Watsco Inc (WSO.B) 2014 Q3 法說會逐字稿

Good morning, and welcome to the Watsco third-quarter earnings conference call. All participants will be in listen-only mode.

(Operator Instructions)

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

Good morning, everyone. Welcome to our third quarter conference call. This is Albert Nahmad, President and CEO, and with me is Barry Logan, Senior Vice President; and Paul Johnston, Office of the Chairman.

As we always do, let me give you a 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 report.

We delivered another quarter of solid performance. We are continuing to operate at record levels, establishing new record for sales, operating income, net income, and earnings per share. We continue to gain market share in our HVAC equipment business in the United States and Canada. Sales increased 5% to a record $1.13 billion during the quarter. Residential HVAC equipment sales in the United States increased 8%, reflecting share gains and double-digit growth in sales of high efficiency systems. Other HVAC products were flat, and commercial refrigeration products increased 14%. Domestic revenues increased 5%, and the international revenues increased 4%.

Gross margins improved 30 basis points, and SG&A as a percentage of sales decreased 20 basis points during the quarter. Our operating margins expanded 50 points to 9.3% in our third quarter. Net income increased 19% to a record $54 million, and earnings per share increased 18% to a record $1.56.

Now, the nine months. Revenues increased 5% to a record $3.1 billion. Residential HVAC equipment sales in the United States increased 9%. Sales of other HVAC products increased 2% and commercial refrigeration products increased 7%. Gross profit margins increased 20 basis points, and SG&A as a percentage of sales decreased 20 basis points during the nine months. Our operating margins expanded 40 basis points to 8.3%, matching the all-time high established prior to the recession. Net income increased 15% to a record $127 million, and earnings per share increased 14% to a record $3.64 per share for the first nine months of 2014.

I do want to remind everyone that 2014 results include a significant investment made in our business. We have opened locations and added over 200 employees to increase sales capacity and improve local service. We added more products and launched new technologies that will provide innovative solutions to sell products and help customers. Over the next several years, we expect these investments to generate growth, develop share for our vendor partners, and further distance ourselves from competition.

Now, the balance sheet remains conservative, with a debt to EBITDA of only 1.1 times at September 30, 2014. Going into the fourth quarter, which is a strong seasonal period for cash flow, we expect a meaningful reduction in debt by the end of the year.

Regarding dividends, the present annual dividend rate is $2.40 per share, an increase of 50% versus a year ago. Our philosophy on dividends is to reward shareholders by sharing increasing amounts of cash flow through higher dividends. For the nine months' period, dividend payments increased 88% to $49 million. We will consider further increases in the near future as we remain confident in our ability to generate strong cash flow while maintaining a conservative financial position and a low cost of capital to invest in our business.

Now, moving on to our outlook. Our outlook for this year is for EPS -- earnings per share -- to remain in the range of $4.20 to $4.40, representing an annual EPS growth rate of between 14% and 20%. That's for the year, 2014.

Now, one final thing, the housekeeping item. On November 10 at 12 noon in New York City, we are hosting an investor and analyst meeting. We will present the Watsco story and answer questions until we are done. If you are an institutional investor or one of our analysts and have not signed up, let Barry know, and his e-mail address is in the press release and you can contact him.

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

We will now begin the question answer session.

(Operator Instructions)

Our first question is from Winnie Clark with UBS.

Good morning.

Good morning, Winnie.

With the summer season behind us, can you talk about how business trended over the peak period for this year? And did you see any improvement over the course of the quarter? Also, I know you don't like to comment weather, but conditions were fairly mild this season, so I'm assuming that could have been a modest headwind?

Gee, I don't know how to answer that. We don't like any excuses like weather, we've just done real good for the first nine months and don't anticipate that it's not going to continue in the fourth quarter. Paul, do you want to add any color to that?

Yes, the quarter obviously had weather, like it does every quarter. The weather was different in each one of the months. And what we were seeing was, we have a wide geographic stance that Watsco carries with its branches. And so like Al said, we really don't like to lean on weather as a reason why sales are up or down. I'm real proud of our guys that they continue to sell product and grew faster than the marketplace. That's the real story.

