Watsco Inc (WSO.B) 2011 Q3 法說會逐字稿

Good morning. My name is Linda and I'll be your conference operator today. At this time, I would like to welcome everyone to the third quarter earnings conference call.

All lines have been placed on mute to prevent any background noise. (Operator Instructions). Thank you Mr. Albert Nahmad, you may begin your conference.

Good morning everyone and welcome to Watsco's third quarter conference call. This is Albert Nahmad, President and CEO with me is Barry Logan, Senior Vice President, and Paul Johnston, Vice PresidentFirst as normal, 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. Ultimate results may differ materially from the Forward-looking statements.

Now, for the quarter we delivered record earnings per share, record sales, a higher operating margin and had continued strong execution by carrier enterprise. We consider this a terrific accomplishment given the strong comps of a year ago, and a challenging consumer environment. Today we announced that we are increasing our is quarterly dividend by 9% to $0 .62 per share effective with our next statement in January 2012.

Watsco has paid dividends for over 35 years and has increased its dividend in each of the last 10 years. This reflects our ongoing confidence in our business, and our commitment to provide value to our shareholders. Now, let's talk about highlights for the quarter.

We generated a strong unit growth in residential HVAC equipment reflecting increased demand for replacement sales led by dry-charged outdoor units. Watsco has a broad variety of brands and products that allow us to compete in all residential market segments, from the value-based models up to the high-tech high-efficiency segment.

Sales of commercial HVAC products were up 20% plus. We've been working closely with our OEMs to provide improved merchandising and stocking programs which resulted in improved sales. We continue to see strong growth in CarrierEnterprise's supply sales which were up 25% plus, reflecting the benefit of merchandising and new product initiatives that were begun on day one of the joint venture.

I'm excited to see these programs take hold and provide meaningful results. Performance for new locations in the Northeast and Mexico are meeting our expectations. These are new markets for us and we are aggressively moving forward with our plans to increase product offerings, open new branches, and gain share.

We also believe that knowledge gained in our first run venture with Carrier two-years ago will help accelerate the profitability in these new markets, In summary, we know the economic environment is going to remain tough. We will continue to work with our OEM partners to grow market share. We will reduce operating costs and generate earnings growth. We are also confident that we will produce significant cash flow during the fourth quarter and maintain a conservative balance sheet.

Now the details third quarter performance. Revenues grew 12% to a record $914 million, same store sales improved 4% with a 5% increase in HVAC equipment, a 1% increase in other HVAC products, and a 4% increasein commercial refrigeration products.

Gross profit increased 12% to a record $219 million. Gross margins declined 10 basis points to 24.0%, reflecting the higher sales mix of HVAC equipment which have lower margins. SG&A increased 10% including the new locations.

It was flat otherwise. Operating income improved 16% to a record $74 million and operating margins expanded 20 basis points to 8.1%. On a same store basis, operating income increased 11% versus the 4% increase in sales and operating margins expanded 40 basis points to 8.3%. Our diluted earnings per share increased 5% to a record $1.02 per share.

Now moving to the nine-month results. Revenues increased 7% to a record $2.3 billion and were up 2% on the same store basis. Gross profit increased 9% to a record $568 million and gross margins improved 60 basis points to 24.3%. SG&A excluding new locations increased 1%.

Operating income improved 16% to a record $167 million, and operating margins expanded 50 basis points to 7.1%. On a same store basis, operating income increased 12%, versus the 2% increase in sales and operating margin expanded 60 basis points to 7.2%. Diluted earnings per share increased 8% to $2.34 per share.

As for cash flow, Watsco has used $59 million of operating cash flow during the nine-month period. This includes $87 million of incremental-vendor payments from one-time changes in payment terms. As I mentioned earlier, we expect substantial cash flow during the fourth quarter. We do expect positive cash flow for the year and excluding the impact of the one-time payments, we expect operating cash flow to exceed net income.

Again, we have continued confidence in our business and the ability to generate cash flow, and have raised the dividend 9% to $0.62 per share with your next dividend in January 2012. That's a quarterly dividend of $0.62. To update our current for 2011 our sentiments are more conservative given the current environment. Our outlook for 2011 earnings per share is in the range of $2.65 to $2.75 per share.

