Watsco Inc (WSO.B) 2014 Q2 法說會逐字稿

Good morning and welcome to the Watsco second-quarter earnings conference call.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Albert Nahmad. Please go ahead.

Good morning. This is Albert Nahmad, President and CEO. With me on this call is Barry Logan, Senior Vice President; and Paul Johnson, Office of the Chairman.

First, our usual 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, on to our earnings call.

Well, let's start off by saying that Watsco continues to operate at record-breaking levels. We will first discuss in this conference call our financial results and then discuss the investments that are being made to accelerate growth, build market share and bring innovation to our business.

All-time highs were achieved during the quarter in sales, operating income, operating margins, net income and earnings per share. Revenues grew 4% to a record $1.2 billion during the quarter.

In the United States, sales of residential HVAC equipment increased 8%, reflecting market share gains and double-digit growth in sales of high efficiency systems. Commercial HVAC equipment increased 6%.

Other HVAC products increased 2%. Commercial refrigeration products increased 5%. Domestic revenues increased 6%. And international sales decreased 4%.

Gross margins improved 10 basis points, and SG&A as a percentage of sales decreased 20 basis points. Our operating margin increased 30 basis points to 9.7%. Now 9.7% is a record operating margin for any quarter in Watsco's history.

New records were also set for net income, which increased 9%, and for earnings per share, which increased 8% to a record $1.60. For the first half of 2014, revenues were up 5% to $1.9 billion. During the first half, sales of residential HVAC equipment in the United States increased 10% from a combination of strong unit growth and an improved sales mix of high efficiency systems.

Gross profit margins increased 10 basis points, and SG&A as a percentage of sales decreased 20 basis points during the first half. Operating margins expanded 30 basis points to 7.7%. New records were established for net income and earnings per share during the half. Net income increased 13%, and earnings per share increased 11% to $2.08 per share during the half.

Now for dividends. Our quarterly dividends increased by 50% to $0.60 per share. This is the 40th consecutive year that Watsco has paid a dividend. The balance remains conservative, with debt-to-EBITDA of 1.2 times at June 31, 2014.

On July 1, 2014, we exercised a second option to purchase an additional 10% ownership interest in Carrier Enterprise for cash consideration of approximately $90 million. And this marks the five-year anniversary of our joint venture with Carrier, which has been an unqualified success for both companies. We estimate earnings per share accretion from this transaction of $0.20 to $0.25 per share over the next 12 months.

Now, onto our outlook. Our 2014 outlook is for earnings per share of $4.20 to $4.40. That represents an annual EPS growth rate of between 14% and 20%.

And now I want to talk about investments in our Company. To begin with, we are highly confident in the foundation of our business and the long-term growth prospects of our industry. So, we are stepping up investments to accelerate growth and performance.

Now these investments we categorize in the four buckets. First, more people to sell products to service customers and build share of market. Secondly, a broader product offering to increase our commercial coverage. Thirdly, more locations to increase our density in local service. And lastly, more technology to enhance the customer experience.

Over the last 12 months we have added over 200 persons to accomplish these goals and we are in the market for more great talent. Here is relevant data. We have added 60 marketing leaders and sales people. We have added 30 product specialist with a focus mainly in the commercial and VRF markets.

We have added over 80 store personnel to add greater service capacity throughout our network. We have opened 8 branches, with plans to open 20 more over the next 12 months. We have added over 30 technology positions to develop and launch apps and software that will differentiate our business from our competitors. This is a great time for our industry, and the Watsco team is focused on expanding our market-leading position.

With that said, Barry, Paul and I will be happy to answer your questions.

Are there questions, Andrew?

We will now begin the question-and-answer session.

(Operator Instructions)

The first question comes from Michael [Seng] of Morgan Stanley. Please go ahead.

Thanks for taking the question. I wanted to dig into the guidance model a little bit. Specifically, can you talk about how the guidance -- or what the guidance implies for sales and margins in the back half?

It sounds like you're pretty happy about the top line, and maybe you're seeing some step-up investments. So can you guys decompose that or give us a little more color?

Well, we don't typically break down anything further than that, Michael, because it's very difficult to predict the impact of the markets that we serve from quarter to quarter. That's why we try to look at it on an annual basis. And that's why we wait until we have some visibility, which is the end of the second quarter. Is there any color, Barry, that you'd like to add?

