Watsco Inc (WSO.B) 2019 Q1 法說會逐字稿

Welcome to the Watsco First Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note that this event is being recorded.

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

Good morning, everyone, and I hope everyone is having a beautiful spring day. Welcome to Watsco's First Quarter Earnings Call. This is Al Nahmad, Chairman and CEO, and with me is A.J. Nahmad, President; Paul Johnston, Executive Vice President; and Barry Logan, Senior Vice President.

Now before we start, our 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. I'm fighting off a cold. Now Watsco produced another record quarter. Sales, operating profit, same-store operating margins, net income and cash flow, all reached new highs. Results reflect better gross margins and flat same-store SG&A.

Our performance was achieved in adverse weather in certain markets, also difficult sales comparisons from year ago, and one less selling day during this quarter. Although it's very early, we believe 2019 will be another record year. We also continue to make investments. We have opened 12 new locations and -- that add more density in our markets. And we have continued to develop, launch and iterate a variety of customer-focused technologies. Over the long run, these innovations will transform our way of doing business.

Now a few of this quarter's technology results. E-commerce run rate is approaching 30% of sales and were $1.2 billion over the last 12 months. Furthermore, we surpassed 50,000 unique users in our mobile apps.

Next, sales growth rates for active users continue to outpace nonusers. Let me say that, again. Sales growth rates for active users continue to outpace nonusers. Less year-over-year sales attrition is occurring with our user community. And finally, these results speak to one of our most fundamental long-term objectives, which is to partner with our customer and help them outgrow the market. That's what we want them to do. We want our customers to outgrow the market.

Now moving on to our balance sheet and cash flow. Our balance sheet remains very conservative and strong, with an 8% debt to total cap ratio. Operating cash flow for the quarter was a record $53 million, and we, again, target cash flow to exceed net income this year. In January, we increased our dividend by 10% to an annual rate of $6.40 per share. Interesting enough, 2019 marks the 45th year -- I should say, consecutive year that we have paid dividends. 45 consecutive years of paying dividends.

We often mention our 18% 30-year compounded annualized growth rate for total shareholder return, which is among the highest of all public companies, that's 18% in compounded growth rate of total shareholder return. But we want to note that our 30-year compounded growth rate for dividends is 23%. Future dividends increases will be considered in light of investment opportunities, cash flow, our financial condition and business conditions.

In April, we completed the acquisition of DASCO Supply, a great company that has operated in Northeast U.S. for 45 years. It is wonderful to now be a part of DASCO's family. I see it that way, part of the DASCO family, because that's how we look at it. DASCO's name and culture will continue and will be led by the same team that made them successful.

We continue to seek additional opportunities to grow our network, and we believe an ideal time -- this is an ideal time for owners to engage with us, and I hope they do.

Our press release provides important details about our performance, and we will be happy to provide more color during Q&A. One last thing is to renew our invitation to visit us in Miami and learn more about our technology journey. Those who have visited come away with a better understanding of our culture and strategy.

Now with that said, I want to turn to A.J., Paul and Barry for your questions as well as me. Anita?

(Operator Instructions) The first question today comes from Stephen Volkmann with Jefferies.

Maybe we can just kick it off. We've talked over the last couple of quarters about kind of the end market conditions and I guess, Florida and Mexico, specifically, but I think Al, you also mentioned some weather kind of interruptions. So I guess, can you just give us the way of the land or what you're seeing in your end markets?

Let's turn to our daily guy, Paul Johnston, venture that sort of thing.

Yes. We had -- sorry, we can take them one at a time. Florida, obviously, was a unique market this year. The weather wasn't what it normally is, but still we had a very good year in Florida -- or a good quarter in Florida. Mexico, we're still ferreting out what's going on in the political scene there. And as soon as that becomes clear, I think we'd have better outlook as far as what's going in Mexico. But, yes, pretty normal, small -- seasonally small quarter and both markets performed well.

Was Florida up for you this year, this quarter?

We don't get into exactly what each one of our market places do.

Okay. Fair enough. And since you called out weather, do you have sort of a rough estimate of what you think that might have cost you in the quarter for growth?

No. That's -- that would be a million-dollar question, that would be very, very tough to predict how much impact weather has. There are so many other different pieces of what we do in our business with the parts business, the supply, the new construction, the replacement market. It would be totally a wild guess.

