Watsco Inc (WSO.B) 2013 Q4 法說會逐字稿

Good day and welcome to the Watsco fourth-quarter 2013 earnings conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Mr. Albert Nahmad. Mr. Nahmad, the floor is yours, sir.

Thank you. Good morning, everyone, and welcome to our fourth-quarter conference call. This is Al Nahmad, I am the President and CEO. With me is Barry Logan and Paul Johnston. Both of those gentlemen are Senior Executives at the Corporate level.

First our normal cautionary statement. This conference call has forward-looking statements as defend 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.

On to our report. Watsco's great fourth quarter completed a strong and record setting 2013. In a little humor here, this morning I got an email from someone that says Watsco rocks. I got a big smile on my face and I think because that's the same sense that we feel here.

2013 sales, operating income, and net income, earnings per share reached all time highs. Let me say that again, sales, operating income, net income, and earnings per share reached all time highs in the year 2013. US sales increased 11% during the quarter, including 17% residential equipment growth and 8% growth for other HVAC products.

We experienced strong replacement demand with continued movement toward higher efficiency systems. Sales to the new housing market also improved. Revenue growth matched with higher selling margins and careful SG&A management produced margin expansion and a 22% earnings-per-share growth.

Now for the details. First, for the year, revenues grew 9% to a record $3.7 billion. Same-store growth was 7%. In the USA, sales of HVAC equipment increased 11%. Other HVAC product sales increased 5% and commercial refrigeration products increased 3%.

Commercial HVAC equipment, which is 11% of total sales, was flat but showed growth over the last half of the year. International sales were down 5% but produced a 12% profit growth for the year. Our Company's gross profit increased 10% and gross margin improved 30 basis points during the year.

SG&A increased just 3%, excluding new locations. Operating profit improved 21% to a record $271 million. And operating margins expanded 70 basis points to 7.2%. Now on the same-store basis, operating profit increased 19% and operating margins improved 70 basis points to 7.3% Earnings per share increased 21% to a record $3.68 per share.

Now, let's talk about the quarter. Revenues grew 8% to a record $827 million. We see US trends strengthen as residential equipment sales increased with strong unit growth, improved pricing, and a better sales mix of higher efficiency systems.

Sales of other HVAC products increased 8%. International sales declined 5% but profits grew 17% as the top line pressure was anticipated and well managed. Gross profit increased 9% and gross margin improved 10 basis points and SG&A was up 6%.

Our Company's operating of profit grew 20% to a record $40 million during the fourth quarter with operating expenses expanding 50 basis points. I'm sorry, with operating margins expanding 50 basis points. And finally, fourth-quarter earnings per share increased 22% to $0.50 per share.

For the full year, operating cash flow was $150 million in 2013 or $4.66 per share. Let me repeat that, cash flow was $4.66 per share. And debt was reduced 27% to finish the year at $230 million. Our debt-to-EBITDA ratio is under 1 and our debt-to-total cap ratio was 17%.

Now regarding cash flow, our goal is to pay increasing dividends each year depending on our debt position and other prospective capital needs. I think we have always indicated that. We still feel that way. We will evaluate raising the dividends before year end as we expect another strong year of cash flow.

Also a reminder that in 2014 we planned to purchase an additional 10% interest in our first joint venture with Carrier. And speaking about Carrier, this is the 5th-year anniversary in the joint venture. Carrier has been a terrific partner and the joint venture strategy has been a win-win for both companies.

Now before we get into the Q&A, I'm going to make a few comments. First, as we have said many times, we operate our Company with one important concept in mind and that is the long term. Looking back, I think the record speaks for itself.

Here is some information to verify that. Our total shareholder return, which is defined as stock price and dividends, over the last five years grew 30% on a compounded growth basis. And over the last 10 years, the growth rate was 20%. And over the last 25 years, it was 19%. Or over those 25 years, a total return of 7390%.

We are enjoying building our Company and believe that our focus, capital, and spirit of innovation and entrepreneurship will produce terrific results in the future. With that said, Barry, Paul and I will be happy to answer your questions. Mike, it's all yours.