As for our longer termed outlook -- let me do that again. As for our longer term outlook, our passion for our fundamentals remain. Our products are a significant component in the movement toward energy efficiency, energy conservation, and greener solutions.

HVAC systems account for more than half of the energy used in the United States and US homes I should say, and 89 million systems are over 10 years old, operating at efficiencies that are well below current federal mandates. That's a lot of pent-up demand, we believe. Replacement of these systems is inevitable and offers us terrific revenue opportunity and other meaningful cost savings for consumers. And offer meaningful 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. Over the last ten years, our focus and strategy has produced compounded annual-growth rates of 8% for sales, 14% for operating income, and 35% for dividends.

And our goals are the same, to provide the best local service to our contractor customers, to be a great partner for OEM suppliers, to innovate with technology, and to maintain our conservative, long-term focus on growing a much larger, more valuable company. With that, Barry, Paul, and I will be happy to answer your questions.

(Operator Instructions). We do have a question from the line of Keith Hughes from SunTrust. Your line is open.

Thank you. I just wanted to delve in more on the gross margin in the quarter. You had mentioned some mixed issues affecting with higher equipment, and I know we also got those dry-shift lower margin product out there. Can you kind of parse how much those two things affected you in proportionality.

Well, I'm not sure if we can give you that information, but I'll let Barry take it a crack.

Thank you. Well first, the change in gross profit is strictly the mix between equipment and non-equipment. There was not any kind of pressures so to speak on the equipment margin overall.

Okay. And given the guidance for the full year that is applying for the fourth quarter, it sounds as those in terms of margin and revenue trends, more or less similar to what we saw in the third. Am I reading that correctly, just from the high level?

I'm sorry, you said from a revenue-trend point of view?

Revenue trend margin, yes. It looks like you'll be moving through the end of the year at roughly a similar pace to what we just saw. Is that fair to say?

That's your implication, but that would be fair.

Okay. That is all for me, thank you.

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

Good morning, guys. Could you give us the mix of equipment sales this quarter that were the dry-charged R22 verses our 410A. Yes, it was in the 15% to 20% range is what our mix was on the dry-charged units, which is about what I think we expected coming into the quarter. Paul, is that increasing in percentage of mix as you move through the quarter, or is it holding pretty steady?

It increased in the third quarter as the availability of dry-charged units became available and I believe it's going to hold steady at that point.

So are you guys adjusting your inventories, I assume, to account for a greater mix of dry-shift R22 going forward?

Yes, we did. We have and we did, yes.

Ok. And in looking at demand trends in the business on a month-by-month basis if you're willing do that, how did the quarter look in terms of same store sales? It was 4% for the full quarter. Was that relatively consistent July, August, September? Was there acceleration, deacceleration for the quarter?

I'll deal with that. If you remember the prior conference call, earnings conference call, we talked about a strong start to July. That has softened up since then, so the trends has been towards softness.

Okay. Is there anything in particular you would attribute that to?

Well, I mean I don't like to give broad answers, but I will here. I think it's consumer confidence.

Okay.

I think the fundamentals are still there in every respect. I mean, we do provide products that save consumers energy, we do provide a very competitive product at all segments of the air conditioning and heating market. It's simply confidence, I believe.

People are concerned for themselves. On the other hand, offsetting that is the need to have heating and the need to have cooling.

Two final questions. Can you give us the impact of the Northeast US and Mexico carrier joint venture on both revenues and earnings in the quarter, and then secondly, what was the depreciation and amortization expense for you guys this quarter?

Matt, you can read off of the service, the press release, the revenues, and see the contribution of earnings from Northeastern Canada. If you see the difference between same-store sales and same-store operating costs, you can get it from there. Depreciation and amortization for can the quarter was $8.5 million -- I'm sorry, $8.5 million is year-to-date so for the quarter it's $3 million.

I'd like to say we're delighted to be in the Northeast and delighted to be in Mexico. That's going to exceed our expectations as time goes on.

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

Good morning, Bryan.

Good morning. It's actually Ryan.

I knew that.