The next question comes from Jeff Hammond with KeyBanc.

Just wanted to kind of go through the 2 buckets, one the investment spend you called out, the $1.5 million incremental or $0.03 in the first quarter tied to the Alert Labs acquisition. Can you just talk about how you see that trending through the year? And what you think the full year kind of investment spend headwind is?

Well, I'll turn that over Mr. A.J.

Thank you. We're excited about the Alert Labs acquisition. It's a bet for us, it's speculative, but we believe that the products are being to market, which are just coming online now, should be great for our customers and great for their customers. Judging by the initial reactions through the contractors that we show these tools to, we're excited. We are investing there, and we'll continue to invest as well as the other technology programs. And as I said, over time, where we see opportunity that has a great return on investment opportunity, we're going to go for it. These are investments that we don't expect to pay off in the next month or quarter, but over the long term, and we are a long-term company, so it's consistent with our philosophy.

Is there a way to quantify what -- is that $1.5 million run rate you had in the first quarter, is that the right way to think about the headwind through the year?

I think so.

Yes.

I think that's a good conservative way to look at it.

Okay. Then conversely, I think you talked about some productivity initiatives that help same-store SG&A flat for the quarter. Can you just talk about what you're doing there and how that progresses as you go into the selling season from a cost save perspective?

Mr. Logan?

Well, yes, obviously with 575 locations as we ended the quarter, really I would say in the fall of last year, after the selling season, we really went into a deep dive into data using the BI platform that we have and really simply challenged the status quo with data across our -- across the whole number of branches that we have in Watsco. So during the fall and into the early part of this year, the business unit leaders used the data, made decisions, made changes, and that reflects in the SG&A to start this year. How that plays out in season, obviously, is a matter of the growth rate that's throughout the season. But in terms of repositioning cost, using the data platform we have and being aggressive in that sense, certainly showed itself in this quarter.

Okay. Then the last one. Any color you can give us on April trends and how you're feeling about inventories in your channel as you head into the selling season?

Barry? I don't like to talk about going forward anymore, but what do you want to say about it?

Well, again, it's always too early to make a call in the season. In terms of growth and growth rates in April, again, it's a very narrow slice. I'll say we feel better, I'll say it that way. And -- but we need to feel extremely well all the way through the fall and -- but so far so good early in April.

The next question comes from Brett Linzey with Vertical Research Partners.

Just want to come back to the comment in the release about accelerating several technology investments. I think you said 12 new locations in the quarter. I mean, are you starting to pull forward some of the deployment actions that you would have expected later in the year? Or these actions that were even kind of outside 2019 that you're trying to accelerate and pull into 2019?

Well, I can't give you a precise answer. I can tell you that our decentralized management system authorizes and encourages local leaders to decide when they need a location and why. We don't oversee that, we support it. That's one of the reasons we're so strong in the local markets. So I can't tell you what it's in mind unless somebody else have data. Paul, do you have data what you've heard already from the field?

No, it's just exactly what our people had seen last year as far as market changes, where they needed to position a new branch. And obviously, the importance is to get that branch in place and get the employee -- the employees in place before the season actually starts. So generally speaking, if you're going to have a branch open in 2019, you've got to have it open in the first quarter.

Okay. Great. And then, just shifting to the revenue line. You had flat same-store sales in the quarter, 2% equipment growth, we just heard from Carrier that they saw a 5% growth in their North America residential business. Maybe just help us bridge that disconnect. I know Carrier is obviously a big vendor for you guys. Is it simply just channel loading and channel dynamics, the furnace side, any color you could provide there?

Paul?

Yes, it definitely is. They're reporting what shipments are to their distribution, and we're reporting what sales are to the contractor who actually is installing the units either in a new home or in a replacement mode. So yes, that's -- what you find is because of the high demand that we have in the June, July time frame, most OEMs are going to have higher sales in the front part of the year and then their sales will level out. Conversely, a distributor is going to have lower sales in the first quarter and higher sales in the second quarter.

I'll also add that in the quarter, we also had a 1 less selling day. If I adjust for that, it's right around 4%, our equipment business, for the quarter. So just keep that in mind.

The next question comes from Ryan Merkel with William Blair.

First question from me. I wanted to ask about gross margin expansion in the quarter. What were the drivers and then can it continue?

Barry?