Thank you, sir. We will now begin the question-and-answer session.

(Operator Instructions)

The first question we have comes from Keith Hughes of SunTrust.

Good morning, Keith.

How are you all? A couple of questions.

One, within the HVAC equipment sales, you had commented that residential systems were up 17%. The segment itself was up around 10%. What were some of the offsets of that? I believe international was going down 5%, but were there any other businesses within there that were weaker?

Any other business units you mean?

Well, I mean if residential businesses were up 17% and the HVAC --

The non-HVAC, yes, the non-equipment business did not perform as well as the equipment business nor did the refrigeration business.

I mean within the HVAC equipment. You had mentioned that residential HVAC equipment was up 17%. Is that correct, in the quarter?

Yes.

Okay.

Domestically, it was up 17%.

What, Barry?

Domestically, up 17%.

Yes. And so, was the international was what pulled down that average, Barry?

Yes, yes. That's the biggest chunk.

Okay.

The biggest chunk, okay. (multiple speakers) And second question is on the -- you had mentioned commercial, Al, in your discussion about it improving in the second half of the year. Could you talk a little bit more about that, and what you see for 2014 in that sector?

Sure, sure we can. Go ahead, Paul.

Yes, we had some -- we had weakness in our commercial equipment sales in the first half of the year. We'd indicated in the third-quarter call that it was improving. We continued to see improvement in the fourth quarter.

Basically the year was not stellar, but it was -- at least wasn't negative. And we hope to continue to see those trends in commercial equipment sales continue into 2014.

Okay. And final question on gross margin, it was up 10 or so basis points the last couple of quarters. Anything coming here in 2014 on gross margin that would accelerate that faster, cause it to slow down, things of that nature?

Well, that's a good crystal ball. Do you have a crystal ball like that, Barry?

(laughter) Sure. Obviously the equipment growth rate has been terrific. And equipment does have a lower margin than the other stuff, which is okay.

Right.

That's the reality of it. We will take the growth because the earnings contribution is significant.

The non-equipment, which has the higher margin, we did see an improvement in the fourth quarter. I think there is some stabilization of pricing, especially in many of those product lines.

So we will take those two things together and believe it can be a better year for that product group next year, which will blend into a higher margin. So that's an opportunity. We have not seen the full benefit of it yet, but we saw some progress in the fourth quarter.

Okay. That's it for me. Thank you.

Thanks, Keith.

Next we have Matt Duncan, Stephens Inc.

Am I on?

Here.

First question I've got is just with going back to that 17% equipment growth that you saw in the US. Can you break that down for us a little bit between what is going on with pricing versus how much maybe mix and unit growth contributed to that?

It's driven to it --

Barry or Paul? Barry?

Yes, Matt, it's driven by the -- Hello? Yes, Matt, it's driven by the unit growth primarily. There is a few points where price and mix, but it's largely driven by pure unit growth.

Okay. And, Barry, do you have any thoughts around how, if I try to break that down between equipment sales for replacement versus new construction, is one growing much faster than the other? I would assume that it's probably more replacement driven given that we're seeing slower growth than the other HVAC products, which typically are attached to a new build.

So is it really the replacement market that's driving that? A recovery in that replacement market with all the pent up demand we have been talking about for a while now?

Yes. In the fourth quarter, I will just talk to the fourth quarter. The fourth quarter we saw a material improvement in our replacement demand far outstrip the increases that we saw in new construction.

Interesting. And Paul, do you have any thoughts on what is driving that? Why do you think you are starting to see that now?

I just think you can only repair a piece of equipment so long and so much, and I think at some point people have to do the replacement. (multiple speakers)

And I think consumer confidence helps with that, too, improving consumer confidence.

Okay. Last thing for me, I know it's a little bit early in the year at this point to probably give guidance, but do you have any high-level thoughts on what kind of revenue and earnings growth you might expect from the business this year or is it just too early to give guidance?

It is too early. But I can tell you that I feel really good. We feel really good about 2014. I think overall reaching the scale, the size that we are now, we can do bigger things than our competitors.

