Watsco Inc (WSO.B) 2017 Q3 法說會逐字稿

Good morning, and welcome to the Watsco, Inc. Third Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Albert Nahmad, Chairman and CEO. Please go ahead.

Good morning, and welcome to our third quarter conference call. This is Al Nahmad, Chairman and CEO, with Mr. A.J. Nahmad, President; Paul Johnston, Executive Vice President; and Barry Logan, Senior Vice President.

As always, the cautionary statement. This conference call has forward-looking statements as defined by the 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 Watsco set records for net income and earnings per share despite the disruptions in our largest markets. Our cash flow is strong, growing 46% in the quarter and 26% for the year. We expect to deliver on our stated goal of cash flow exceeding net income gains this year, and we will evaluate increasing our dividends at the start of the year.

As for the disruptions. 190 locations since were closed for some period of time during and after the hurricane, including our export operations in Miami. The Mexico earthquake affected our operations in Central Mexico. Collectively, these markets represent 35% of Watsco's annual sales. The markets are recovering, and we are experiencing double-digit growth.

Our balance sheet remains conservative, with debt-to-EBITDA ratio under 1x. That's a pretty conservative balance sheet, and we like it that way. We continue to look for investments to grow our network, constantly looking for investments or acquisitions or mergers with people that do the same thing we do.

Watsco technology evolution continues to make progress. Our long-term goals are to help the over 400,000 contractors and technicians that do business with us and to make our own operations more efficient. Our annual run rate for technology spending remains at $23 million. More customers are using our apps and e-commerce to gain speed and efficiency, and we believe Watsco's e-commerce sales can reach $1 billion this current year.

More locations have been provided order fulfillment technology to complete and ship orders quick -- quicker and save customer time. More SKUs have been added to our product information database, which has now over 600,000 SKUs. Inventory turns have improved and square footage has been reduced, with more progress in reducing square footage in the future. More employees are using our business intelligence platforms to improve insight and decision-making.

This is a long-term evolution that will require time for traditional customers and employees to become fully immersed in what are new technologies in our industry. That's always a problem. People -- these are wonderful people, and we're giving them something new to use, so it takes a while for them to adopt. We expect this to go for some time before we get considerable adoption, but we like what we're doing.

Now for the quarter. Earnings per share increased 2% to a record $1.82. Net income increased 3% to a record $65 million. Same-store sales was flat, including 2% growth for residential products. SG&A expenses were flat for the quarter. Third quarter results reflecting a contribution from 35% investment in Russell Sigler. They're having a terrific year, and we could not be happier to be part of their family.

Moving on to the 9 months. EPS increased 7% to a record $4.62. Net income increased 8% to a record $165 million. Our operating profit increased 2% to a record $293 million. Sales increased 2% to a record $3.4 billion and have increased 3% on a same-store basis.

In terms of our outlook, we expect continued record performance, with EPS in the range of $5.50 to $5.60 per share.

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

(Operator Instructions) The first question comes from Jeff Hammond of KeyBanc Capital Markets.

This is actually Brad filling in for Jeff. So my question is surrounding the impact from the storms. Just wondering how much of that $0.10 do you get back in the fourth quarter? That will be probably a net positive. Just trying to size up a stronger seasonal quarter with the disruptions versus weaker...

That's not possible to tell you when that $0.10 is going to come back. I can just tell you that the demand in those markets that were affected is very strong; as we said, reflecting double-digit growth. But I can tell you also that this recovery is not going to be in the next quarter. It's going to be, I believe, over perhaps as much as 2 and 3 years because sometimes people have to have their equipment repaired. They do that pretty fast, and then sometimes they have to have their equipment replaced. That takes a little longer. And also, in the commercial side, these things take much longer to do what they have to do. So this is a long-term positive for us. I mean, I'll hate to say that something positive has come from storm -- or storms, but it has. So it's a long-term play for this.

Okay. And then along the same lines, just referring to the flat same-stores number in 3Q. Were the storms factored in any manner into that number? Just having a tough time getting down to that flat reported number. I'm wondering if that was FX headwind or kind of the puts and takes around that?

Sure. Barry?

Yes. Well, first, there is no FX impact on the quarter or the year to speak of, so that's not ever a material part of our discussion. And you're right, in terms of flat same-store sales growth, it wasn't flat. Before the hurricanes, we were seeing growth, and the interruptions simply turned that into a flat quarter. So it's -- it really is that simple and not much more color to give.

The next question comes from Matt Duncan of Stephens Inc.