Ryan, we have a simple thing we track called selling margin, which is our markup on the products that we buy and resell, and that was up the full 20 basis points that you see in the financials. So that's simply being a good merchant in light of some price increases. There are more price increases that are -- that came in, in March that will play out for the remainder of the year. But I would say just good blocking and tackling on buying and reselling products as a merchant.

So maybe the rest of the year, kind of flat, maybe up 10 basis points for gross margin, is that fair?

Ryan, it's always a seasonal call, again, based on what's going on in the market. So I'm not ready to speculate on that, but we like the way the year is starting.

Okay. And then, on SG&A, just curious, what do you think is a reasonable range for SG&A growth in 2019? And let's assume that organic sales are up 4%, 5%.

Barry?

All right. Well, again, I said this, historically, that about 50% of our SG&A is more variable than fixed. So in terms of correlation to growth rates in sales, that's how I would look at it. In terms of the present state and the current state, again, Ryan, we started the year in a very good, aggressive, conservative posture with cost. As Al said, our culture is to have our business unit leaders operate our business. It's not done from our level, it's their level. And if they want to add cost or add people or deal with customers that -- in a more effective way, they're incentivized to drive EBIT growth. So just know, again, it's a more conservative posture to start the year and, again, our business unit leaders are the ones that pulled that off, and it's a good starting place.

Okay. That's more color than I was actually expecting on those 2 questions.

You deserve more color, Ryan.

I really try. All right. Let me give back to one nonfinancial question. So is there any risk that the reduced headcount could hurt service levels?

Well, that's a very good question. But again, corporate is not making headcount reductions, it's the people that are in the local markets. And I think that they will adjust headcount as they see fit. If the consumers or the customers require more personnel, they'll do it. It's not a fixed system. We believe that they're smart in what they do, our field leaders, and they'll deal with what's required.

The next question comes from Robert Barry with Buckingham Research.

Nice to see strong performance on the SG&A front.

Thanks.

So going back to the same-store sales being flat, I'm sure you guys are not happy with that. I mean, what do you think you can do to get that going?

Well, we gave some explanations, or I did. I gave you 3 reasons. And Barry has further developed that, that if we have 1 less day, which would dramatically change what you're asking about. So I think we're fine.

Okay. Do you get that day back in third quarter?

I'm sorry, what?

In the third quarter, do you have an extra day? I think you get it back.

Eventually, yes, it all catches up. That's correct. And also, don't forget that last year was a very large first quarter across the border in the industry.

Right. No, fair enough. Okay. Any buying ahead of those March price hikes? I saw the inventory was...

Yes. Absolutely. I'll let Paul give you some details on that.

Yes. We certainly -- there's a good reason why we have a powerful balance sheet. We use it as merchants to be able to buy forward a bit. We don't do it in an extreme manner, we just do it in a prudent manner, which we can move the inventory through. So yes, we did buy some inventory beforehand.

But also sometimes we noticed logistics from OEMs where they don't have the drivers or the trucking that they need. So we -- then we -- just to be conservative, to be able to support our contracted customers, we'll buy ahead, so we can assure our customers of having the product they need.

Yes. It really goes back to your sales question, right? We want to make sure we have every product that every customer needs on every day and every location. So -- and this...

What is our completion rate, Mr. President, on that? What is the data?

Yes, since the implementation of our demand planning inventory optimization tools, our customer service levels in terms of order fulfillment rates have gone from in the neighborhood of 92% to 97%-plus. And that's a factor of using math and science and data to make sure that, again, we have the right products at the right place at the right time to match the expected demand. And we can use our balance sheet as needed to ensure that, and that's what helps customers feel comfortable that when they walk into our store that source that they will have what they need.

Got it. Just lastly from me, I saw that you promoted Steve Rush to COO. Can you -- any comments on what he is going to be focused on?

Yes. Steve Rush, our 20-year veteran. Everywhere we've asked him to go, he does -- he leaves a trail of success. And he now will focus, rather than on individual units, he'll focus on the entire operation. He is good. He will support the Co-Chief Operating Officers and their leaders in doing even better. He is a veteran, and the operations will report to him.

Anything in particular he is focused on, any initiatives or kind of his priorities in that role?

When he tells me, maybe I'll pass it on to you. Maybe A.J. knows. Go ahead.

