Watsco Inc (WSO) 2008 Q4 法說會逐字稿

Thank you for holding. My name is Sherry and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter earnings release 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). At this time, I will turn the call over to Mr. Albert Nahmad. You may begin your conference.

Good morning, everyone. Welcome to our fourth quarter conference call. This is Albert Nahmad, President and CEO. With me is Barry Logan, Senior Vice President and Paul Johnson, Vice President. First, let me read the cautionary statement that we always do. This is 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 those various laws. Ultimate results may differ materially from the forward-looking statements.

As all of you know, these are unprecedented economic times and just about all factors of the economic landscape have been impacted. Despite the challenges, our Company had its fourth best year in our six year history from operating results and our Company's financial position is the strongest it has been in our history. Watsco's organization has done a good job managing to the opportunities. (Inaudible) within our markets, as well as improving selling markets and lowering SG&A in response to a difficult revenue environment. We identified and implemented numerous profit-advancing activities in 2008 which produced earnings of $30 million. The Watsco management philosophy of local entrepreneurs and managing business conditions within individual markets has certainly contributed to the performance. I would like to repeat that because it really tells who we are and that is that our philosophy of local entrepreneurs managing business conditions within individual markets, that's what produces our constantly good results.

A strong indicator of the success, is our ability to expand gross profit margins, which reached all-time records for both the year and the quarter, and that's a remarkable accomplishment. We also lowered year-over-year SG&A by 6% on a same store basis and during the fourth quarter, dropped SG&A 10% over the same period last year. Sales reflect higher pricing as well as a richer mix of higher efficiency systems and a substantial conversion of equipment sales to ozone-friendly 410a systems, which both are important accomplishments. Revenues from the sale of high efficiency units, air-conditioning systems that are 14 SEER and above, grew 10% during the year. Revenues of 410a products more than doubled and represented 40% of unitary product sales during the fourth quarter. We are pleased see this progress in a tough economy, as it shows that consumers are now more aware of their impact on the environment and are making buying decisions to improve their home's energy efficiency and reduce the impact on global climate change.

The mandated phase-out of R22 equipment becomes effective at the end of 2009. We anticipate that the trends we experienced since the second half of 2008 increasing sales of higher efficiency equipment and 410a systems will accelerate as we move closer to the phase out date. Our sense is that this should be positive development for our business because the entire system needs to be changed out when transitioning to 410a, not just the outdoor condensing unit. Also, the new stimulus legislation provides opportunities for our industry. The legislation provides tax credits to homeowners, for having energy-efficient air conditioners or furnaces. The tax credit will cover 30% of the cost, up to a total of $1500. The federal tax credit, along with local utility rebates paid to consumers for upgrading their AC systems, provides us and our contractor customers additional catalysts to improve the sales mix of higher efficiency products. I might add, the states are providing incentives for the revenues to move to higher efficiency air-conditioning.

We had a monster year for cash flow in 2008, surpassing 2007's record year and we have raised dividends once again. The Watsco Board approved an additional 7% increase in our quarterly dividends to $0.48 per share, beginning in the second quarter of 2009. 2009 will mark the eighth straight year we have increased dividends, which are now at an annual run rate of $1.92 per share. This allows for meaningful yield giving our stock price, but more importantly, our increasing dividends are a direct means to return value to our shareholders. Our conservative management on the balance sheet is paying off. We remain in a position to focus on long-term growth opportunities. We will use our financial strength competitively by offering broad product availability. That's something the smaller distributors are going to have trouble doing, by the way. We are going to offer this at the local level and continue to aggressively seek transactions due to the larger size of our branch network. These efforts will further strengthen our position to best serve the rotation replacement market.

Our balance sheet remains strong. We are at a net-positive cash position with debt of $20 million, in cash of over $40 million. We also have cash available under our $300 million line; it's revolving credit agreement which is in place through 2012 and currently, interest costs of such a line would be less than 1%. Again, we consider our strong financial position to be a competitive weapon in the current market environment and we are actively seeking opportunities in a disciplined manner.