Maybe to take another stab at that last question. I'm sure you guys have taken a look at what you think the revenue impact was. You gave us an earnings impact, but what was the revenue impact of the storms? And as you look at your 65% of locations that weren't impacted versus the 35% that were, what was the difference in revenue performance there?

Barry?

Well, first, there are things we think we know, as the old saying goes, things we know we don't know in terms of the impact. I mean, contractor activity, consumer activity, commercial activity, end-market activity and the storm, you don't really know the full impact of that. And looking at $0.10, we try to make a good educated conservative guess at it and -- because we thought we should say something, but I think the reality is that impact on revenue and the business activity in markets this large, again, that's more than 1/3 of our total business in these markets. And those were location closures. There were also areas that were under threat and hurricane warnings and -- that are not in that number, which, again, certainly impacted short term, the business longer term. I agree with Al. It's an immediate repair, replacement activity. It becomes a reinvestment activity and then a rebuilding activity, which is all going to take time.

Okay. Barry, maybe what was the growth rate in the impacted locations before the storms hit? How much were they growing before the storms came through?

In the single-digit range.

Okay. And then last thing for me. Just, Al, you mentioned the balance sheet, strong cash flow. Obviously, you're in a pretty strong position there. Any thoughts on what you might be able to do with that looking ahead? I know there's the other 65% of Sigler you'd like to own at some point. Is it possible that you might be able to get another deal across the finish line here in the next 12 months? Or just how are you thinking about using the balance sheet?

Well, I've said over and over again, we think we can significantly grow our company internally and through acquisitions. And we are pursuing companies that we believe we like to be part of our system. Can I tell you when it's going to occur, if 2 or 3 or 4? I don't know. But I do think they will occur, and I think they will add significantly to the size of Watsco. And that's why we maintain a very strong balance sheet. And we're just optimistic that the trend in technology will be evaluated by some of the companies we love to do business with and maybe we can help them with their technology because after all, we put over $100 million into ours, and it's going to take a while to be adopted by our customers and by our employees. But nevertheless, it's a great asset, and maybe they'll see some value to that. And when -- if they weren't willing to do something in the past, maybe they'd be more willing this time. At least that's my hope and also our expectation. Hard to say when, but we're certainly in the game.

The next question comes from Ryan Merkel of William Blair.

So first question for me. Nice to hear October is up double digits. Is this both parts and supplies and equipment? And is one growing faster than the other?

Good question. Good question. Paul?

Yes. It's -- we're seeing it in parts and supplies and equipment in October. Obviously, equipment is leading -- is up stronger than the parts business has been, but parts has been something that we've been focused on all year.

I think he's referring to October.

That's what I'm -- October, we were up.

Okay. So it sounds like both are up nicely.

Yes.

Okay. And then on gross margins. Just clarify for us, was the year-over-year decline, was that product mix driven?

Barry?

I'm sorry, one more time?

Yes, the year-over-year decline in gross margin, was that just driven by the mix of products? So just the parts and supplies was down more than equipment?

That's correct. That is the mix change for the quarter, yes.

Okay. And then just lastly, I thought the 2% resi equipment growth was a good number, all considered. What do you think the industry grew? And then what would you attribute the share gain to? Is it the technology and the service people you hire?

Paul?

Yes. The way we've got the industry pegged is that the industry was probably down. On the resi side, it was probably down 2% for the quarter. So I suppose soon enough, 2% would indicate an obvious share gain. I think part of that was just normal business. We have a strong position, as you know, in the replacement market, which we continue to push on. And that's really where the technology that we've invested on features itself the strongest. And we have a smaller presence in residential new construction, which was up for the quarter also.

The next question comes from Robert Barry of Susquehanna.

This is Jake Lacks on for Rob. Can you comment on pricing? Are you seeing any price come through to help, though, with upside question?

Very good question. Go ahead, Paul.

Yes, we're starting to see there's -- I think everybody is familiar that there's a lot of what they call headwind out there with commodity pricing right now, with copper going up, steel going up. We're starting to see price increase announcements in the mid-single-digit coming from most of our equipment side vendors as well as now we're starting to see -- on the parts and supplies side, we're starting to see price increases.

Great. And then a follow-up. On the decline in refrigeration, was that also storm impacted?

Paul?

Yes. To a certain extent, yes, it was. The -- probably a bigger piece of our business on the commercial refrigeration is done in the Texas and Florida markets, where they did have impact. It's hard to get your arms completely around the commercial refrigeration impact because we get into so many different applications for the product that's involved, from icemakers to actual refrigerant to compressors and parts and pieces.