No I don't think so, Michael. The trends that you've seen earlier over the last year, the last several quarters, was relative consistency in the United States, some inconsistency in international markets, but as a composite, pretty consistent. So I don't think we're thinking much differently as we go through the rest of the year.

But would you say it's fair -- the characterization that you guys are pretty happy with the top line and maybe July, month today the trends hasn't gone materially worse?

I would say that we're always looking for more growth, and that's why we're investing. But I think we're on very solid grounds. I think we're a very strong company. I think we're the best in what we do.

And asked about July, I like what I see. Early -- it's early, but I like what we see.

Okay, thanks. And then secondly, on your investments comments, do you see these incremental costs as something you need to do to drive growth above market? Or do you see it more as something you need to do in response to what you're seeing competitively?

Well, that's a good question. But, no, we're not concerned at all what competitive issues are, because I think we're the leader. And it did exactly what you said. We want to increase our performance for our vendors. It's a big thing in our thinking. We want to always gain share for them, if we can.

So, we're investing, first, because we can. We have the capability to do that. And secondly, because that's what we do. We develop share gains and we develop growth in revenues and earnings for our stockholders.

Great, thanks.

The next question comes from Ryan Merkel of William Blair and Company. Please go ahead.

My first question is on the Carrier JV. Can you give us a sense for what you're assuming that adds to second half EPS as part of the guidance?

Barry, you want to take that?

Yes, Ryan. As we said in the commentary, $0.20 to $0.25 is our estimate for an annual period. And it's pretty evenly split between this year -- the rest of this year and the first half of next year.

Okay. And then on international sales down 4%, can you break that out a little bit further? I'm curious how much Canada was down in both US dollars and in local currency.

That's a very good question, and I think you have focused on the international side of the business. And Barry, go ahead and respond to that.

Yes, Ryan. There are two markets. There's Latin America and the Caribbean and Mexico and so on, and Canada. And as a group, their businesses were flat in their local currencies. So the decline you see is primarily the currency impact in Canada.

Okay. And then just last one for me. On the stepped-up investment, can you provide some numbers? I'm just curious how much of incremental spend you're planning on in 2014 over 2013, for example.

Well, it's several millions of dollars, but were not going to get into see any specific quantification of that. It's significant.

Okay, great. Thank you.

The next question comes from David Manthey of Robert W. Baird. Please go ahead.

In terms of the share gains that you talk about here, beyond industry growth, could you talk about -- you've got split systems and VRF and commercial, other things that you're working on. Are any of those today big enough that they're moving the needle, or are they all less than 1% contributors to growth?

I don't think I understood the question. Did you, Paul?

No. Are you saying we've got all these initiatives that we've talked about on VRF, commercial, et cetera. Are they enough to move the needle?

Yes. Just meaning, in terms of the overall growth rate you're seeing today?

But the investment that we're doing is across the board. It isn't -- it's across the entire spectrum of what we do. Now, if you're asking, is VRF yet moving the -- shall we say, the needle? The answer is, no.

Okay. Great.

We've said that over and over again, that VRF is a long-term project. And we want to be the largest distribution company in that product offering, but it's still not a significant part of what we do. It will be, but it's not now.

So, just thinking about commercial in general and the split systems, and it seems international is obviously big enough to move the needle right now. But these other embryonic growth areas, at what point -- I mean, are we talking three to five years from now that they become big enough?

Good (inaudible). I don't know. But we're very focused on growing them, and I guess, stay tuned.

Okay.

I couldn't answer that with any accuracy

Right. Back to the investments and the cost side of the equation. Did you say that you hired those 200 people over the last month, which would imply that --

Oh, no. We started this hiring second half of last year. We've accelerated some this year.

All right. So, should we assume, I don't know, 80% of it is in the second-quarter run rate SG&A, or is there more coming in the third quarter?

Barry, do you have a feel for that?

Yes, Jeff. I would say second quarter versus second quarter a year ago, yes, there is a reasonable amount of new spend in the SG&A. And it will accelerate some as we finish off the year, and we've included those costs in our outlook.

I'd rather call them investments than costs.

Right, okay. And then last question, in terms of the quarter here, and I know people are trying to get at your confidence as you look forward. Was weather any kind of impact for you in the second quarter? And could you talk about things trended through the quarter and as you looked into July, it got better? (multiple speakers)

We have consistently tried not to talk about the weather, because we don't want to be a weather-driven business. We know we would not be realistic not to say that weather doesn't impact, but we don't comment on that. Our goal is to grow our business, regardless of weather conditions, wherever they may be.