So, based on the full year guidance, you're expecting EPS growth in the fourth quarter despite a difficult comparison and challenging consumer environment. What are some of the positives and negatives in your mind as we think about modeling?

I think, Ryan, you know, very direct answer is SG&A. If you go back to last year's performance and consider it, you know we have a good opportunity in the fourth quarter to lower SG&A on a same store basis, obviously. Mexico and the Northeast are in the numbers this year which helps the quarter, but if I pierce through and look at things through an operational basis, we can reduce SG&A for the fourth quarter.

Okay. So it's primarily an SG&A line where you think you can overcome maybe some weakness on top line?

Yes.

Okay. And then that same question, what has been driving the strong commercial HVAC sales this year, and is that strength sustainable as we head into next year?

Paul?

Yes. As we said in -- as Al said earlier, the reason why our commercial sales are going up is because we're working with our OEMs, developing new programs to merchandise to put the inventory in place. We've raised our focus on the replacement side of the commercial business and it's working. We are very, very pleased with that.

Also, we've been adding some new commercial products at the higher end, getting beyond the 30-ton level and getting up to 65-tons. Whether or not it's sustainable, gosh, I wish I knew. My sense is we should be able to sustain it and our attempt is going to be to sustain it, and we're hoping for an excellent 2012 with commercial.

Great, thanks for the call. Just last one. On the 5% increase in the HVAC equipment, what was the unit growth and price mix headwind?

Barry, you have that.

The unit growth was double digits for the quarter and back down to 5%, about a 5% overall price difference quarter-over-quarter.

Great, thank you for taking the questions.

You're welcome.

Our next question comes from the line of Jack Kasprzak at BB & T Capital MarketsYour line is open.

Thanks, good morning. I was going to ask about pricing you just referenced it, but the mid-single digit price decline worse as then it has been in recent quarters or is that kind of what you have been dealing with this year?

Did you say price decline? There's been no price decline. I'm sorry.

It's the sales mix of products. It's not a decline in prices per se. It's the different segments of product that we sell that account for the difference.

I got it.

It's actually slightly better this quarter than it was in the second quarter.

So within equipment, it's the selection of price points that's having an effect?

That's correct. The good news is for us, we have got about 10 different brands that we sell across all price segments, across all features and benefits up and down the spectrum. So that's helped Watsco operate that way and perform this way this year because there's certainly been a lot of changes and a lot of irritation that's gone on in the industry over that. So for us to have the broad array that we have speaks to the performance, number one. Within that, though, there's been a shift towards some of the lower cost products and that goes back to Al's comment about the consumer.

Okay, great. It looked like gross margin on acquired sales in Q3 was down some from Q2. Is that -- what's going on there? Anything specific?

It's really the mix of Mexico coming into the equation in the third quarter and as you would expect me to say, it's an opportunity to raise gross profit in that market.

So no reason to think that will ultimately will be in line with the rest of the business, I mean the rest of Carrier?

No.

Okay. Thanks very much.

Our next question comes from the line of Steve Cusack from JPMorgan. You're line is open.

Good morning. It's Drew in for Steve this morning. Just revisiting the 4Q outlook. Again,you guys had a very strong fourth quarter last year, up 23 on the equipment and just remind us how to think about that- - I don't remember you guys calling that one-time tailwinds last year, but is there anything unusual when you think about the comp, whether it was a tax credit for the year anything else going on year-over-year?

Go ahead, Barry.

Our fourth quarter was strong a year ago. Going back objectively, same-store sales up 17%. There's a lot of market share in that number last year and the same people, the same execution is desired for this year in terms of building the business, getting market share, and so on. The people are the same. Execution has to happen, but that's the plan. We think we've done that certainly in the third quarter as a trend item.

Also last year we did not have New Mexico and the Northeast markets. It does introduce us in especially the Northeast in the heating market which is a profit opportunity. And then as I mentioned, SG&A in the fourth quarter a year ago is something that a year later is an opportunity to reduce organically and to provide some earnings list there.

Okay. That's helpful. Your replacement compressor sales in the quarter, are those still, trending relatively strong or are those tailed off with the R22.

It's Paul. Those tailed off with the increase in sales on the R22 product.

