Watsco Inc (WSO) 2012 Q4 法說會逐字稿

Good morning, my name is Adrian, and I will be your conference Operator today. At this time, I would like to welcome everyone to the fourth quarter and year end earnings report 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)

Albert Nahmad, CEO, you may begin your conference.

Good morning, everyone, and welcome to our fourth 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 normal 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.

2012, Watsco had an excellent year. First, here are a few highlights. Our international business expanded to a revenue run rate of about $500 million, with 53 locations in Canada, Mexico and Puerto Rico. We also operate a great export business that sells to other markets in the Americas and the Caribbean. We will continue opening new locations and adding products, as we're very excited about our international business. In the United States, we grew market share for both residential and commercial product segments. Residential unit growth was especially strong in the fourth quarter, and that momentum has carried into 2013. We saw growth in sales of R410A replacement systems, including growth in the premium tier 16+ SEER systems. Partially offsetting this was a higher sales mix of base level 13 SEER systems. In other words, equipment sales were strong at the high and low ends of the product offering, with a decline in the middle. We believe this reflects some of the uncertainty consumers are feeling about the economy. Longer term, the trend towards consumer upgrades -- let me start that again. Longer term, the trend towards the consumer upgrading existing systems to more efficient and environmentally friendly products, versus patching up their old system, is what is important. We would expect that sales mix to improve with the economy, along with enacted EPA regulations that will raise minimum energy standards for many of the products we sell.

Sales of commercial HVAC refrigeration products were up double digits from the -- for the second year in a row. We've added more products and territories to grow this market segment, and these investments have produced growth in market share. Sales to the new construction market, which accounts for about 10% of Watsco sales, showed signs of life during the fourth quarter and has continued into the early part of 2013. We also improved operating efficiencies in 2012. SG&A as a percentage of sales is at an all-time low.

Now that the -- now, the detailed performance for the full-year 2012. Revenues grew 15% to a record $3.4 billion, and were up 4% on a same store basis. Gross profit increased 12%, gross margins was 23.7%, and SG&A decreased 1% excluding new locations. Operating income improved 13% to a record $225 million. Same store operating profit increased 1%, with an operating margin of 6.6%. Earnings per share, adjusted for the special dividend, increased 11% to a record $3.03 per share.

Now a look for the fourth quarter. Revenues grew 19% to a record $776 million (sic - see press release -- $766 million,) and were up 7% on a same store basis. HVAC equipment sales were up 5%, other HVAC products were up 6%, and commercial refrigeration products grew at 31%. Gross profit increased 14% to a record $183 million, and gross margin was 23.9%. Operating income improved 3% to a record $33 million, and an operating margin of 4.4%. Earnings per share increased 5% to $0.41 per share on an adjusted basis.

Now on to cash flow and our balance sheet. Operating cash flow for the year was a blockbuster $173 million, far exceeding our goal of cash flow equal or exceeding net income. In 2013 we recalibrated our annual dividend rate to $1 per share, after payment of the $5 special dividend. We plan on reducing debt, and will evaluate raising the dividend rate again before the end of 2013. We are going to wait -- in terms of an outlook for the year, we're going to wait so we can get some more visibility into the selling season. Then we will provide some guidance. With that said, Barry, Paul and I will be happy to answer your questions.

(Operator Instructions)

The first question comes from the line of a person whose line has not been transcribed. Please state your name and affiliation.

This is Sanjay from Lazard. Couple of questions here guys. First can you talk a bit more about -- I know you guys are evaluating at this point in time, but how should we really be thinking about the dividend payout for you guys this year? Anything more you could share us on that front would be very helpful?

Our history shows that we certainly like sharing cash flow with shareholders, and given the fact that we paid a regular dividend last year but also had a special dividend of $5 per share, we have not changed our posture in the future that we would like to share increasing amounts of cash flow with shareholders. So we are very much of the same mind, we just want to see how the year turns out and see -- and payoff some of the debt that we incurred to pay the special dividend. But I think you can take from my comments that we are of the same mind we have always been, of increasing dividends per share as time goes on.