And more importantly, the OEMs, the manufactures know that in their partnerships with us, we can move the needle for them because of our extensive distribution network. The more we scale, the more we can produce for our OEM partners. And that's going to help us again in 2014 and going forward.

Okay. So, Al, should we expect to see you give guidance then, probably on the first-quarter call?

A little early. I think that I like February. And if that continues, I think we will be in pretty good shape.

Okay. Thank you.

Next we have Mark Douglass, Longbow Research.

Hello, good morning, gentlemen.

Good morning, Mark.

Are there any updates on the regional standards in the US, both on the furnace side, which is the legal entanglements, and then the AC heat pump, which is still slated for January 15?

Sure. Let me go to Paul on that one.

Yes. The one we really stayed behind and get involved with obviously is the split system regional. That has the biggest bearing on us. And we see it obviously being implemented January 1, 2015 as scheduled.

The question, Mark, I think around it is how long of a stay is the government going to provide or the EPA going to provide us with being able to move out the 13-SEER equipment from the South, be able to sell it through? And that I don't think anything has been put out on yet. Still, I think it is starting to become clear, but it's still in limbo as far as how long we're going to be able to sell 13-SEER product in the South.

Okay, but it should be a tailwind for the industry in 2015?

Absolutely. And obviously with Watsco, we had the added advantage that we can move equipment among our geographic centers. So if we have 13-SEER stranded in the South, we can move it to the North and sell it.

Yes. Okay. And then, looks like you are still clearly gaining share in US resi. You are still looking for runway to outgrow the markets?

With people thinking it looks like low- to mid-single digit growth for resi in the US, whether you agree or disagree. Can you outgrow 1.5 times? Is that even feasible, or --?

[Too hard] grow 1.5 times? I will make a general statement then, Paul, you can deal with it, if you want, in more details. When we represent a brand of equipment, our highest goal for that partner is to increase share market for that partner. And we have a very, very good track record with that.

And I don't think that is going to stop. I think that our entire culture is based on growing share for our equipment partners. Now, more specifically in more detail, Paul, do you want to deal with his question?

Yes. Frankly, Mark, share market is the performance that we have to gauge ourselves on. Just growing with the market is not going to be good enough for Watsco to be able to meet its targets and its long-term goals.

We track market share continually and there is a lot of parts in the US that we don't have locations yet, all through the Upper Midwest, the Northwest. We have a lot more opportunities I think in market share. We are years away from reaching our goal as far as what our market penetration is.

What are you looking at as far as new store build outs in 2014, if you are willing to -- ?

That is something that the operating units actually have in their plans, and it's something that they'll execute and they'll execute it based upon what the market conditions that they see would make it advantageous for us to put a new store in.

Our management system is decentralized. And as Paul says, they will make decisions on what they see in the local markets. We encourage them not only to organically put up new stores, but also to look for acquisitions that complement their efforts in these geographical markets.

It's a decentralized process. We like it that way. Decision making should be at that level.

And I think they are. The tone that I get from our subsidiaries and our managers is that they are going to expand the branch network.

Okay. Thank you.

The next question I have comes from David Manthey of Robert W. Baird.

Hello, David.

Hello, good morning, Al. Unit demand is clearly strong and the increases you are seeing in efficiency definitely helps that price mix equation as well.

Yes.

If you talk about looking into 2014 and the equipment manufacturers primarily. Are you expecting low-single digit type price increases from them?

Paul?

Yes, we are expecting low-single digit price increases. Most of those were announced in the fourth quarter, early in the fourth quarter already. So, I think we have seen our price increases for the year.

It's just a matter now of how much of that price increase sticks, and regionally where we're able to extract more price from the market. But I think we have seen the price increases.

Right. Is that similar to what you saw last year?

It's almost spot on what we saw the year before.

Right. Okay. And then second, could you talk a little bit about these -- the commercial equipment and your relationship with manufacturers there? Is it similar to residential in terms of manufacturer authorization that you can only sell those products where they authorize you to do so, or is it more of an open relationship or how does that work?