Okay. And then lastly, just a bigger picture question. We've seen a couple of the OEM results from 3Q and what seems to be a pretty significant amount of dislocation in terms of share shifts within these players.

Without commenting on specific OEMs, which I know you wouldn't want to do, but is it your impression, too, that there's more dislocation then usual, I know your minority expense went you, maybe a little more than we expected year-over-year. Is there anything to read into that? Is there as much dislocation out there in terms of share as it would appear from the outside?

Well, of course, we'd like to think we are the strongest distributor out there with huge branch network, over 520 locations, and we like to think we represent the best brands, and we like to think we have the most aggressive organization, so we don't think we're suffering any share loss. It's too early because we don't have any history data to show we're gaining share, but when I look at some of the reports that I'm seeing, same as you are, it sort of suggest we are gaining share.

And also from an OEM -- I know you guys are doing very well from an OEM prospective as well, between the different OEMs?

Oh, I don't know, we couldn't comment on that because we can only talk about what we're doing. I think we're doing well for all of our OEMs.

I believe our OEMs are very happy with our performance in the marketplace this year, and I can't speak to the OEMs we don't represent.

Okay. Thank you very much.

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

Good morning, Jeff.

Good morning, guys. if you look at the equipment growth, was it materially different from between the kind of legacy Watsco, and the Carrier JV's?

Don't forget the legacy business has a big part in what we call Baker Distributing, and that's a refrigeration business. If we had any place to negate some softness more than the others, that would be in that business, not the HVAC business.

Okay, but the refrigeration piece was up in the quarter, right?

Yes, but there are other issues regarding the competitive pressures on refrigerant gases and things like that.

Is that down- -

it's a margin issue Okay. A temporary margin issue.

But on just staying on the HVAC equipment side, is there a material difference between your HVAC equipment business and legacy Watsco and Carrier?

I don't think so. Paul or Barry?

I have the numbers. No, they're almost spot on. It would be a rounding error.

Okay. I think you mentioned, Al, 25% growth in the non-equipment piece for Carrier.

Is that suggesting that the non-equipment, and maybe that goes back to the Baker issue, but does that suggest that the non-equipment side in the basis is that much weaker? No, no, these are different kind of supplies. The HVAC is a different market than the refrigerant market, and I'm glad you brought that up because even though we're increasing the offering of Carrier Enterprise locations in the non-equipment, we have not yet provided all of the additional product offering. That's still in the future. Paul, do you know what percentage of what we do in non-equipment they are carrying at Carrier Enterprises, I'm talking about the HVAC business?

On the HVAC side, they're probably at 75%, but on the recent acquisitions that we've made, we're just getting the ballpark for 90 days. So, that's where the real improvement is going happen for us, I think in the fourth quarter and beginning next year.

Ok. And if I just look at the minority interest line, it seems like perhaps the Carrier JV's are actually performing at a higher margin than the base is that fair?

Well, they're doing real well. The joint venture is doing extremely well, but so are the other OEMs that we represent in the HVAC business. If anything, we're going to have to improve in our refrigeration business.

Okay.

To have it stay up with the HVAC business.

Okay, great. Can you quantify what those one-time vendor payments were?

Yes, I think so. It's a contractual thing thatBarry, you would be the most familiar with it.

The $87 million, Jeff, is two vendors. One of them was part of our joint-venture transaction with Carrier two years ago that had stated terms, and as we said in our 10-Q those terms would change, and that accounts for a good portion of the $87 million true-up that was made in the third quarter. The other was a vendor opportunity that I'm not going to disclose, but it is something that made good business and financial sense.

Most of it came from the contract we have with Carrier in the joint venture, but we simply asked for dating and that dating expired.

Ok. And the true-up is one-time?

Yes. We are done.

Okay.

unless we have new transactions, I guess I'm not exactly correct because as we do new transactions with others, we always ask for this at the beginning.

Ok. Great. and then just finally can you talk about the M&A landscape, you've been kind of quiet on the independence, what do you see in there?