Fair enough. So two quick follow-ups then, if I may. One of the comments you made in your prepared remarks about the high-end products doing well, and two, parts business doing well, can you go into that in a little bit more detail as to what is driving some of that? Then I have one more follow-up after that.

Go ahead Mr. Johnston, Paul.

Oh, okay. Yes, the parts and supply business began performing in the fourth quarter, and we talked at one of the other conference calls that it has been flat to down. We finally saw it rebound in the fourth quarter from that, primarily due to the life that we are seeing in the residential new construction market. We are still seeing a split between high and low equipment sales that we have been experiencing for most of this year, and that trend did continue in the fourth quarter, where we had the high-efficiency product being sold to the -- and we had the low end of our 13 SEER products that continued to show life. The expectation that we would have is that we are going to see the middle ground to start growing as the residential new construction picks up, because that generally will tend to be not a 13 SEER product, it will generally tend on the single-family side to be a 14 SEER, because that is the minimum requirement to get the Energy Star certificate.

Your next question comes from the line of another person whose line has not been transcribed. Please state your name and affiliation.

This is Ryan Merkel, William Blair. So wanted to start back about the mix again, could you give some numbers, what percent of equipment mix is at the 13 level versus 14, versus 16-plus? And maybe could you give it for the year? I'm not that concerned about the quarter.

Do we provide that kind of the detail, Barry or Paul?

No, we really haven't, Ryan. If you take the growth rate, and again average it down for the 13 SEER an average it up some for 16, that gives you a sense of where the middle is.

Okay.

But I'd rather not give out of the specific mix of 13, 14, 16 and so on.

Let me ask it a different way, what inning do think we are in for this mix down to the lower SEERs? And then maybe even within SEERs, are you seeing a preference for value lines, which also hurt some? So just wondering if -- I think we've seen this the last two years. Are we at a bottom here, and potentially with maybe the economy getting better and housing getting better, we could see a mix back up, which would be a tremendous benefit?

I agree with the outlook that you just said, once that occurs. I don't know that we are ready to call that timing yet.

Okay.

But I think when it -- what that occurs, it will be very positive.

But you would agree that over the past two years it's gone against you?

Yes, the mix and the --

Right, in reality it's the sensitivity of the season, our season will really begin in earnest in the spring and summer, and that is really -- that question can be answered.

Okay.

It is not something that is a trend in the shorter months here, where it is off-season.

Okay. And then in terms of the commentary about the residential getting better and even in new construction, could you just give some numbers with regards to the fourth quarter? The new housing, how much was it up? And then could you just be a little bit more specific, what signs specifically are you seeing that tell you that the new housing market is getting better for your products?

Who wants this, Barry or Paul? Paul, go ahead.

I can started it out, and Barry, chime on in. I always look for the leading indicator to be any sort of ductwork that goes in, generally that happens after the frame up and roof occurs. We definitely are seeing a nice increase, a double-digit increase in duct products that we are selling. We are starting to experience that -- obviously, it's starting in the Southeast and it's moving west with the weather. So that is the leading indicator that says something good is going to happen on the equipment side. On the equipment side, yes, we did see some equipment flow-through. On a percentage basis it really does not mean much, because the numbers are starting from such a small base that as the equipment occurs, I think it is going to happen first quarter, second quarter, we will have a better idea as far as how big the new construction market is going to be for us on the equipment side. But we are definitely seeing the beginning of it with the duct work.

(Operator Instructions)

Your next question comes from the line of another person whose line has not been transcribed. Please state your name and your affiliation.

They do not even know they are on.

No, they don't.

Adrian, you got to do a better job. Let's go to the next one.

The next person's line is now open.

Hello? Go ahead. Would you please identify yourself?