The next question comes from Luke Junk of Baird.

First question for A.J. Just curious what the technology plans are for Sigler and then your term here. Just wondering how quickly you can help them adopt your apps, the business intelligence and inventory management tools.

Yes. That'll be driven by them mostly. They have come and learned about some of the technologies we have. And I've started to meet some of the folks, and the pace will be set by them. That's very much consistent with our culture is -- our job is to be helpful to the operators and listen and react to when they're ready.

Great. And then second, just a bigger picture question. Taking a step back, just wondering if there are any high-level updates you can provide on the VRF and ductless business, either relative to the growth trajectory more broadly or just how you're feeling about the strategic positioning of that business.

Paul?

I've been in love with the ductless business forever, and I'm glad to say that it continues to grow. We saw a little bit of slowdown in the industry growth for the quarter, for the third quarter. But within Watsco, we saw a very strong growth across the board, both in the VRF as well as the mini-split and the multi-split product lines. So still pushing ahead and still that's a major growth initiative within Watsco.

The next question comes from Walter Liptak of Seaport Global.

I wanted to ask about the technology with relation to the weather events. And I hope I'm not going too far offtrack with this. But could you and your employees learn anything about utilizing the technology during the storms? Do you have a better control over visibility knowing where they have products positioned or cash flow, et cetera?

I think that's a great question. My guess, it's something that's on the horizon. But go ahead, A.J.

Yes. I would tell you -- I mean, certainly, theoretically, that's should all be true, right? We have better demand planning, inventory optimization tools. We have enhanced our technology in terms of moving products around, the logistics. I don't have empirical data to share with you to tell you that all that was done better in these storms and -- had we not had the technology. But -- and by the way, a big part of that is e-commerce as well. Our stores are open 24/7 with e-commerce. So even if employees were not able to get to the branches or get to work because of the storms, our customers still -- could still find the products they need and get them ordered. So no empirical data to support that but certainly feel like that's a competitive advantage we have in situations like these.

Okay. I guess thinking about data and -- did you see -- on the customer side, you mentioned e-commerce. Was this a better e-commerce quarter because of the storms? Or just in general then -- I don't know if you track like app downloads or other data from customers or customers starting to look at you guys in the mobile app and e-commerce and relying on that.

Yes. We track just about everything you can imagine, and the trends still remain positive. There's a continued adoption of our technology platforms. What's interesting -- so now that we're out of the summer selling season, this is the season to drive continued adoption and that culture change and the change management and driving behavior -- our digital behavior. So our customers -- our contractors are in the summer months, they are tied up every minute of every day with installing and repairing and servicing air conditioning systems. Now that they have time to take a breath, we'll be there with them and getting them more and more comfortable buying online. So the trends remain positive. Of course, we all want that slope of adoption to be even a higher accelerated rate. But we're -- we feel good about the progress we're making.

(Operator Instructions) And the next question comes from Chris Dankert of Longbow Research.

I guess, first off, in the release you guys have highlighted that Watsco made some additional investments in products and people. I guess, is that more just a matter of course? Or is that kind of worth quantifying? Anything else you'd share around that?

Why don't we share the employee increase, Barry?

Sure. Well, net, year-over-year, it's about 100 more people. And it's really what I referred to before as increasing capacity, increasing capacity to serve customers, to sell more, to cover markets. And it's obviously all in the field in a customer-facing way. So we talked about this the last, really, a couple of quarters and some continuation in the third quarter. But it's all, again, increasing capacity to sell and serve customers.

Got it. Got it. And then just kind of circling back to one of the earlier questions on pricing. I guess you said you start to see some of those increased notifications work through. Are those going in to effect immediately? Or is that into 2018? Just kind of what does the timing look like around those increases?

Paul?

It varies depending on what the -- which manufacturer, what type of products. Some of them are immediate. Some of them are December 1. Some of them are January 1. It just depends on that particular manufacturer.

Got it. Got it. And I guess just one last one if I could for A.J. here. Remembering right back the Analyst Day, ticket size for customers who had adopted the app was, if I'm remembering it right, like 2x almost what it is for traditional customers. Is that still the case? Are we seeing any type of change to what the benefit is from having the app in place?

That is still the -- it's not 2x. I wish it was 2x, but it is significantly higher. And the metric is line items per invoice. So they're buying more items when they buy online than when they buy offline. And yes, that trend continues.

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

Once again, thanks for your interest in our company and look forward to speaking to all of you in the fourth quarter. Bye now.

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