Absolutely. To that point, on share gains, can you talk a little bit about the level of share gains that you realized in the US and Canada, maybe specifically some of the key drivers there and how actually you think the underlying market performed relative to the strong results you posted?

I think our share gain is a reflection of sales force, adding sales people. And like we said, adding locations in the field. We have great manufacturers that support us in those endeavors to grow share. I just think it's a combination of an awful lot of things that go into forcing share gains in a market that wasn't that exciting this year.

Great. Just one last one on refrigeration. You saw a really strong pickup in the quarter. Can you comment on the key drivers that? It looks like your business trended far better than some of the other companies have been experiencing this quarter?

That just means were better, doesn't it?

Barry --

That was a joke.

I know. It's also been one of those parts of our business where we are investing in people to drive the business and grow the business. There are over 80 product lines in the category of refrigeration. And as I look down the list, there's double-digit growth of many of them. So, I think it's just some raw energy going into that market and some territories that have been granted to extend our reach in the new territories, and it has been a good business for us this year.

Great. Thank you so much, and congratulations on the strong results.

Thank you.

Our next question comes from Mike [Seng] with Morgan Stanley.

Good morning, guys.

Good morning.

Paul, you -- Barry, you talked about, in the past questions, making a lot of sales force investments this year, but G&A as a percentage of revs was actually down year-over-year, which is pretty impressive. I think CapEx was down year-over-year too. Could you maybe talk about the puts and takes there in terms of investments versus costs out.

I'm looking in as SG&A being up 4% year-over-year in the quarter, so I'm not sure what you're looking at. That's what I see in the financials is a 4% growth in SG&A. So, that trend is probably above the recent average over the last few years, and that's where the investments are showing themselves. CapE is more a reflection on --

But as a percentage of sales, in SG&A is dropping to record level. That's because we are leveraging -- as we scale our revenues, we are leveraging the infrastructure and as a percentage of sales, SG&A is dropping. That's a good thing.

Got it. Right. And on the tax rate during the quarter, I don't think it has been that high since 2010, is that a function of the Carrier transaction, or could you talk about what's going on there?

It is, yes. We picked up 10% greater investment in Carrier for this last quarter and Carrier Enterprise. That adds to our tax dollars and increases our tax rate. That's just raw algebra on additional earnings coming from Carrier Enterprise.

Great, thanks, guys.

Our next question comes from Matt Duncan with Stephens Inc.

Good morning, guys.

Good morning, Matt.

Al, you guys are seeing your equipment growth obviously outpacing parts and supplies. I assume that that's probably a function that more of the growth is coming from the replacement market as compared to construction. Can you talk a little bit about what you're seeing from those two drivers for your equipment growth? And also the parts and supplies.

Sure, go ahead, Paul.

It's -- I think we have been seeing this trend for the last several quarters where our equipment growth is outstripping our parts growth. Obviously, when equipment goes -- get stronger, there is pressure on our parts sales. And it's a trend that we like, we have got a nice balance of business between our parts business and our equipment business. And it's a good, healthy situation that we have got here.

And Paul, how much is the mix shift toward higher efficiency systems hoping that equipment growth rate?

It's -- I can't give you an exact percentage on that, but it is growing at a much faster rate, obviously, than our overall equipment sales growth.

Okay, and then last thing for me. Last week the EPA came out with its final ruling on R22 manufacturing allowances for next year through 2019. And it looks like they're phasing that out a bit faster maybe than previously expected. How do you think that's going to impact you guys?

Great question, Matt. Go ahead, Paul.

That was a great move, we really applaud the EPA for being courageous to take that action. They reduced the allocations for 2015 by some 57% on R22. Obviously, that's going to cause the price of R22 as a material to go up. We really don't know what the impact of that is going to be in the sell through higher efficiency equipment because we know we have got the regional standards coming into play at the same time there's a reduction in R22 availability. All I can do is say right now that I hope it's very positive. I feel it's going to be very positive.