Now, for the specifics on 2008's performance. Sales were $1.7 billion, and on the same-store basis, declined 10%. We estimate sales for the replacement market were flat, that's a very important point, sales for the replacement market were flat,. Sales for the commercial market were down 5% and sales for the new housing market experienced declines of 40% to 50%, depending on the specific market. Gross profit was $442 million, with gross profit margin improving, that's improving, 60 basis points for a record 26%. Same-store gross profit margins improved 70 basis points to 26.1%. SG&A for the year was down 6% on a same-store basis. Our operating profit was $99 million in operating margins of 5.8%. Same-store operating margins were 6% versus 6.3% last year. Again, we believe this is a good performance given the change in revenues. Earnings per share declined 10%, to $2.18 for diluted share on a net income of $60 million.

As for the quarter, sales were $335 million, down 15%, on a same-store basis. Holiday declines in our primary markets approached 50%. That accounts for much of the impact on revenues. Now it is important for me to remind you that the fourth and first quarter are low periods for the replacement market and therefore, new construction in the general economy can have a disproportionate impact on sales, and therefore, earnings. This typically balances out as we move into the replacement season during the second and third quarters. Gross profit for the quarter, this is the fourth quarter, was $86 million, gross margin improved 40 basis points to a record 25.8%. SG&A was down 10%. Operating profit was $5.8 million on operating margins of 1.7%.

Now on to cash flow. Again, it was a terrific year for cash flow. Operating cash flow was $113 million, or $4.09 per share, versus $107 million, or $3.84 per share, in 2007, as well in excess of our stated goal of having cash flow exceed net income. Cash generated in 2008 was used to pay increasing dividends of $49 million, a 30% increase versus last year, debt reduction of $34 million, and share repurchases of $5 million. 2008 cash flow results include a $20 million additional investment in new 410a air conditioning systems, which we stocked in advance of the environmental mandate that takes place at the end of the year. Contractors are actively selling and marketing these new products well in advance of the mandate. We are in a strong position to respond to their needs. The combination of higher efficiency solutions match with these new, greener products bodes well for the replacement market as both contractors and consumers will have attractive solutions to upgrade existing systems.

As I mentioned earlier, cash of $41 million at year end, and debt was $20 million for a net cash position of $21 million. Cash, plus capacity in our $300 million credit line, puts us in a great position to invest in our business. Now in terms of 2009, first quarter trends are softer than the fourth quarter and because this is the most seasonable time of the year, we plan to provide our outlook for the full year during our first quarter conference call in April. Plus, we are evaluating and implementing additional profit-enhancing activities and we have also had better visibility through the early part of the replacement season at that time and this the conservative thing to do, we believe.

Before I get in answering questions, it is important to again look at the long-term story of our Company. We only think long-term and only think in terms of maintaining a disciplined approach of building a much larger company using the same conservative principals that gotten us this far. During our 20 years as a distributer, revenues have grown on a compounded annual rate of close to 20%. In the market capitalization, this Company has increased more than 60 fold but an important reminder, our share is just 8 % of the estimated $26 billion market, that's a $26 billion wholesale market, for HVAC/R products and we intend to grow our leading market position substantially in the coming years. We feel confident that this is achievable because we already have achieved double digit market share in some very competitive and very large markets. Now with that said, Barry, Paul and I will be happy to answer your questions.

(Operator Instructions). Your first question comes from Matt Duncan with Stephens. Your line is open.

Good morning, Al, Barry and Paul. How are you guys today?

Good morning.

The first question I've got, now you touched on this a little bit, and I appreciate that it's probably a little bit difficult to give 2009 guidance at this point in time, but I don't know if maybe you can give us directionality of sort of where you guys think the year may be going versus 2008, just as a starting point, and then we can wait until April for full guidance?

I think the long-term nature of our business shows you that our earnings primarily flow in the second and third quarter. That's based on the replacement demand.

Sure.

If that is normal, meaning that the temperatures are normal, I think we will be all right for the year.

Okay. So you think replacements would be up then for the year as long as temperatures are sort of a normal kind of year?

We experienced in '08 no decline in demand for replacements, so even if we see that, I think we will be all right. We are getting more efficient, as I have indicated, we took some $30 million out last year and we are already planning on more in '09 so I believe with the usual, normal replacement market we'll be fine.

