So a lot of this we're learning as we go into the season and then can read and react during the season.

Okay, great. Thanks, guys.

Your next question comes from the line of David Manthey from Robert W. Baird. Your line is now open.

Hi, good morning.

Good morning, Dave.

Al, I was wondering if you could put a finer point on a strong March? Could you give us an idea, is that double digit growth organic or what?

No, I'm not going to do that, but I can tell you that March generally equals January and February. This is a traditional experience. It's not just this year, and March certainly recovered whatever softness we saw in January and February, and it was strong.

Yes, but you do mean strong as in relative to last year March, not? --

Yes, I always do that, yes.

Right, right. All right. Is there any, I'm not sure if Paul or somebody can give us the mix of high-efficiency. You talked a little bit about the mid range and high range. Can you tell us what is 13 SEER today and what it was a year ago?

I don't think we will be issuing that, no.

Suffice it to say that we're not -- the mix is not deteriorating to lower efficiency. It is still maintaining consistency in the mix which is a wonderful experience. Consumers are staying on to high-efficiency interest and putting them in their homes. That's a terrific thing. And that trend -- the mix is holding steady and nothing has changed, even though the tax credit is gone. And I think that's great. Great for the industry, great for the consumer, great for the OEMs. It's just a wonderful phenomena that's going on in the air conditioning and heating world.

Okay. Then final question. The gross margin, I know that you said the 120 basis points would not be sustainable at the rate of change, but I guess in saying that, looking at last year that means that the absolute level is not sustainable at 25% either? Is that the right way to think about it?

Well, I don't know. Did you mean all of that, Barry? I don't think you meant all of that.

We finished last year at 23.7%, Jeff, so to jump up over 25% in the next 12-month period would, again, would be a very ambitious way of looking at it. So we certainly expect to improve gross profit beyond where it was. First quarter is a nice start, but again, that's a lofty level in a one year's change.

Yes. Okay.

But we're working on it.

I hear you. All right, good luck.

Our intent is to raise it, but again, be reasonable about it.

(Operator Instructions). The next question in the line comes from Ryan Merkel from William Blair. Your line is now open.

Thanks, just two follow-ups. Maybe, Al or Barry, could you talk about industry growth this year? For example, UTX expects the US [resi] market to be up high single digits. Does this seem like a reasonable target?

I think so.

I would not disagree with my partners. We're comfortable with that, yes.

Okay, and then just to finish the thought, would it be fair to say that growth for Watsco in 2010 was mostly about market share gains and mix because shipments were basically flat, and that in 2011 you should finally get some help from industry growth as well as continued market share gains and then also price?

I couldn't put it better than that. I think that reflects our thinking.

Great. Thank you very much.

And there are no further questions in the queue at this time.

(inaudible - multiple speakers)

I'll turn the call back over to the presenters.

Paul, did you say something?

Yes. I think I had one relevant thought to -- Yes. I had one relevant thought to what Ryan just said that gives us confidence, too, that no one ever asked. But we --It's important to us in how we evaluate the business, and that's credit. We've got 50,000 contractors that owe us receivables of almost $300 million, so we see everyday the health of that customer when they pay us everyday, and the health of that customer group in credit is as good as we have seen in our careers. So that's a good testimony not to just how it's being managed, but I think to the health of our customer and the end market that is being served.

Good point. Okay, well I enjoyed this and we look forward to the next conference call at the end of the second quarter. Thank you for your interest. Bye.

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