Paul, what role are you guys going to have in the potential recycling of R22? Are you going to get involved in that at all to help out? Maybe keep some R22 systems alive that maybe don't necessarily have to be replaced yet? Is there a way for Wats going to be involved in that?

Absolutely. We -- as a matter of fact, we've been involved for about the last five years. We got very aggressive when we thought there was going to be some spot shortages five years ago, it never panned out or materialized. But our people continue to have a pretty strong recycling program in each one of our Companies. It's probably going to accelerate, obviously in 2015. It's good for the environment, because the gas now has a value to it to recycle that means that the contractor wants to reclaim it.

Right, they're less likely to vent it off now, I would assume, so.

Correct, it's too valuable.

Yes, thanks, guys.

Our next question comes from Josh Pokrzywinski with Buckingham Research.

Hi, Josh.

Hi, good morning, guys. Sorry for the noise in the background here. I'm actually surprised we've gone this long on the call without touching on the regional standards. I guess a few things. First, on the inventory transition or any kind of pre-build versus pre-buy. It seems like the prevailing wisdom is that there's going to be a good amount of either consigned inventory or inventory held by the OEMs. Is that the way you guys are thinking about next year? And should we see any inventory build in your network in the fourth quarter? I guess first question.

Go ahead, Paul.

I couldn't hear, Josh just kind of cut off there, I don't know if we need to call 911 (laughter).

Josh, are you still on?

Still on, can you guys hear me?

Yes, Josh. Definitely there's going to be a pre-build by the OEMs, and I think that's something that they can address. Is there going to be a pre-buy by the distribution network and how that's going to flow through is something that we're going to be managing and obviously, we're going to be managing it very closely. I really don't see an awful lot of activity in the fourth quarter for us. If it is, it's going to be a very small amount. I can't speak to any of the other distribution in the marketplace.

That's fair. And then I guess as we think about once this transition is completely moved out and there is no more 13 SEER here in the sunbelt, how much of your business today should go 13 to 14 SEER? I get the sense that the industry is about 25% of the market, 13 going to 14 with the transaction. Clearly, you guys would be higher, just giving some more some sunbelt exposure. So, I guess first question, how should we think about that percentage? And then I think prevailing wisdom is a 15% price increase, 13% to 14% once price gets worked down. Is there something you guys would still agree with?

Those are the numbers we keep on hearing. And we hear the same numbers you do for the same OEMs as far as what the price increases is going to be. I think we have stated this each quarter. We've seen material increases over the last several years in our high-efficiency product. And being in the sunbelt, I think people have greater need for high-efficiency products. We are not in sync, we have not been in sync with the industry as far as percent of our equipment that is 13 SEER for quite a number of years. Most of our contractors have been selling up, using utility rebates, using some of the tax credits that we've had in years past. I am hoping to see a change, but I don't think it's going to be quite as big as what it will be for some of the lower efficiency distributor.

Even with the additional exposure in the sunbelt versus some of the other guys, do think it's going to be below that heard average of 25%?

I don't have any idea. Just the heard averages, you know?

Fair enough, and then just one last one. Al, I know you don't want to give specific numbers or shy away from it for competitive reasons. But you have signaled, I think the past few calls, higher investments spend, and I think in quotes, in the millions of dollars. Maybe leaving specific numbers out, how should we think about the trend line 14 to 15? Should 15 see another step up? Or should that hit the same run rate, or are these one-time investments that should go away?

That's a good question. That's an unequivocal yes. It will continue to increase.

Okay, so will be higher next year than --

We are on a growth pattern. We are going to -- we have the cash flow to invest, and we're going to continue to make significant investments in people and technology.

Okay, great, thanks, guys.

Our next question comes from Jeff Hammond with KeyBanc Capital Markets.

Good morning, guys. Your guidance range unchanged with a pretty ride range still with one quarter to go and seasonably weak. Can you give us a bias within that range? How your thinking about?

Jeff, we thought about that. This is the best we're going to do in terms of guidance.