Sure. And then Al, as I look at the percent of unit sales that were 14 SEER and higher, you touched on that for the full year, can you tell us what it was in the fourth quarter and how has that been trending in the past few quarters?

Barry or Paul, do you have that data?

Yes, Matt, it's almost 40%, 39% for the quarter versus 29% for the year. So 40% is certainly a growth. That conversion from a inventory perspective will be largely in place as we start the replacement season.

Barry, is that 410a, or is that 14 SEER and higher?

I'm sorry, that's 410a.

We don't have good data right now on what the 14 SEER and above was for the quarter itself.

Okay.

I would estimate that the fourth quarter wouldn't be a true reflection of what the demand is since that is an off quarter for replacement anyway, but year to date, for the entire year, it came in at close to 20 % for 14 SEER and above equipment.

I appreciate that Paul. A couple more things here and then I will go jump back in queue. First of all, was there any impact of pricing in this quarter with copper prices having come down? Are you guys seeing any changes in pricing?

We haven't.

The lower prices do hurts us as long as we have inventory at the higher prices We had an impact of that during '08 but we are pretty much out of that situation now and will contribute to higher margins during '09, we believe. On the equipment side of our business, there is certainly no impact, there is improved pricing in the fourth quarter for the equipment environment.

He was asking about steel and copper.

Okay. Two final things, in the press release, and then you guys mentioned it again on the call that you are looking at additional cost cuts on top of the $30 million to $40 million on the program you already announced. Can you put some brackets around what these additional cost cuts may be in terms of dollars, what is the time frame in instituting those cuts, and one housekeeping item, what was depreciation and amortization in the quarter and then I will jump back in the queue? Thanks, guys.

I think the '09 planning is just beginning now, we didn't want to do it too early because we wanted to experience some parts of the first quarter and now that we have experienced some of it, serious planning is going on at the security level, we would not be able to provide you the information as to what the steps we are taking to become efficient because we don't have it. We will have it by the April meeting and will quantify it for the year.

Okay and then Barry, deappreciation and amortization in the fourth quarter was what?

$1.72 million.

Okay, thank you very much guys.

Your next question comes from Michael Cox with Piper Jaffray. Your line is open.

Thank you. My first question is on working capital. You have done an excellent job taking working capital out and driving cash flow. Where do you think you are in the opportunity there and do you see working capital as a source of funds in 2009?

Yes we do, because I don't think we have maxed out on inventory turns. You might want to contribute to that Paul. You're my point man on that.

We still have a long way to go on inventory turns. We're at around 4.1 to 4.2 turns on the subsidiary that we are talking about, as well as we had a buildup that Al indicated during the opening remarks on 410 inventories, so we are holding 410 inventory of equipment, plus R22. So it is an incremental $20 million that we have been carrying there. As we get more efficient, our companies are getting efficient on the inventory side, we are still good upside on reducing inventories without reducing the service levels that we provide our customers.

We believe we can reach an interim inventory turn of six, off of the foreign chains now. We got quite--once we get to six, we will then raise the bar even further.

At the AHR Show, there was a lot of commentary from manufactures about getting push back on pricing. Any discussion around manufacture's ability to hold price through '09 with the lower commodity price environment and some of the weakness in demand?

Certainly there has been weakness in demand, Michael, and certainly that has not influenced pricing. Pricing was up this year, last year and certainly in the quarter as well. I think it's a stable industry from that perspective. I don't think there is going to be a great deal of push back or difficulty on pricing. Efficiency drives pricing as well. We talk about efficiency not just to drive sells but also to drive margin and because of the higher pricing and the higher margin, as something that stabilizes our industry, not just Watsco's numbers. So the lower commodity of copper is one component of what these things cost. Steel, aluminum, and everything else in the system, I don't think has reacted as wildly as copper has and that's just a small component. It's a pretty stable price environment for this year.

Great, thank you very much.

Your next question comes from Ian Zaffino with Oppenheimer. Your line is open.

Good morning. Thank you for taking my question. Just wanted to talk about comment on replacement sales. You mentioned they were flat. Is that on a revenue standpoint or is that on a volume? Can get in to that a little bit more?

