Watsco Inc (WSO.B) 2011 Q2 法說會逐字稿

Good morning. My name is Alicia, and I will be your conference operator today. At this time I would like to welcome everyone to the second quarter earnings conference call. (Operator Instructions) Thank you, Mr. Albert Nahmad, you may begin your conference.

Good morning, everyone, welcome to our second quarter conference call. This is Al Nahmad, President and CEO; with me is Barry Logan, our Senior Vice President and Paul Johnston, our Vice President.

As normal, let me first provide the 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.

Now lets get started. During the quarter, we delivered record sales, higher margins and record earnings per share.

We also announced today that we have signed an agreement with Carrier to extend the joint venture into Mexico. Carrier has been selling products in Mexico since 1947, and has a great brand recognition throughout the country. We expect to close this transaction this coming Friday.

This business comes with a strong, young, aggressive team with six locations and $80 million revenues over the last 12 months. We will sell Carrier's complete line of products, and look forward to adding other parts and supplies, more locations and build market share. We feel this is a growth mark for our future. We are energized about Mexico, as it is a natural extension for our United States business, and is complimented by our export business based in Miami.

In all, our revenues into Latin America and the Caribbean are over $200 million, within an overall market their approaches $3 billion in size, with an estimated $2 billion in Mexico alone.

After the first half of 2011 is a good start from an operational execution point of view. Same-store sales were up 1% and gross profit is up 5% with a 110 basis points higher selling margins. SG&A, excluding new locations, was held as a 1% increase, and operating income was up 12% with margins expanding 70 basis points. Looking at the course performance, similar operational achievements are in our results.

Increased selling margins, higher operating profits and improved margins where revenues were simply harder to come by, especially for residential products. Lower unit volumes, the largest factor in the 5% decline in equipment sales, which was up against a huge 25% growth rate comparison in 2010. We also continue to see higher sales volumes in replacement compressors, which tell us consumers are still concerned about spending money, and are deferring some degree of replacement unit purchases.

Sales (inaudible) of mid-efficiency products -- 14 to 15 SEER units -- retreated some, but the high-efficiency units -- above 15 SEER -- continue to grow and are above the pre-tax credit levels. Sales of commercial products continue to grow and have advanced double digits year to day. As for residential, business has accelerated and we are experiencing growth in July.

Long-term, our passion for our fundamentals remains. Our products are a significant component in the movement toward energy efficiency, energy conservation and greener solutions. ACAC systems -- let's start that again -- HVAC systems account for more than half of the energy used in the U.S. [home], and over 74 million systems are over 10 years old, operating at efficiencies well below current federal mandates. Replacement of these units, or these systems is inevitable, and offers us terrific revenue opportunities [and] offers cost savings for consumers.

We also continue to build the company and will continue to grow our network by opening locations and by making acquisitions. In April we added 28 locations with $210 million of revenue, and [will] add Mexico to our North American footprint. These are a few markets that represent huge opportunities --I should say these are new markets that represent huge opportunities for us.

Our overall annualized run rate now exceeds $3 billion, yet balance sheet remains conservative. We have the capital to invest, and continue to look for additional opportunities.

Now the detailed performance for the second quarter. Revenues grew 2% to a record $884 million. Revenues this quarter include a joint venture formed on April 29 with Carrier. They've added $45 million of revenue to 28 locations in the Northeast U.S. This business is off to a good start under Watsco's management.

Same-store sales for the quarter were off 2%, HVAC equipment was down 5%, other HVAC product sales were down 1% and sales of commercial refrigeration products continue to grow, increasing 8% in the quarter.

Gross profit increased 6% to a record $213 million and gross margins improved 80 basis points to 24.1%. This demonstrates strong discipline, given the overall business climate, and the effective execution of price increases.

SG&A increased to the new locations but was flat on the same-store basis. Operating income improved 7% to a record $76 million and operating margins expanded 30 basis points to 8.5%.

Our diluted earnings per share was a record $1.09 per share, and we generated cash flow of $3 million. We raised our dividend in April by 10% to an annualized rate of $2.28 per share. This is the tenth year of increasing dividends.

Now for results for the first half of the year. Revenues grew 3% to a record $1.4 billion and were up 1% on the same-store basis. HVAC equipment was down 2%, other HVAC product sales were up 1% and sales of commercial refrigeration products grew 13%.