Okay. All right. Thanks a lot.

Sure.

The next question comes from Matt Duncan of Stephens Inc. Please go ahead.

Good morning guys this is Will on the call for Matt. I just had -- most of my questions have already been answered. I just had a couple of housekeeping items, if you might? If you have depreciation and amortization for us, and possibly CapEx spend in the quarter? Can you break that out for us?

(Inaudible) the details in a table in the press release, Will, if you take a look. It's there. You can see the line items in the press release.

Is the CapEx in there?

Yes.

All right. I appreciate it, guys.

The next question comes from Walter Liptak of Global Hunter Securities. Please go ahead.

I wanted to ask just a little bit more detail on the quarter and how the revenue, especially for res, the HVAC progressed. And I know June, July are probably the biggest months of the year, if I'm not mistaken, and just comment on the overall trend. I know housing market has been a little bit weak, but the unemployment's coming down. How do you see the overall market?

Sure. I can express those to you. The second quarter started very strong, and then it seemed -- the market seemed to soften as the quarter ended. That's why I'm very pleased that we were able to gain share during that period.

Now the third quarter, I'm very encouraged by, starting strong. But, we're early into the third quarter. So, June softness is now becoming July strength.

That's great. That's good to hear. I wonder if you have an idea about the -- in your region of -- the market growth, and if you can take a stab at what kind of market share you're gaining from these internal initiatives?

No. I don't think we would go into geographic things like that. We rather stay with it on a macro level.

Okay, fair enough. And then, I'm curious about the regional standards and how that may impact you in --

Sure. That's a good question. Go ahead, Paul.

Okay, yes. The regional standards is a flip of the coin right now. What we've seen and been able to hear is there's -- the rule making is not complete yet. It probably will not be complete as far as the enforcement of it until the beginning of 2015.

Regardless, there's an 18-month window where we would be able to continue to sell 13 SEER product for an 18-month period. Nothing really has changed in the last quarter, except some -- a little bit more confusion coming out of our government. That's all.

And that's nothing new. Would you build inventory in the fourth quarter? Are you planning on increasing your stock of the older product? And then is there 2015 benefit from that?

No. I'd say that it's premature to even estimate that right now, based on not having the rules coming from the EPA and the FTC. Right now, we're anticipating a normal end of the year. If that changes, obviously, we would react to whatever the government regs are.

Okay, all right. Fair enough. Thank you.

The next question comes from Keith Hughes of SunTrust. Please go ahead.

Two questions. The branch launch of 20 branches, tell us more about that. Is that just expansion into new markets or filling out territories you're already big in?

As you know, we have a very decentralized management system. We charge our leaders in those markets to tell us and to identify where they feel they can better serve the customer. And to understand that one of our competitive advantages is our ability to increase density in the markets we serve, because with that density, you substantially increase the service to the customer because the contractor has less distance to go and can get it serviced more efficiently.

So, it's not any great theory. It's just our regional and local leaders saying, here's where I think I can meet the goal of servicing the customer better. Is nothing more than that.

Second question, on the growth in other HVAC products, the 2% seems significantly below what you had in US residential equipment. At home builder-related, what are the trends there, and what kind of trends do you see moving forward in terms of growth rate in that segment?

Well, we don't like to think of ourselves as a new construction distributor, although we do participate. But it's never a material part of our Company in terms of our revenues and earnings. Paul, can you add anything to that?

Yes. I think we've indicated before, it's double digit for us, but it's low double digit as far as what new construction equipment movement is in residential. We continue to participate in it with several brands, and there wasn't really any big ups or downs in the quarter.

So, with other HVAC only at 2%, it seems like it would be closer to your equipment sales. But we've seen this before, a spread between the two. I thought at some point, these accessories would catch up in the growth rate. It doesn't appear to be happening right now. What did you seen trends there that's caused the big deflection between the two numbers?

Barry, do you have anything on that?

There's really two families of products, Keith, and that number in there, as you call them, accessories. We call them non-equipment. Parts is one, and you can imagine, as the equipment grows, parts actually can decline in that type of a trend. Which we don't mind, because we're certainly making more money and margin contribution selling replacement systems versus parts.