It is total revenues, Ian. The units are down in single digits, the pricing up single digits, low single digits to make it a flat year for replacement.

Have you noticed any type of--you saw an in increase in the higher efficiency units, but have you seen any trend towards a tradedown to the lower, less expensive units in any instances? Or how should we think about that?

It's a mix that has been going on for a year and a half or two years where each of the manufacturers and each locations, more importantly, have a good/better/ best offering, and that mix has changed over time over the last couple of years, not just a recent event. The industry is managing to that, the prospect of that, while selling a greater concentration of high-efficiency units. So it is some offsetting environment going on for that opportunity. It's nothing that stands out. It's something that's been a trend over the last year or two.

Okay. Thank you very much.

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

Thanks. Good morning, guys. Could you tell me what percentage of your revenues were new residential construction, in the fourth quarter and what percent do you expect that to be in second and third quarters of '09?

Certainly declines. Right, David?

Exactly.

Well, the industry, at this point, in terms of looking forward, is somewhere around 5 million or 5.5 million units, I believe. Emerson would be a good test of that number and if housing is 550,000 units, which is one projection that I have seen, that gives you a ratio of our industry looking forward. Looking at the fourth quarter, it's not something we really splice in quarters, Dave, but my educated remark would be somewhere around 30% during the quarter. During the year, it is something less because of the replacement season.

Got it, perfect. Then, as you're look at the mix of our 410a versus R22, if you can just clarify how you see that playing out as we move through 2009, both in terms of revenues and inventories. Did you say that you expect to be fully R410 by the end of 2009 or did you not say that?

Now the mandate at the end of 2009. The manufacturing R22 products for residential uses must stop to federal mandate.

Sorry? I'm just wondering how long you are going the carry this extra inventory? At what point do you cross over completely? I thought 2009 was going to be the year where--

I agree with you. I think we should be out of R22 inventory by then. Whatever that might be will certainly sell, it won't be much.

Our Company's are selling out their R22 inventories. There are a few contractors, however, who are holding out and not going to stop selling them because R22 is still a good refrigerant for them. Each one of our companies has developed plans to reduce their R22 inventory and phase it out by year end.

All of the changes work well for us as the federal government moves towards environmental controls, that's what this 410a is--moves towards higher efficiency, that's where the SEER levels are moving to 14 and up. Those are great long-term opportunities for us and regardless of what is going on in the economy at this moment, it just mandates wonderful opportunities going forward because it all serves what the public wants. higher efficiency and more green products in the 410a refrigerant which doesn't pollute the environment as much as R22 does.

One more question in terms of some color on products. Could you talk about trends you are seeing in the Grandaire product line and then also, if you could talk about indoor air quality if that's lost any traction here in the recession?

I don't know what we want to say about Grandaire. That's a brand, one of our own brands.

I would rather talk about the -- rather than pick on a specific brand or specific product from a disclosure point of view. If we just stick to my comment before about the lower end of the market. Grandaire's position at the lower end of the market, along with other brands we carry at this end, it's very unique for us as a distributor to have good/better/best at all of our locations, Grandaire fills that need in many of the markets that we have. As I said before, the low end of the market has been a source of growth for us and it's a good flexibility that we have with that particular product line. We added to it during 2008 as well at the ACR locations we added since last year.

We don't see any material change in indoor air quality. It has not taken off yet.

Okay. Guys, thank you very much.

You bet.

Your next question comes from Dan Wang with Steve Riley and Company.

Good morning. First question was regarding the first quarter. I know, we all know, it's still a seasonally slow period for you, but could you perhaps comment on the kind of sales trends that you've seen so far in the first half of this quarter?

Well, the fourth quarter, we reported down 15% decline over the prior year. We said earlier today in the conference call that the first quarter, so far, is even softer than that.

And you mentioned that obviously, you're in the middle of the planning process for the year, probably will get a better feel for that in a couple of months, but I'm sure as part of that process, you're speaking closely with your OEM partners and could you provide kind of a thought on what they are saying collectively or some of the data points you are seeing from them?