Hi, good morning, it's Josh Pokrzywinski at MKM. Just wanted to dig in here a little bit on the mix, it seems like with the fourth quarter obviously you guys are seeing some of the resi side pick up, and I think back to an earlier question, it's not just about SEER it is about the feature on the units beyond that. It seems like you had a couple mix tailwinds there in the fourth quarter, namely commercial refrigeration, which I think you guys do pretty well on, and then thinking about new construction, maybe picking up here a little bit, but obviously a replacement becomes more important in -- through the spring and summer. It seems like all of the OEMs are talking about that to being a continued pressure on the mix side, whether it's low SEER or low feature. Should we expect more gross margin pressure in the coming quarters, just as maybe commercial refrigeration is, again, tough comps, and more of that replacement element comes into play?

Paul?

I wish I had a great answer for you, Josh, on that one, but I think what we are seeing right now with the commercial refrigeration, a lot of that' growth came on the equipment side of commercial refrigeration, not from our standard parts-and-piece-type business that we do in that area. So that I hope continues, because that just means we are gaining more and more market share in the equipment that we are selling out there, which means more opportunity for after-market for us later. When you get into the actual SEER, is it over with the 13 SEER being compressed down to what we call a cube, or a stripped-down 13 SEER as opposed to a featured 13 SEER? I don't have a sense for it, I have only an opinion, and my opinion is that I think it's going to be some tough sledding for a couple of quarters. When it comes on the replacement side, the consumer still probably is going to be hurting.

So just thinking about --?

The good news is, though, is -- the good news is, like I said earlier, the 14 SEER is something that you are going to see in a lot of the residential new construction. It does not mean that it is going to come in at a better margin, because it is new construction.

Right, totally understood. But I guess it -- but it does have the advantage of pulling in some of those ancillary parts and supplies, too?

Absolutely.

Yes, it does.

Just thinking about that seasonally, though, I would imagine that in the -- in 2Q, 3Q, the replacement element becomes more important or -- like how should we think about that versus the cadence of new construction for your business?

There is no question that we are an after-market business primarily, and that will always be the most important thing. I think of new constructions as a bit of a lift, but fundamentally we are in the after-market, and that is the largest part of the industry and we are the leading player there.

Okay. And then just one last question on the dividend, should we think of that as kind of a binary outcome that you guys kind of keep it down until you are prepared to take it back up closer to that, call it $0.62 level you were running before, or is there a possibility you kind of meet people halfway as you --?

You mean, as we do this?

Yes, a bit more (multiple speakers) --

First, we are pretty confident of our cash flow because we have been at this for many years. At what rate will we increase it, I don't think we should make a prediction. But in terms of what it might end up long-term, we expect to go beyond what we have done in the past, because this Company is growing, it's going to be a much bigger company, and the cash flow, we suspect they're going to substantially grow, and there is no limit to where we are going to do the sharing of the cash with the -- with dividend. So I don't think there is any benchmark that has been set that we will not exceed a certain amount, I think we will just keep going. We see no big clouds ahead of us in terms of fundamentally growing the business, and so I can say that there is just no limit to what we are thinking in terms of cash dividend.

Okay. But in terms of the pace of increasing in the future --

That sort of depends on a lot -- we have not mentioned this yet, but on our investment. We are always acquisition-minded, and we will be looking at cash needs for that as well.

Jeff Hammond, KeyBanc Capital Markets.

Hi, this is Chris O'Cull filling in for Jeff Hammond with KeyBanc. Thanks for taking my question. I know it seems like it has been a fading issue, but can you talk a little bit about R22 as a percentage of sales, and maybe how you see that trending into 2013?

You know, I'll let Paul handle this, go ahead Paul. (Laughter)

I am hoping -- only if you promise this is the last time that we talk about dry charge. (Laughter) I think it has about run its course. It is a very, very small percent of our sales, which it was at the end of the third quarter, and it continues to trail off in the fourth quarter. We expect even further pressure on that side of the market to wrap up, as the EPA has actually reduced the amount of allocation that they're going to provide to the industry for R22 in 2013. The expectation right now is that the amount of R22 that is going to be available in the market is probably going to be down from close to 60 million pounds last year down to 40 million. So I think that's going to hopefully be the final nail in the coffin of that product line.