And there are also 600 other different product lines, literally 600 different product lines, that make up the rest of the family of products. And there are some plus-10 and there are some flat product groups in there, Keith. There's not one answer that covers that whole category.

Okay. Thank you.

The next question comes from Jeff Hammond of KeyBanc Capital Markets. Please go ahead.

I jumped on a little late, so I don't know if you addressed this already. Can you talk about --

(multiple speakers) -- stuff, Jeff. (laughter)

Can you talk about price mix and what the commercial HVAC equipment did?

Price mix, well we have reported that we moved into higher margin -- the product mix has moved towards higher margin, which benefited the quarter. And what's the rest of that question?

How's pricing going through? All the OEMs put through price increases --

Paul, do you want to answer that?

Yes. We had the price increases. Most of them hit us in the fourth quarter, and they pretty much have all flowed through. There wasn't much resistance in the market in the price increases, so it worked.

Okay. And then the other question was commercial HVAC equipment, what was that? What did that do in the quarter?

That went up. It went up 6%.

Okay. And then, it looks like you had a little more working capital build. How should we think about free cash flow for the year relative to your 100% of net income target?

Yes. Our goal is still to achieve cash flow to equal or beat net income for the year.

Okay. And then just back to the 13 SEER changes. How are you thinking about pre-buying or not pre-buying equipment ahead of the change?

Well, Paul gave you a lot of detail on that previously. But the point is that's not a decision that we've reached. And we're not the kind of company that likes to pre-buy in any event. We just see things as they happen. But there's no way to give you any help with that now because we don't know what the government is going to do.

Okay. Thanks, guys.

The next question comes from Mark Douglass of Longbow Research. Please go ahead.

You talk about -- you mentioned you added 8 branches, 20 more are coming. Off of what base? How many branches do you currently have that you're adding to?

Barry?

About 570, Mark.

570. Okay. Excellent.

And you mention that you saw double-digit growth, higher efficiency products. Is that a real strong mix-up? Is that an acceleration from what you've seen earlier?

Barry?

Yes, Mark, it is. We talk about -- and in our message about the US market being up 8% for the quarter. If I were to split that into standard efficiency versus high efficiency, it's single-digit growth in the lower tier, and double-digit growth in the higher tier. So, it is a meaningful movement and meaningful trend.

Okay. And with that starting now and being entirely voluntary by the consumer, accelerating now. I assume that that probably also dampens whatever effect that the regulations would actually have on new systems for next year anyways, wouldn't you think?

No, I disagree with that, Mark. First, the baseline system is still a majority of what we sell. So, to the extent that business converts into a higher tier system next year by regulation, it's definitely a benefit to the sales.

The mix of today still is nothing like the mix of, let's say, four or five years ago, pre-recession. That's been part of the recovery of the consumer is to spend more, and to upgrade, and contractors are more confident to make those recommendations. But, you should also get the sense that that mix is still not where it was, let's say, five, six years ago.

Okay. So, still room for improvement, significant room for improvement.

Yes.

And then, the effect of the -- what do you anticipate would the effect be on aggregate price -- or on sales with the regulations hitting next year?

If I can say one thing, do you realize that the regulations go into effect, but there's an 18-month window --?

Right, right.

-- where everybody will still be selling 13 SEER products. I'd love to say there's going to be something coming from the regulations next year, but that's not anticipated.

Okay, thank you.

I mean, Mark, the way I would characterize it is, it's not a get-rich-quick concept for next year. I wouldn't characterize it that way. This is a slow blend of upgraded products that will enter the market over the next several quarters, and let's call it, get-rich-slow.

And meanwhile, the consumer is still mixing up to even 17, 18, even above 20 SEER anyways, right? That helps?

Right.

Okay. Thank you.

(Operator Instructions)

The next question comes from Rajat Gupta of JPMorgan. Please go ahead.

Thanks for taking my question. Most of them were answered, but just one housekeeping one. How much pure revenue base is from Carrier Enterprise right now?

We don't break that out, Roger.

Just a rough color percentage or anything? Or you (multiple speakers) --

We used to call it legacy, and the legacy business isn't Carrier Enterprises, but we don't do that anymore.

Okay, thanks. That's all I had.

The next question comes from Samuel Eisner of Goldman Sachs. Please go ahead.

Samuel.

Going back to some of the questions earlier on margins, obviously, in the first and the second quarter, EBIT margins or operating margins were up 40 and 30 basis points. Should we expect that same level of expansion in the second half of the year?