Well, from what we understand, the housing, not that that matters to us too much, in the fourth and first quarter, there's pessimism in new housing starts. That's what we hear from the OEM. I don't think we hear much more than that,. They are certainly getting more efficient, as we all are. I don't know what else I can add at the OEM level. I know about some of them hedging, but you know that as well As far as I'm concerned, every one of the OEM's that we do business with presently is delivering on time and performing as we would like them to.

Shifting back to the 410a versus the R22 products, I think the relative pricing for those two product categories were equalizing. Could you provide more detail about the relative pricing now and price margins for you?

The pricing has come down on the 410 or the R22 has gone up to the 410 pricing but basically the outdoor units, have a similar price now pretty much across the board. The difference makes the comparison difficult is with most of the OEMS's now, anything 14 SEER and above are only 410a, we are not selling any R22 product in the higher efficiency profile. The second thing that makes it unique, is that when you change out a 410 unit, you positively have to change out the indoor unit, also, because it's a higher pressure system than you had with the R22. So, it's hard to do an apples-to-apples comparison overall. The bottom line is one is higher efficiency, two, it's a full system change out where as some contractors could get away with changing out the outdoor unit with a R22 product. So, it's good news for us as Al indicated in the opening remarks. It's a system changeout and a higher efficiency changeout.

It really isn't good, Dan, to make a line item comparison of a R22 product versus a 410.

Got it. Finally, final question was regarding the overall store network and how that could shift this year? You're always keeping a long-term outlook and continue to invest in the right areas. Could we expect any actions-- closings, openings in the branch network or store network?

We have -- as we stated, we are in our strongest financial position ever in our 60 year history. We have excess cash in a very large line of--credit line at a low price. So we are most eager to add our network by making acquisitions and I remain optimistic we will be able to do some of that this year. Especially if the market , you know is -- as it has been -- or even if it improves, I still think that given our position we will be able to add to our network through

Great, thank you very much.

Your next question comes from Keith Hughes with SunTrust. Your line is open.

Thank you. Your comments on the rebate. Has the government defined what energy efficiency is? What do you have to buy in order to qualify for that?

16 SEER or higher.

16 SEER or higher. Okay. And thus far, the stimulus bill is going to be signed today, is that correct?

Well, you probably know as much as we do, it's what is supposed to happen.

I haven't read all 1000 pages of it yet.

By the way there is another part of the government bill, that we haven't disclosed to you, for no reason, if the weatherization, they are allocating $5 billion to assist homeowners, typically of the low income level, to weatherize their house with better installation. We are a major supplier of insulation to the people who will do that to people's homes. While we focus on equipment, let's not forget that the supplies and the non-equipment side of our business will also be stimulated by this new federal spending because $5 billion will go a long way in helping people insulate their houses better. We are a primary distributer of insulation.

Following up on insulation and non-HVAC equipment products, you commented earlier, we are commodity prices coming down to steel, I guess question for Paul, are you seeing sort of across the board in commodity items, things that maybe aren't directly affected by copper and steel that aren't affect by volumes and industries across the board, price falls at this point?

No we haven't. In some of the commodities like refrigerants, which we do a substantial volume, we haven't seen any deterioration in pricing. A lot of the things like our tape business, our fabricated copper-type products that are more highly fabricated, thermostat wire and that sort of thing, we haven't really seen the price declines that we've seen with raw copper tubing and sheet metal, flat steel and that type of product. I think the markets held good on those items. The ones that hit the headlines, yes, we seen continuous declines. Copper seems like it's stabilized in the $1.50 range, good stability is what we are after on those products.

Final question on the small players in your industry have to be under severe pressure given the trends in the fourth and the first quarter. You historically have not greenfielded a lot of locations and there are a lot of specific reasons for that, but is business getting so bad that some of these distributors maybe not worth buying, in some cases? Would you consider a bigger greenfield-type strategy on locations and geographic, particularly -- adjoined green geographic areas?

We do greenfield from time to time but my preference is to acquire branches that have already a customer base and who could use an injection of capital to increase their product offering that they can't do because they don't have the money to do it. We buy product from over 600 manufacturers, and we love to go into an existing branch with customers and increase the offering so that the contractor has much higher service level. We also like adding to the investment by bringing on more salespeople to cover the density with more competent and aggressive salespeople. I think my preference will always be to acquire a branch with customers and then capitalize with more people and more products. We certainly have gone and executed that policy real well.