Gross profit increased 8% to a record $348 million, gross margins improved to 110 basis points to 24.6%, and SG&A, excluding new locations, increased by 1%. Operating income improved 16% to a record $92 million and operating margins expanded 70 basis points to 6.5%. And for the first half, diluted earnings per share was $1.32 per share during the first half of this year.

Now as for providing outlook for 2011. We're seeing growth in July. In terms of formal guidance we want to remain cautious as seasonal trends remain unclear. We are managing margin and SG&A aggressively and as evidenced by our first half results we know sales growth could convert into terrific earnings growth and we do expect 2011 will be a record year for Watsco.

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

(Operator Instructions). Our first question comes from the line of Matt Duncan from Stevens Inc. Your line is open.

Good morning, Matt.

Morning, Al. The first question I've got for you -- and you walked through this a little bit, and I know some of this was in the press release -- but if you could talk a bit more about what you guys think was behind the year over year decline and same-store revenues. I know you broke out the equipment decline versus parts and supplies. But what in market trends are you seeing that you think might explain the year over year decline?

I will ask Paul Johnson, who keeps real track of trends, to answer that.

I'll give it my best shot. Obviously, what we're seeing is we're seeing a continued strength in some of the replacement components that Al referred to in the release, particularly in compressors. Some of the other components that we've seen growth in are things like copper products and refrigerant.

However, on the equipment side, and I can speak for Watsco, we saw generally a decline in our -- what I call mid-tier efficiency equipment, where we actually saw equipment in the 14, 15 SEER migrate back down to a 13 SEER. We didn't see any weakness in our high efficiency equipment, but as we move into the lower efficiency, the 13-sear product, I think you're going to see the equipment sales themselves on a dollar basis actually declined. And that was what we referenced before.

(inaudible) consumer confidence --

Do you see any difference between value lines and the premium brands that you guys sell in the quarter? Was there any divergence in the performance of those?

There was a bit but there was no exact trend that I can pinpoint that would tell me that there's -- that the value lines are [taking up]. We saw a couple of lines grow but also a couple of value lines not grow.

What about R-410A versus dry ship R22. What kind of mix are you seeing of dry ship R22 so far?

We saw the mix change quite a bit in the second quarter, on a year to date basis it really doesn't have a major impact on us, but on a second quarter basis, we did see a material increase in 22.

And last, maybe you can break out how you think your revenues changed year over year for both replacements and new construction. Do you believe replacements were down year over year?

I don't think we have much of a new construction market to start with. So I don't think it's really material.

Okay. Alright, thanks.

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

Hello, David

Hi. Good morning, Al. First off, I was wondering if you'd take a shot at price mix versus units in equipment.

Barry.

Good morning, Dave. The units are down about 3%, 3 to 4% for the quarter. And overall the sales are down 5%. So that would give you a sense of price and mix.

Okay. Thanks, Barry. Anything on parts and supplies or refrigeration in terms of pricing?

It's not something that is really measured at that granular level, David. I can't tell you the price of duct tape and what it did during the course of the quarter. Just too many skews to count on that side of it. I'd say generally, there has been some inflation year to date, probably something that happened earlier in the year and has flattened out as the second quarter unwound.

Right. I have to ask the question every quarter, though. Second, in terms of gross margin. Could you talk about the mix impact on gross margin. And if you look at just equipment specifically, were margins higher or lower within just the equipment or, again, was it more of a mixed shift year over year that led to the margin increase?

We did see margin improvement in all categories. The primary movement, though, was from the parts and supplies growing at the faster rate than the equipment. The equipment certainly has a lower margin than the [non-]HVAC equipment and refrigeration products.

Okay. And then final question as it relates to what you're seeing right now. It looks like historically, third quarter, it tends to be in the range of second quarter but often a little lower. Given that you saw weak trends in the second quarter and you're seeing improving trends thus far in the third quarter, would you anticipate roughly parity quarter to quarter, or should we expect normal seasonal trends from here?

David. I think it's anybody's guess that -- I believe we will show a better third quarter in earnings per share than we did in the second quarter. Given what is going on in July. July revenues are growing. Our efficiency levels, as you can tell, with our margin expansion, have really improved. So any top line demand is going -- growth in that is going to move to the earnings line.

Okay. Thank you.

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

Thanks. Good morning everyone. First question, can talk about same-store sales by month. How did the quarter play out and how did it finish?

Well, I don't know that we want to do by month. But we started noticing a softness in the spring, sometime in May, and that continued into June. And now it seems to be reversing itself in July.