I like to try, I can assure you. We have such a strong balance sheet and we're looking because our goal is to build this network to acquisition as well as organically, so we're out there knocking, but I wish I could tell you that we're on the - you know, ready to close on something but we're not. That's speaks to the health of the distributor business. These fellows, even though that the economy is poor, they're strong and sometimes it takes a family something to have to do with a family or corporate change of strategy before we can get involved with an acquisition.

Okay. How about, you continue to dialogue with OEMs. What are you seeing from a kind of captive distribution?

We are the never say never guys. We're constantly, sometimes it takes years, but we've done it three times now with OEMs that do their own distribution, and three times we have hit a home run for them and for us. We have that record to refer to, So, we're knocking on doors.

Okay, Thanks, guys.

Looking at our share performance with our big OEMs that we have it, would be a good advertisement for those who are not apart of Watsco to probably join.

Great. Thanks, guys.

Our next question comes from the line of Ian Zaffino from Oppenheimer. Your line is open.

Good morning, Ian.

Hi, how, are you doing there? Quick question would just be on -- I know you've talk a little bit about the monthly same-store sales and you saw some deterioration. Did you see any negative monthly comps or is everything positive?

No, as we went towards the end of the quarter and the beginning of the fourth quarter we are showing single digit declines, same-store declines.

Okay. But you didn't see any declines in the third quarter, correct?

Did we, Barry, I don't remember?

No, no we did not, Ian.

All right. Thank you very much.

And we do have another question from the line of Keith Hughes from SunTrust. Your line is open.

Yes, Inventory is still up pretty significantly year-to-year. Is driving that down going to be a big part of the cash flow and return of deposit cash flow you discussed for the fourth quarter?

Absolutely, and collections and receivables, right.

Do you think you'll be out to sell year-over-year as you end 2011?

That we will be out of debt?

No, That you be up in inventory year-over-year

Barry?

Keith, there's inventory sitting in 35 locations in Mexico and in the Northeast that were not there a year ago, and so that would account for part of the inventory increase. Organically we would expect inventory to be down year-over-year.

So $35 million is the adjustment I need to make to gauge that correct?

That's a good number.

That's a good number to use, okay. All right, thank you.

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

Good morning, guys. First question as it relates to where you're talking about reducing costs in the short-term. Could you give us examples of where you're cutting and where the opportunity is there?

Barry?

I'm sorry, repeat the question.

He wants to know about the SG&A reductions that you mentioned we were anticipating achieving in the fourth quarter.

Obviously, going back to the comp of a year ago with the earnings up the way they were, there was a lot of variable compensation that was paid given that revenues were up 17%, so there's a variable cost that comes down on a fly- revenue environment. Also, we've asked our leadership throughout the Company to simply go into their branches, their networks, their regions and find opportunities to reduce costs, so we have a lot of confidence in that process and something we've done in the past, something we're doing again.

Okay, thanks. And could you talk about the regulatory environment? Do you see any changes out there, any headway on closing this R22 dry-shift loophole or are there any new rebates that you're hearing about more on a federal level than a state or utility?

Paul?

There's no movement at all as far as looking head for new rebates for next year. I think our government is kind of tapped out on those. As far as any change in the ability to close the loophole, we're not holding out any hopes that the EPA is going to redecide and decide that they can't do a dry-charge R22 next year. So we're anticipating having dry-charge R22 through 2012 right now.

Okay. Then just can you refresh us on when the phase out of production of R22 starts and how that's going to flow? Then, Paul, I don't know if you have an update on the price of a jug of R22 versus 410 right now?

As you remember, the step down continues year-by-year. We have not yet seen anything from the EPA as far as what the allocations are going to look like for next year, but it continues to step down until 2015. There still will be R22 available. The price should go up.

As recently as yesterday, we had a price notification from one of our vendors that the price of R22 will go up another $0.50 a pound. Basically, you've seen almost a convergence of the price between R22 and 410A given that the demand for 410A with the dry-charge R22's out there has gotten a little bit softer, and the demand for R22 because these are uncharged units has increased.

Ok. That makes sense. And then finally, as you guys are looking to 2012, just I understand there's this pent-up demand argument out there and everything else, but could you give us your initial impressions on how you're thinking about that market, the market in 2012 as you're planning for next year? I don't mean to ask you for your projections in terms of this pent-up demand thing for sure, but I'm just trying to gauge in terms of are we looking at a flattish kind of market and then hoping for some catalyst? Is that what you are thinking about?