Thank you.

Your next question comes from Holden Lewis with bb and t. Your line is open.

Thank you, good morning. I wanted to try to burrow into the mix question a little bit more because it seems like you have some moving pieces here, specifically you talked about trading down within the mix a little bit which is negative, but at the same time, talked about the relative growth of the 14 SEER mix, the 410a mix, and I guess I'm curious when you look at the 2008 results, you had 60 basis points improvement in gross margin, was the mix in net positives all in, net negative because the trading down in to what extent did that impact the gross margin for the year?

I'm going to let Barry answer this, but obviously gross profit margin has been increasing all year long. There weren't too many bad things going on in our gross profit margins.

Pricing was also a key, I'm trying to get a sense because we are talking about similar mix issues impacting 09, I'm trying to get a sense of whether mix was positive in 08, if it was primarily pricing, carry those analogies in to 09.

Sure. Holden, when we talk about pricing I -- we are talking about equipment business and that is about 45% of our business. When we say pricing is up, we are speaking to that side of our business. Pricing in margins are up on of our businesses, the non-equipment margins are behaving better than the equipment margins, so this is not a one-dimensional conversation on good/better/best mix or efficiency, it's across 600 different vendors and 600 types of product lines I cross the board conversation in terms of what the subsidiaries accomplished and executing this. If I focus on equipment, the pricing is up for the year, some measure of passing on price increases, positive contribution from higher efficiency, some pricing change because of the sale mix but not enough to move the needle in the big picture. It's really 600 stories in one, it's not one particular product line or product group.

Okay. If I take that further into 2009, thinking conceptually, I guess the trading-down issue is probably where it's going to be, maybe so that erosion does not continue. I would think that the mixed benefit 14 SEER plus, and 410a would actually get better, maybe the mix component would be improved in '09 over '08. The pricing piece, which was a big deal, which was a big contributor in '08, is not going to see fresh increase in pricing, is that the right way to look at the moving prices in the gross margin?

Think so. I think that's a good analysis.

Okay. I would add to that that -- we haven't reported on our planning for 09, but I don't know why the trend of higher in creasing gross profit margins is not going to continue. Which probably for all of these that you are stating plus subsidiaries are increasing many merchandising skills.

Thanks for that. Then secondly, with regard to the $8 million, that you referenced, is that $8 million on top of the -- did you exit the fourth quarter, at sort of the $30 million annualized run rate, is that $8 million you are going to recognize, you saw that recognized in the fourth quarter and first half of '09 because you weren't at that rate in the first quarter or second quarter of '08 or is that $8 million sort of part of the brand new initiatives that you're envisioning?

That's the 2008 playing itself out over five quarters. I wouldn't call it annualized rate, some of that will push into the second quarter, as well.

That $8 million, you're going to realize incremental $8 million over the course of 2009?

That's correct.

The first half.

Okay.

Then we expect new initiatives which would tell you more about it as we get in to serious with the planning process and report on the April time frame.

For our modeling purposes, can you give some sense of order of magnitude, not specific numbers but is it similar to the one you announced before or are you running lean enough or is it unrealistic to think that you can get another $35 million?

The way we work is that the these things come from the subsidiaries that take it down to the branch. Whatever we would tell you at our level would be just guessing and I rather not do that.

Fair enough. Lastly, you typically give the quarterly growth rates for HVAC equipment, supplies, refrigeration and the mix of each, can you provide that for the quarter?

Equipment side it's, let's see, for the fourth quarter is 14%, non-equipment is 14% and the commercial would be 15%.

Thanks. The mix of each?

45% equipment, 55% non-equipment and refrigeration is 11%.

Thank you, guys.

Sure.

Your final question in queue comes from Manish Shapo with Kaiger Analysts.

My question has already been answered. Thanks.

At this time, there are no further questions in queue. Go ahead.

Thanks very much for attending the conference call, we look forward to talking to you in April. Have a nice day.

This concludes today's conference call. you may disconnect and thank you for using the Conferencing Center.