Is weather playing a factor there, do you think?

You would think it would have a huge factor. But the trend that we mentioned to you earlier, consumers are repairing as evidenced by revenues from our compressor sales. And it will impact it, but not as you would normally see in the weather picture the way it is today. I think that has a lot to do with consumer confidence.

But eventually, the long-term story still hold because these machines, even if you repair them will eventually wear out and must be replaced. And when they are replaced it will be for higher efficiency, because that's all that is produced now. Higher efficiencies that are now produced that are more efficient than anything that -- most of what is already in the installed base.

Second question, I believe Carrier announced another price increase for split systems. Does that have a good chance of sticking, given the demand environment? How are you thinking about that?

Paul?

I think it has a good chance of sticking. Whether we'll get away with the entire amount or not is another thing. But I think as you talk to most manufacturers, I think they are all experiencing higher costs not only from a transportation standpoint, but also from copper and steel and some of the other commodities that go into the products. I think it's a necessary thing for that increase to stick.

Okay, thanks. I'll get back in line.

Our next question comes from the line of Tom Hayes. Please state your company name. Your line is open.

Thank you, Tom Hayes, Piper Jaffray. Morning, gentlemen.

Good morning.

On the last call you singled out Texas and California as markets that were still' iffy, using your words. I was just wondering if you could provide an update on what you saw in those markets this quarter, and your expectations for the balance of the year.

I will make a general statement, Texas is strong. Now in Paul can you comment -- in more detail.

California still remains a tough market for everybody who's participating in it. It was down last year. It was not up in the first quarter, we don't have second quarter numbers, so we really can't tell what the industry did. But overall, the comps are certainly becoming easier to compare California to prior year with, but we're not seeing it recover. It hasn't been hot, hasn't been new construction -- it has high unemployment and a state government that --

But the good news is Texas. Texas is a huge market and it's coming back strong.

Okay. Can I shift a little bit to a financial question. If you can just remind us generally what the margin profile is on the commercial refrigeration products, I guess, compared to the base of the business.

Barry. Generally speaking, commercial refrigeration products contain a higher margin.

I don't want to get too competitive -- or talk too much about percentage margins and that business because that's certainly a competitive factor that we -- you know --Suffice to say it is higher than the overall composites with the equipment being lower than the overall composites. By the way, just to give context on your question about the geographic trend that you answered, I want to put it in context of our business, not just the marketplace, but Texas would be 15% to 20% of our sales, so we're happy with the consequences going on in Texas. California is about 4% of what we do, a little less than 4%, so I just want to put that in context.

Thank you -- last question. At the end of the quarter, how many Company-owned stores are in operation?

525. How many company stores? How many locations?

Locations.

525.

Thank you.

Our next question comes in the line of Jeffrey Hammond. Please state your company name. Your line is open.

Hi, KeyBanc Capital Markets. I jumped on here a little bit late, but did you give your R22 mix in the quarter?

We have not. We just indicated it was up for the quarter compared to first quarter.

Okay. And, just in general, is R22 a bigger piece of the mix than would you have thought coming into the year?

It was anybody's guess what it was going to be coming into the year. It's very regional, what we have seen, but I would say it's mid-double digits now.

Okay. And then -- what was your general view on R22? Do you think there's any shot that the loophole gets closed? Do you still see -- do you see a lot of share shift taking place as a result of R22?

You know, Carrier has posted with EPA the petition to stop it. I don't think there's been any great movement afoot among AHRI members to support it. I think Carrier is out there on their own on this. That's my feeling now. Would we support it? Yes. We do support Carrier in this. Is it going to continue into next year? It probably will.

Whatever it does, we will be equipped to deal with it.

Okay, and then just final thing. It sounds like -- from the intro remarks you didn't provide guidance, I think the last couple years you had given guidance at that point.

What is the reticence to give color, given we're kind of halfway through the year?

Well, because of the volatility. There is a lot of uncertainty out there. The consumer comes out and gets more aggressive, and then it retrenches. And we just continue to build a long-term strategy which is put out more location, put out more products to those locations and meet the demands of higher efficiency and the environmental green demands that are out there. So we stick to that, and I think that with the volatility, we just are better off not putting out any estimates. Although we have said we expect a record year. And I think that's a pretty good statement of our expectation. Between quarters it's a little difficult because sometimes it flies from second to third -- [demand goes from] second to third, or sometimes it slides from -- it starts at the second, the higher demand. So that's the volatility I'm referring to.