Go ahead, Paul.

It's exactly the same as our residential relationship. Basically, what we have is we have different franchises for different sizes of commercial equipment in different parts of the country. Where some parts of the country we'll be able to go to 65 tons on a rooftop unit. Some parts of the country we actually have an applied charter. But we only have those charters for commercial equipment in the territories that are granted by the agreement.

Okay. Thanks, Paul.

And then last question as an add on to that. Not quite sure how to ask this, but if you think about Watsco's average share within residential, and thinking about how well penetrated you are in the brand that you have in the regions that you are authorized to sell those products, is the commercial side, is it far below that? Meaning with the obligation further we have, there's a tremendous amount of opportunity, and I'm -- ?

Yes, that is an excellent question. And we recognize that opportunity. And I agree with your conclusion. And, Paul, do you want to add some color to that?

Yes, we have great opportunity in the commercial side. It's something that, as you know, if you went back, you've been covering us for a long time, commercial is something in the last five or six years that we have really focused on. Been able to bring in lines that allow us to be competitive in those markets and we are growing our share there.

And I think you like to use the term runway. Yes, I think we got lots of runway on commercial.

All right. Sounds good. Thanks a lot.

There's a little tailwind, yes.

Thank you.

Runway, tailwind.

Tail wind, headwind. Where did these come from? (laughter)

I'm waiting to use cross winds one day just to see what that means.

What would that do?

Mike?

Yes, sir, we have Walter Liptak of Global Hunter Securities.

Okay, Mike. Thanks.

Hello, thanks. I wanted to ask a follow up on the question about 2014 growth. I was a little surprised by your answer because you said that it was your scale that you were feeling really good about. I thought maybe it would be the consumer getting stronger or pent up demand or weather or something like that. And I wondered it -- ?

First, we don't like to use weather. That is not part of our vocabulary. And I know that weather sometimes it impacts certain regions of the country.

But what I mean is, and at previous analyst meeting where we indicated what we think we can grow this to, the summary of that is a $10 billion business running at a $1 billion EBIT.

And when pressed for how do we get there, we didn't want to develop to, explain strategies because we didn't want our competition to listen to it. Then we did say that generally speaking, the ductless market in the United States is under developed and will be developing at a pretty good clip. And because of our scale, therefore, that attracts the OEs, and the ductless manufacturers are primarily, well actually, they're all in Asia to a very high degree.

And when they look at this, see for partners in the United States, with our scale and our size, we are very attractive. And that's one of the ways that we will be, I believe, a very important if not the most important ductless distributor in the Americas.

Okay, good. So I guess you're alluding that you will be adding brands or OEs in ductless?

Absolutely. Yes, Sir.

We will see some of that in 2014?

Well, I hope so.

Okay. All right, good deal. Thank you.

The next question is from David Mandell with William Blair.

Hello, David.

Good morning. Does this quarter's international sales result reflect some of the same issues that you guys saw last quarter? And if so, when will those delays and tough comparisons be worked through?

Well, that is a -- we can give you a little detail on that. The Venezuelan market, I don't think is changing much from where it has been last year. So what we are trying to do is depend less and less on Venezuela.

And then the Mexican situation has improved. The elections are over and we are seeing, and I think we'll continue to see, improvement in Mexico. But don't forget, our international business also includes Canada, and that is very solid, and the export business which is also very solid.

All right. That's helpful. And then on the refrigerant side of the business, any color you could add there? Any expectations for trends heading into 2014?

Paul?

Yes, it will be stable this year. I don't remember if you remember last year. We had a huge price run up by the manufacturers where they picked the price way up and then the price virtually fell off the cliff around April or May when the EPA finally came up with the allocations for the year. That was disturbing last year. We are not having that this year. Barry talked a little bit about --

But I think the question is broader in terms of refrigeration products, not just the refrigerant.

Refrigerant, okay.

You want to answer that, Paul?

Do you want refrigerant or refrigeration?

No, your answer was helpful on the -- regarding the refrigerants.