Okay, thanks. And then in the past I know -- I think we talked about some profitability issues with Carrier Canada. Did that improve in 4Q '12 or, you know, any progress made there?

We are not going to comment on individual units. Profitability of individual units.

You next question comes from the line of Ryan [Merley]. Your line is now open.

That may be Ryan Merkel, am I on again?

(Laughter) (Multiple speakers)

I did get back in line, so hopefully I'm not jumping ahead of some of the other folks, but I just want to get a bit more color, if you would, by geography, because some of my channel checks in the Southeast also reported pretty lackluster organic sales trends, yet you guys put a pretty nice 7% same store sales number. So can you just talk a little bit about where the strength was?

We had a pretty good Southeast --

Ryan, 80% of our volume is in the Southeast, so that means we probably took market share from the channel check.

Okay. And what about Texas?

I would include that in our Southeast. Really, 80% of our business is Texas to DC, down to Miami, so that would fit that profile.

Right, I was just wondering the growth rate in Texas, I think it was --?

Right, but you're missing the ball on the international business, that's a very strong business for us.

Okay, so the international export business, those were the big drivers? Okay.

Yes, well, we said that at the beginning of this call, it's almost $0.5 billion and it is growing very rapidly, and we are very good at it. When I say international, we are talking about this hemisphere.

Right.

Canada, Mexico, and then where we have locations in Puerto Rico, we have locations -- but we are also exporting throughout the rest of Latin America, and that is a fast-growing business.

Okay, and just last question for me, the refrigeration business is very, very strong. Could you just talk about what is really driving that business, and is R22 in there, and are those sales pretty strong given the price increase?

It's predominantly equipment. We have added more product into that segment, which is -- has really -- and put it into more locations, more territories throughout the country, and we're seeing the benefits of what we -- what we seeded last year is actually coming out right now, and that is we are growing share in ice machines, we're growing share in compressors, et cetera, so it has been a good story for us.

Your next question comes from the line of Stephen Ragard. Your line is now open.

Stephen in for Matt. Just a few questions here. Do you have how much Carrier Canada contributed to sales this quarter?

No, we're not going to break out those sort of things.

What I would say is you can see in the press release --

It is part of the $0.5 billion that we have broken up, but I do not want to get into breaking $0.5 billion into pieces.

Okay. Then I guess just a couple housekeeping items, can you give us D&A and CapEx for the quarter, do you have that with you?

Sure, D&A is about $7 million and CapEx is $3 million for the quarter.

Great, thank you.

Your next question comes from the line of Paul Betz. Your line is now open.

Your organic SG&A went up 4% in the quarter. Was there anything special or different this quarter? Hello, can you hear me?

Yes, there is nothing individually that affected the number. As we mentioned earlier, we are growing some product lines, there is some headcount attached to that. Our international business as we mentioned, too, has had some remarkable growth, and we are making some investments there, but nothing that stands out in terms of any individual events or circumstances.

Okay, a then just for clarification, did you say D&A was $7 million in the quarter?

Yes.

Okay. Is there a reason for that increase, because that has been running about $3 million?

That is depreciation. If I add amortization to it, and amortization of stock, restricted stock, it comes up to $7 million. I cannot tell what you are comparing it, to but that is the number for the quarter.

Your next question comes from the line of Keith Hughes. Your line is now open.

Just back to the gross margin, we've seen declines for most of the year and in the quarter. Is that solely due to the mix that talked about at the beginning of the call or are there other contributing factors?

Barry?

Keith, the mix is the largest reason by far, and also obviously the strength in commercial has a lower margin as well. That would affect the mix to some extent. The stronger growth rate in equipment versus non-equipment would also account for some of the difference.

Shouldn't that start correcting itself (technical difficulty) more non-equipment. Wouldn't that be self-correcting to a certain extent in '13?

Yes, the growth in the non-equipment, in terms of showing up for an entire year in 2013, if that is the case, should help margin, yes. We really highlighted for the fourth quarter from a revenue point of view, for to have an impact on margin, that really needs to sustain itself through 2013 and on.