And then I know you announced another Carrier JV, and you've stayed active on that front. Can talk just about how did the end demand dynamics and market dynamics impact your are conversations on acquisitions, whether it be other independents or additional opportunities with Carrier?

Well, first of all, the Mexican joint venture meets our concept and eventually you want to reach a $0.5 billion business in Latin America. Where, as we said earlier, at about $2 million where we see a lot of growth there. We'll reach that number through exports, or by having investments on ground, as I said in Mexico by opening up more locations and adding more products to those locations. Now, as far as any additional investment opportunities with Carrier or independents or even other factories that have branches, we are ongoing with that. We are very, very intent on owning more of these distributorships and building them. Because we do it so well. I don't think anybody does it as well as we do. So that's absolutely a focus for us. And we have the balance sheet to support any such investment.

Okay. Thanks, guys. Appreciate it.

On our next question comes from the line of Josh Pokrzywinski with MKM Partners. Your line is open.

Hi, Josh.

Hi. Good morning, guys. A couple of questions. First on this Carrier Mexico JV. Just maybe some (inaudible) to the extent you can provide it, what the business has done over the past couple of years. Is it down meaningfully, up meaningfully, and maybe a sense of where the margins may come in initially.

I don't know if we going to give you margin information, but we can tell you how the business has done historically. Paul?

The business is down right now from where it has historically been. [Carrier reacted] when the Mexican economy went down we had to quickly put a strong, young management team which we were able to get from other manufacturers in country. So we are very, very happy about the management team we have down there. We see huge opportunities when we put in our product, our additional parts and supply product lines as well as adding simple supplementary equipment lines. Carrier's got a strong market share. They are the number one market name in Mexico. They have been there the longest and historically have been the biggest. So I'm very bullish on Mexico.

Is that mostly commercial or is there residential product in there as well? How should we think about the [mix]?

It's a very well-balanced market. It's got a large commercial refrigeration segment to it, which we would plan on entering at some point in the near term but also has a large commercial apply. It has a fairly small commercial unitary presence and quite large in duct-free splits in the residential side and that's the area that we see tremendous upside in, the residential side in Mexico. 112 million people, 30 million household.

Okay. Understood. And trying to understand your comment earlier, Al, on the record year. Do you mean that on a top line basis, on an EPS basis.

Good question. Revenues and earnings per share.

Okay. So just want to make sure I have this right. Your record was 2006, $2.96 per share.

I'm sorry, ask me that again?

Your record was --

We expect it'll exceed $2.96 a share.

Okay, great. Thank you very much, guys.

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

Hey guys, just a couple of quick follow-ups. Al, I don't know if you can quantify for us the sales growth are you seeing in July relative to what you saw in June. Has it been a meaningful [reacceleration] -- are we talking double digit growth or are we talking single?

Mid-single digits.

Mid-single digits? Okay.

Which is healthy because it's just beginning and I think that that rate of growth could increase.

And is that organic or including the Northeast --

No, I'm talking organic.

Talking organic, okay, that's helpful. And then on the Mexican joint venture, I assume breakdown there is similar to the others, it's 60% / 40% ownership?

That is correct.

And then can you talk about how much you paid for that and the mix of stock or cash?

We paid in cash but we haven't disclosed the purchase price.

Okay. Thank you.

Our next question comes from the line of Bob [Canty] (inaudible).

Good morning, Bob.

Good morning. Could you talk a little bit about your leverage? You have very little leverage right now. How do you see that growing? Or is there a range you guys like to operate in going forward as you expand into Mexico and possibly other areas?

That's been a tale of conservatism on our part, as we built the Company from about $4 million in revenues twenty years ago to $3 billion. We've always -- did it on a conservative balance sheet. I'd don't expect that's going to change. I cannot give you what leverage numbers we think we're going to get, because that's sort of speculation. But we like a conservative balance sheet. We know it's [under] leverage, we like it that way. But as the investments come along and we use more cash, then we'll see how that goes.

So you don't -- You're not going to say 'hey, we'll stay under one and a half times --

No, I won't venture on those sort of guesses. It depend on the size of what we have to do.

Okay. Thank you.

(Operator Instructions). We have no further questions.

Well, thanks for listening. We've got a great company, and we think we're going to continue to make a lot of progress. See you at the next quarter. Bye.