I guess we'll have to wait and see.

Good. I think a lot of the expansion is really SG&A-driven. And that seems to be in the face of some new investments that you guys are making.

Can you talk about where the leverage specifically is coming from? Is it back office? Is it selling expenses that are down? Just curious what's driving the SG&A margin lower?

Well, that's what the investments are that we mentioned. We are making investments to produce growth, and it's reflected in the numbers we're disclosing.

All right. And then, in terms of the high-efficiency sales, how much was that up on a year-on-year basis? I'm just curious what the impact of that was on your margins, either gross or operating?

[Mr. Ryan] Barry, go ahead.

Yes, Sam, as I mentioned, I'll leave it at double-digit growth in the high-efficiency category. And for gross profit, there's a moderate benefit, but it's really more of a dollar-revenue benefit for us, not something that would drive up materially gross profit margin performance.

Understood. And I realize the first quarter, obviously, is a seasonally weak quarter. But is that double-digit level of growth, is that an acceleration from the first quarter?

It's consistent.

Okay. Thanks very much.

The next question comes from Jeff Hammond of KeyBanc Capital Markets. Please go ahead with your follow-up.

On this distributed/undistributed earnings, that came in higher than my number -- my forecast. Anything going on there to drive that number materially higher?

Yes. Carrier Enterprises is really performing well.

Okay. And tax seems to be running a little bit higher, as well. Any -- does that have to do with the US versus non-US mix, or --?

Well, Jeff. First, the tax rate year over year is almost identical, so I don't know why you would have something lower for the year. I went back and looked, and the tax rate is identical year over year.

The US, obviously, did have a better quarter than the international, so there's a little bit of tax rate cost there, but it's enough to matter. Maybe look at the model for the rest of the year and we can talk about it, if you need to.

Okay, great. And then just -- you guys put out guidance today, and it was a little bit below consensus. Is it as simple as the international businesses maybe being a little more challenged versus the earlier run rate, or is there some other --?

I don't think so, Jeff. We don't give any guidance until this time for the second quarter. We don't guide the analysts; they do their own calculations. This is how we feel. And it's as we feel, we show you.

We haven't an adjusted any of our thinking. We don't think we're any better or any worse. We just deal with it as we see it.

And we do have better visibility now that the second quarter is over, and so we're telling you what we think we're going to do. But we don't compare ourselves to the analysts, because that's not what we do. We just tell you what we think. What the analysts did or did not do, well, you're an analyst. You'll have to figure at that out, why you did what you did, but that's not us.

Okay, thanks.

Those analyst estimates are not our estimates. This is -- for this year, this is the first time we're telling you what we think we could achieve.

The next question comes from Winnie Clark of UBS. Please go ahead.

Just to hit on refrigeration -- I think last quarter you mentioned that pricing was a bit volatile, so it was hard to really have a read on the underlying end market. Has that stabilized, and do you have a better sense of what you're seeing there?

That's a great question. Go ahead, Paul.

Yes. I think it's safe to say that refrigerant pricing has stabilized and starting to move back up.

Okay, great. And then on the international -- can you talk a little bit about Canada versus the other regions? Are you seeing -- are they similar, or are you actually seeing a better performance in Latin America, the Caribbean and Mexico, for example, versus Canada? If you could break out the underlying trends there, that would be helpful.

I don't know that we want to do that for you. We can tell you Canada is -- we're doing well in Canada. But I don't want to start breaking down international performance. I don't think we want to do that. Barry, you got anything to add to Canada?

No, Winnie. As I said earlier, I think the business volume is flat in local currency. Their profits are up a little bit in local currency. And I would say there's been a better performance as the year has gone on. So, I wouldn't want to start splitting up countries and markets individually like that.

Okay, great. And then, just quickly. I know is something that's asked pretty consistently to you, but just on capital allocation, now that you've purchased an additional piece of the JV, any way to comment on what you're thinking about capital allocation going forward would be helpful.

Our capital expenditures, because we are a distribution business, is -- I would think it's traditional that you've seen over the years. Except you may see more of acceleration in technology investment, software, things like that.

Okay, great. Thanks so much.

This concludes our question-and-answer session. I would like to turn the conference back over to Albert Nahmad for any closing remarks.

Well, thanks very much for your interest in our Company, and I look forward to having our third-quarter conference call in the future. Bye-bye.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.