I guess finally within the mix within commercial, you were saying I believe in the prepared comments that there was strong new equipment orders associated with that. Is that lower gross margin as well compared to the rest of commercial? Refrigeration, I'm sorry.

It is lower than the rest of the commercial refrigeration margins, yes. Equipment is a lower margin in commercial refrigeration than the rest of it, of the products.

How is it as a unit now compared to what you are seeing in your residential business? Is it still lower?

Repeat that?

So if we look at commercial refrigeration over a cycle, are we going to perpetually see it below what we've seen in the residential market or is there some circumstances that are pushing it lower now?

I do not know, I have never looked at it that way. I just don't have an answer. I will check that out for you.

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

I am with Baird. The question is on the -- also on the cost side, and when we strip things out and sort of look at the core organic contribution margin, I'm coming up with something sort of in the upper single digits. It seemed like the fourth quarter contribution margins were actually negative. I'm just trying to figure out, as we are looking to 2013, you discussed the SG&A being a little bit hot in the fourth quarter here. As we are looking forward, do get contribution margins that are in the low double digits if you get an acceleration in same store sales, or are we going to be kind of hovering here where we are?

No, David, we don't expect to hover. I think if we look at a three or four-year period and not a single quarter in the fourth quarter, we don't see any difference in the outlook, looking ahead, than the longer-term average. I wouldn't draw too many inferences in an off-season fourth quarter, with some of the SG&A investments we have decided to make. Those are investments for next year, it is producing some sales growth, and expect to produce more sales growth, and leverage those expenses. So if you look at a two or three-year average going back to 2009, '10, '11, and you can see the contribution margin in those ranges, I think, going forward.

Got it, okay. So the investments you are talking about, these are sort of one-time deals, this is not ongoing run rate stuff, and because it shows up in the fourth order it just shows negative leverage?

I would not say hiring great salespeople and recruiting strong leaders a one-time event, that is something we have gotten more aggressive with, I think, as the year closed out, as we got into 2012 and see some of the outlook or 2013. Those aren't one-time events, those are important investments, and we expect to see the benefit of them.

Okay. And then a question I've been struggling with for some time here, in terms of this shift from repair back to replacement of systems, and along with that I guess the resurgence in construction and so forth, is there a point out there that you think that we'll actually see double-digit gains in overall same-store sales? It would just seem that if you're selling a replacement unit, and the system and everything around it as it relates to new construction, those ticket items would be much, much higher than just a repair product. I am wondering do you see a time out there, if that trend really takes hold, that we should be looking at double-digit kind of organic growth?

I hope so. I would think that -- logic tells you that would occur.

Okay, so we haven't seen --?

We are going to have to start seeing better replacement, because you are replacing the coil, you're replacing in some cases the air handle when you replace the 410 unit. So yes, we are starting some -- the indoor unit sales are starting to pick up. And obviously we've always talked about our ticket item -- if we get a complete house, the full ticket for a house is obviously better than a replacement unit is even, so the combination of those two could yield us with a double-digit growth rate.

Okay. Right, that's it. I think that's all I had right now. Thanks a lot, guys

Your next question comes from the line of Keith Hughes. Your line is now open.

Just another question, specifically on residential. Man, I know you had a very strong first quarter last year that was weather-influenced. Can you give us any sort of feel how you have been running up against the top tier for the first quarter?

March is the key to the first quarter. It is bigger than January and February combined, so it is hard to give you a very accurate picture, except I can tell you that I like January and February. (Laughter)

Okay. [However], last year were January and February the real -- I know they are smaller months, but were they really the big driver on that strong number, they were just so abnormally good?

Good for you, you have that kind of a memory. All I know is I like January and February this year, but I am not going to go crazy about it until I see March.

(Operator Instructions) Your next question comes from the line of a person who did not leave their information. Your line is now open.

Hello? Person who did not leave the information, who are you? I guess we don't have one.

There are no further questions at this time.

Thanks very much guys, talk to you next quarter. Bye.

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