I think all three of us should take a shot at that one. I'll start by saying that we have not begun our planning for next year, but I can say that regardless of demand, we have enough strength with offering increasing the product offering in our locations and increasing our vigilance on spending that I'm hoping that when we do get into planning, we'll be able to plan at a minimum of 20% earnings per share growth. That's hope at the moment, they're not plans.

I would say that it's going to be driven by market share. It's not going to be driven by the market growing at any rate that's going to create topside growth for us. Like we had this year, we're seeing new markets that we're not participating fully in and we're going to be engaging in those. As we added more commercial products to our line, hopefully next year we are going to be able to add several new products in other areas to give us lift on the top line.

I think the non-market items which we talked about in the call, again, get continued. First, you know, CE has been lunching more and more products throughout their network both on the commercial side, which is something Paul mentioned as well as the supply side which has been going on, and more market share in terms of having more branches in place next year is something that's also partly this year's story and also part of next year's story. From a financial point of view, obviously, we are going to earn Mexico and the Northeast for a full year, and we expect margins to be better then they were historically than they were for those businesses. Then also financially, but importantly, we'll step up our investment in Carrier Enterprise next year in July by 10% which gives us some lift in terms of the performance and the metrics that go behind that step-up in investment.

All right. Great. Thanks very much, guys.

(Operator Instructions). Our next question comes from the line of Robert Barry from UBS. Your line is open.

Hi, guys, good morning. Just wanted to follow up on a couple of things. When the reference in the opening comments about the supplies growth of 25% plus, was that on a same-store basis, or does that reflect the addition of the new properties?

Same store basis.

Same store basis, yes.

For Carrier Enterprise.

Okay. I wasn't clear on your response to the earlier question because just given the math, it does imply some pretty significant deterioration in the legacy, just given the whole thing through one, or am I not thinking about that?

The legacy thing we believe is a third quarter issue. I don't believe it's going to continue.

Could you just clarify what you were referring to, the refrigeration issue?

We've all ready mentioned that there was in margin pressures in some of the refrigerant and other things that we're involved in the refrigeration business which we believe will not be around beyond the third quarter.

Okay. Can you remind us what percent of the business currently is related to commercial?

Commercial refrigeration, I'm sorry? Commercial refrigeration you see is about 7% and commercial air conditioning is something that's probably closer to 10%.

And which were you referring to when you mentioned that it was up 20% plus?

Commercial HVAC.

No, that's a supply business. That's something entirely different. That means that where we have HVAC outlets that we purchase from OEMs where they were doing their own distribution, they were selling primarily equipment only. We are now adding non-equipment products that go along with sales of equipment and we believe that helps gain share on the equipment business as to contractor/customer comes into the store can get most of what he needs at one location, rather than having to buy the equipment at one place and go some place else to buy the supplies.

I thought in the opening remarks you mentioned the commercial business grew 20% plus.

No. Barry, correct me here, wasn't that the commercial equipment business as distinct from commercial refrigeration?

What we said specifically is that commercial HVAC products were up 20% plus, that's commercial HVAC. Our comment on the supply sales of Carrier Enterprise is that they were up 25%. Now Robert, proportionally, that's still a very small number in the big picture of Watsco. We want to highlight thatCarrier Enterprises made progress in terms of getting into the supply business which again, as Al mentioned, pulls through the equipment business and is a good opportunity for growth overall for Carrier Enterprise.

Ok. Great. Andthen just finally, you did mention that you were getting more into a heavier commercial products. Is that related --

Commercial equipment. We're moving up on tonnage and coverage, right. We're representing larger and larger unitary equipment for the replacement market, or wherever their demand is.

I was just curious if that's was being driven with your relationship now with Carrier?

Oh, yes, that's entirely Carrier. The other OEMs that we represent in equipment don't have that size equipment.

Okay, great. Thank you.

All right, and we have no further questions in the queue at this time.

Terrific. Well, thanks for listening and we'll visit again in the next quarter. Bye.

This concludes today's conference call, you may disconnect.