Okay

But thank you.

The next question is from Jeff Hammond from KeyBanc Capital Markets.

Good morning, Jeff.

Good morning, guys. Just on the non-equipment versus equipment, I'm just still trying to get at why non-equipment is lagged so much? And as you look into 2014, if you think that gap continues?

Well, I think someone earlier, and might have been you, Jeff, that's indicated that new construction, as we increase our participation in new construction market, you will see that recover, the non-equipment. But what we are experiencing now is increasing demands for replacement.

Okay, but it seems like if you listen to the OEMs, it seems like, if anything, they have been enjoying better growth in new housing and now we are starting to see a little bit better growth in replacement, so --

I believe that because our mix is primarily replacement. And we do enjoy new construction when it comes in, but we are basically a replacement house.

Okay. And then, okay, just in my model -- go ahead, Paul.

Yes, if I could add one more thing to that, Jeff. When you look at the non-equipment business, it's not just about the supply business. It's also about the parts business. And on the parts side, I look at this as a positive.

It's almost a counter balance. When equipment sales go up like this, we're going to start seeing things like replacement compressors and motors go down.

Yes, less and less repair.

So there is a counterbalance. It's a create minimum, we have strong equipment sales right now.

Right, right, okay. And then --

I guess I'd rather have it this way, you know?

We prefer to be in the non-cyclical replacement business, to be our basic position in the markets. But to be in a position to enjoy the new construction, but not every be dependent on new construction one way or the another.

Okay, great. And then, just in my model, the JV. I guess the minority interest is distribution was a lot higher, which would reflect the Carrier JVs doing a lot better. Did you see, if you look across the legacy business versus the Carrier JVs, is there much variation in the performance?

Both the Carrier JV and the legacy businesses are doing very well. I would not say that one is doing better than the other.

Okay, great. You mentioned ductless and I know there has been a lot of discussion about VRF. Can you just expand on what you have announced or what you are doing there or what you have built in terms of relationships and networks that's going to start driving the tremendous growth in that market?

Paul, do you want to deal with that? Starting with the Carrier Toshiba relationship.

Yes, we have got a huge initiative going on with Carrier right now. As you know, Carrier has had a long-term joint venture with Toshiba. And we are getting that equipment into the market.

The product line is being totally filled out. We are putting people in place in everyone of the locations and we're starting to see some traction there.

Everyone of our carrier locations.

Right.

Yes. And we will have relationships that will be -- too early to tell you what they are, but we will have relationships in the non-Carrier locations to fill the gap there in terms of VRF and ductless products. We are ready, I believe, Paul, are we not the largest distributor of the, not the VRF, necessarily, but the ductless in this place?

Of the ductless, I would have to say we would be the largest independent distributor of ductless by far.

Yes. Although, it's not a material number yet, but it will be. We believe very much that the ductless, both the commercial and residential in the United States markets, it's going to make an increase here of the overall use of cooling and heating equipment.

As far as the non-Carrier, are you just following, I mean, it seems like a lot of the OEMs are announcing strategic alliances.

Yes, that's correct, sure.

So the Tripoli and the Goodman location, you're adopting some of the Daikin product and Rheem, similarly?

Yes. We might have spotted this primarily than others, but everybody is on to it now. Like you said, all the OEMs have -- all but one, all the OEMs have aligned themselves with aging manufacturers.

Okay. If I could sneak one more in, maybe just touch on M&A pipeline. And if you don't get anything done, at what point do you have a sense of urgency to move the needle on the dividend again?

Oh, we'll move the dividend. We are not waiting for M&A. I mean, unless something comes along but I expect this year we will move the dividend. I have a very high, shall we say feeling, that we will move the dividend in 2014 regardless of what happens.

Okay.

I mean, unless something terrible happens to the economy. That's our feeling.

And just M&A pipeline --

I'll put it this way, we like increasing our dividends and I'm pretty sure we're going to able to do it.

And maybe just touch on M&A pipeline?

Well, we are constant at it. But there is nothing that I can tell you that, more than that. We are at it. We like it.