Okay. And then outside of the regional standard noise. What are you hearing from your OEMs just in terms of general normal course of business price increases into next year?

Paul, do you have a feel for the price?

Yes, I do have a feel for that. This is the time of year where we always see the price increases being announced, and we've had a couple of them come in. They are coming in as they normally do within a normal range, somewhere between 3% and 5%. I think the price increases this year aren't going to be quite as relevant as they've been in the past because as we transition in the sunbelt to a 14 SEER minimum, I think we are going to see price increases reflected in the mix change.

Okay. That's helpful. And then just back to this R22 dynamic. If I recall, I think some of the volatility has been maybe a headwind. If we do see this kind of spike in pricing, is that a nice margin opportunity as we look into 2015?

We don't play the game with commodities, especially on R22, so we don't maintain large inventories of it. I think what you're going to see, it's not going to read -- maybe $1 margin increase it will generate from the price going up.

Okay.

There are no surprise earnings coming out of it, no.

Okay, and then just a final question. Maybe, you guys obviously took down the other portion of the Carrier JV, but you have been pretty quiet on M&A otherwise. Maybe just update us on what you're seeing in the pipeline, anything outside of the norm in terms of new adjacencies or geographies?

Well, we want to make investments in M&A, we are always very interested. We like people to know that, and we can't tell you that we have anything in particular to discuss at this point.

Okay. Thanks, guys.

The heart is there and the ability is there.

Our next question comes from Mark Douglass from Longbow Research.

Good morning, gentlemen.

Good morning.

Some details. What were commercial HVAC equipments -- what was the sales growth for commercial HVAC equipment in the third quarter?

I would call it the upper single-digits.

High single-digits?

Yes.

Okay. Thank you. And then with the 8% in US residential, very good number. What was the price? Do happen to know what the price component made up in that number?

Mark, it's a measure of both price and mix. We saw unit growth and we saw mix change, which helped the overall sales growth rate. It's not something we would break down into pieces for you.

Okay. And then -- well, let's see if -- what do you think the market unit growth was in third quarter for the US resi? You think you have a handle on that?

For the industry?

Yes, for the industry.

It's something we make internally based on the public trends that are out there and discussions with our OEMs. It's not something that we publish. It's something ARI will come out with.

Okay, thank you.

Our next question comes from Keith Hughes with SunTrust.

My question has been answered, thank you.

Our next question comes from Luke Junk with Robert W Baird.

Hi, Luke.

Good morning, guys. I'm wondering if you could quantify or maybe just give some context to the percent increase in new salespeople relative to what it was maybe this time a year ago. Just wondering either for the specific roles that you mentioned in the press release or maybe just for the Company overall.

The percentage increase in people, you said?

Yes, just trying to get an idea of, as you are making these investments in the business, sizing the magnitude of the increase in --

It's a double-digit increase.

Okay, and then a follow-up.

That will continue, by the way, Keith. That will continue. Somebody asked me earlier whether that was it, no, that's not it. We are going to continue to make those kind of investments.

Okay. That's great. And then to follow up on commercial trends, up high single-digits. I think that was up 6% last quarter, if I'm remembering. Can you maybe just expand on that and touch on any areas of the business where you are seeing strength, or maybe some traction in some of the newer product lines you've been investing in?

Do we have that kind of information Paul?

No, we really -- most of what we do is in the replacement side of the business. It's a lot of rooftop replacement jobs that we're getting into. And I just think of a lot of that is a little bit of pent up demand that people delayed their replacements with repairs over the last several years, and we're starting to just see some normal replacement business.

What I would say, what I would add is that we're seen consistency. That's the best where we've seen in the commercial market. It's been a consistent growth rate pretty much all year. Pricing margin is up, and I think we've done a good job on commercial. And for refrigeration to tack onto that adds to the confidence of it. So, from that point of view, it's been a good, consistent business this year.

Great, thank you very much.

Our next question comes from David Mandell, William Blair & Company.

Good morning, guys. Within the international side, can you discuss the trends you're seeing in the different regions?

Go ahead, Paul.

Yes, it's -- we have seen a real strong Latin America this year, it's been great for us. And Canada,of course with the currency weakening, has been a tough market. The market is -- the industry is down up there. But like we said in our announcement, we have seen some moderate share gains, which have been good.

And then with the people you're adding, how long does it take them to kind of ramp up to full productivity?

We actually want performance right away. We're trying to hire veterans.

Okay, thanks for taking my question.

Our next question comes from Steve Tusa with JPMorgan.

Good morning. You talked about the 15% premium for 14 SEER, how does that compare to where we currently stand on 14 SEER and just what is your outlook for how that price comes down, if it does, over the course of the next year?

I wish we could predict that, Steve, as far as what the price is going to be (laughter). That'd be great.

It's a great question Stephen.

What kind of indication are you seeing from your suppliers? Is there anybody that's coming out with something that is -- initially that is looking more opportunistic than the other guys?

No.

I think you'd have to ask (inaudible).

Okay. And as far as the industry is concerned, Carrier came out with a pretty big inventory number. What do you think is going to be that magnitude of the pre-build?

We would have no idea. That would be something you would have to ask the OEMs, Steve. We are the buyer, not the builder.

Right. Understood. As far as you're looking at next year, is there anything at present that would -- whether it's trends in construction or consumer behavior, that would lead you to believe that next year should be anything but a trend line year in resi HVAC?

Well, we're an aftermarket business.

We're optimistic.

What's that?

The reason we are optimistic is because we are an aftermarket business. Whether construction goes up or down, it doesn't have a big impact on us. It has a little bit when it's up, but it doesn't take much away when it's down. There's what, 85 million, 89 million homes that use central air conditioning in the United States. And they have a limited life, and there will be demand for replacements, and that is our sweet spot.

And more salesmen and more marketshare.

Understood.

This is our market, this is the one that we focus on. Were not focused on anything else.

Right, and then one last question for you. Just your replacement compressor sales for your distribution, what did those do the quarter?

I don't have that. We can get that for you if we have that

Okay. Thanks.

We have a follow-up question from Josh Pokrzywinski.

Hi, Josh. I know who he is.

(Laughter) Just one more question.

I don't hear any sirens.

Yes, I evaded the police for now. I'm -- Jeff and I were discussing that I'm starting to smuggle R22 in my spare time (laughter). The -- Paul, if I can tap into your memory bank a little bit here and just go back to the 10 to 13 SEER transition. On any kind of pre-buy pre-build, what was the pricing dynamic on the outgoing equipment? So, what did 10 SEER pricing do through the year, and how would you guys think the status quo on 13 SEER equipment pricing should be in the next year? Is a up, down, flat versus other slices of the equipment market?

What happened on the 10 SEER is we actually saw little bit of an uptick, as you remember, on the 10 SEER pricing. During the transition as we narrowed the gap between a 10 and a 13 because there was such a big spread between. And going back to what we've heard for a question already, what sort of compression is there going to be on 14 SEER and what impact is that going to have on our 13 SEER? I don't have a feel yet for how that is going to play out. Is there a big enough spread going from 13 through 14 SEER that we would actually see a little lift on 13 SEER product? I don't know.

Got you. But the bias would be that as 13 SEER becomes more scarce that there is a little bit more of the pricing umbrella there. And maybe that could help offset a little bit of a compression in 14 SEER. Just big picture, not knowing numbers?

I don't know.

Fair enough.

I can't speculate on that. By the way, something I would add to this discussion so we're not forgetting about it is the 16 SEER product and above is part of that category that is been growing double-digits now for several quarters. It's not -- the whole world doesn't just revolve around 13 to14 SEER. There's16 SEER and above product groups have been growing very nicely, and there's no reason to think that that good, better, best philosophy that's in place today continues to expand as well.

Got you, fair enough. Thanks, guys.

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

As always, we thank those of you that are interested in our Company, we appreciate it, and we look forward to reporting again in the next three months. Goodbye for now.

The conference has not concluded. Thank you for attending today's presentation. You may now disconnect.