Our reputation among people that own businesses is very high. I think we are the go to buyer if people decide they want to do something. And that's all I can say. It's just I like the position we are in.

Okay. Thanks, guys.

I cannot add any specifics to that.

(Operator Instructions)

The next question is from Samuel Eisner with Goldman Sachs.

Good morning, Sam.

Thanks, everyone How are you guys?

Have you been to the Uric restaurant that you like so much that we went together to?

(laugher) I have not been back.

Just a couple of follow-up questions here. I know you don't like to talk about weather as it relates to your business, but curious, you have seen a couple of the OEMs talking about weather benefiting the business this quarter. Can you maybe just parse out if you saw any volume pull forward from the first quarter, or any impact from weather on your business this quarter?

We have got a national footprint but, Paul, if you can give him something.

Yes. Weather is something that can move the business around as I think the OEMs have indicated, but for us it really isn't a big -- winter weather, summer weather, it doesn't really impact our business that much, frankly.

Okay.

We didn't see what the OEMs saw.

Did not see what the OEMs saw. Okay.

In terms of you were giving some good color on the ductless and the VRF business, you said it's not that material at the moment. Do you have any numbers that you can throw behind it just so we can understand how big that business is today?

The industry?

Well, just your revenue coming from the -- (multiple speakers)

No, we don't disclose, we will not disclose our number, but we can give you a feel for the industry.

Sure.

Paul? Rev dollars.

The industry is --

Or your earnings.

-- we estimate is over $1 billion now. And it continues to grow. We see it as the fastest moving segment in our industry. Everybody knows that. Everybody has decided to focus on it. It's just at Watsco, we started focusing on our duct-free markets about five years ago. (technical difficulties)

I don't want you to be mislead, but even though we think we are the largest, it's not a material part of the overall revenue mix today.

No, it's not. Not yet.

Understood. And then, if I go back to some of the comments you guys made at the analyst day, in particular, regarding technology investments, can you give us a little bit more indication of what specifically you are doing? If you are willing to give that information -- ?

I think the best way to do that is to, without being too cute about this, Sam, is on the apps, where you can pull down apps. Pull down apps on the Watsco businesses and you will see the emerging applications that are coming out for the contractors. That's a good way to notice exactly what we are doing with that.

And then we've got business intelligence that is a massive investment that will be much better tool than we have ever had, and that the information that we're going to be using is pretty close to realtime. And that is not yet and will not be ready for full implementation, probably for another two or three years.

However, as the parts of it are developed, we start using it. And then there is the E-commerce that we are very focused on and I think we will be introducing parts of that this year. So those are major initiatives, the apps, the BI, the E-commerce.

Then there is always the consumer web site, AC Doctor, which is primarily a service that we provide consumers and when they want to learn about the products and when they are looking for contractors, it's a good reference site for them. It's not an income producing for us, it's a service really to the contractors and to the consumer.

And those are the four groups that where we are investing in large sums. And it's a multi-year thing. It's not something that we're going to say, gee, this year we produced X dollars of growth because of it. It just going to crawl on for several years.

Then we will be, we will be a digital player in this age that has come into the United States economy and I love it.

That's great. Really appreciate the color on that. Thanks, guys.

Sure.

Next we have a follow-up from Mark Douglass of Longbow Research.

Good morning, Mark.

Just a real quickly, Barry, was there any -- in the different segments, any new store additions to the growth that you can parse out, or was this pretty much all same store sales across the board?

Well for the quarter, it was all same store sales. And for the year, we owned Canada for 12 months this year, 8 months last year. Even the year-to-date performance is largely same store.

Okay. That's what I thought. Thank you.

Well at this time, we are showing no further questions. We will go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks. Gentlemen?

We enjoyed having these calls with all of you and we hope that we will see you at the next conference call. Thanks for your interest in Watsco. Bye-bye.

And we thank you, Sir, and to the rest of the management team for your time today. The conference call is now concluded. We thank you for attending today's presentation. At this time, you may disconnect your lines. Thank you and take care, everyone.