Yes, his mission is, again back to that first question, it's growing sales and growing EBIT, right? It's the blocking and the tackling, it's the making sure that the local leadership has what they need and have their teams organized the way they should have them organized. And again, he's done this very successfully in our company for 20 years, and he can be a tremendous resource for the divisional and subsidiary, divisional and regional and local leaders who are making decisions everyday, they can tap into his wisdom. But that's his mission, it's drive sales and EBIT.

The next question comes from Josh Pokrzywinski with Morgan Stanley.

Just a follow-up on couple of questions that have already been asked. Paul, I know talking about 2018 that a lot of the diversion from growth that we saw across the industry was largely geographic, your home state and mine being pretty big outliers relative to the Sun Belt. Do you think something similar to that happened in the first quarter? Or do you think it was a little bit more evenly spread this time around?

I think it was very evenly spread this time around. The first quarter is not an in-season quarter any place in the country except for some furnaces. So really if something is going to play out, if there's going to be variances, we'll start to seeing those in the -- in May and June.

Right. And just, Josh, to be still abstract, but somewhat specific -- and just having fun saying it that way - is if you take the growth rate, account for the selling day difference, then ask a question, U.S. versus international, Latin America versus U.S., commercial versus residential, the bandwidth of growth rates this quarter was almost in a very narrow range consistent with the overall growth rate. So when Paul says it's pretty spread out evenly, that's -- that would add some depth to that comment.

Yes, the way I look at it -- I've always looked at it is, Watsco is a steady grower. We -- sometimes we grow faster than other times, but we always grow. And as long as it can be steady year after year which we are and grow our network that will provide additional growth that way through M&A or additional share market gains, we should continue to be steady, steady grower, sometimes faster, sometimes slower, but that's seems to be our profile. And I think that's pretty healthy.

That's helpful. Just following up on the inventory questions and the decision to bring on a little bit more to start the year. I guess, how do you guys interpret that in terms of -- or how should we interpret that in terms of your outlook for industry pricing this year? I mean, I guess, you've seen some of the metals prices come off, you have a major supplier out there who's still working to get production back online. So maybe some folks want to take some share. Do you think pricing is going to have kind of an above average year in 2019 where you would want to buy ahead or is there something else we should think about?

Paul?

Yes. I think last year was the price year, the year of the price, the year of the tariff, the year of the commodity run-up. So I think we saw a lot more pricing action. Oh my God. So we saw a lot of that price action last year. This year in the first quarter, we've seen some of it. I think it's going to be -- it's going to slow down now because you're not seeing as much fluctuation in the commodity prices, you're not seeing as much fluctuation coming from the steel. Like you said, it came off a little bit. So I'm just hoping for a nice steady. I guess, buying forward has 2 meanings for us. One is, as A.J. stated, to make sure that we have the product available and we have it in the barn and ready to go for our contractor customers. Yes, it is a nice little hedge against the price increase that some of the manufacturers had announced, but basically, I don't see this year as being as volatile or as amazing as what we had last year in the way of pricing.

Yes, this is A.J. I would add that our buy-aheads are already complete. The summer season is starting now, so I think as far as our inventory goes, this is peak.

The next question comes from Chris Dankert with Longbow Research.

In the press release you guys highlighted some freight optimization. I guess, what was the impact of freight in the quarter? And is it just renegotiation of contracts? Or what is going on in that optimization?

I think that's a -- A.J. do want to take that or you want Barry?

Yes, Barry may have the actual numbers. I'll tell you that the process is, again it's all about challenging the status quo, like Barry said earlier, right? We -- it's another part of our operation that's been done largely the same way for a long time, but now, we're bringing data and tools and technology and wisdom to doing it all better. Right? Using our trucks more efficiently, measuring and tracking mileage, using third parties, being more aggressive in using more data that's more available through technology to select low-cost carriers. And this is a multifaceted approach to how we can attack and be more efficient with our freight spend, which is a large number for us, one of the biggest spends across our SG&A. So it's a lot of effort going into it, which, again, will take time to scale across our operation, but Barry, I don't know what the impact was this quarter, I thought you may add?

Yes. Again, we'll just -- first, it's about $60 million number annually. And in the quarter, you can do the math. And for this quarter, again, very flat in terms of trend. And I don't think it's been flat in my career in terms of relative year-over-year changes. So again, what it is, by the way, is last mile delivery. It's in last mile freight. It's moving things from our branch within 20, 30 miles of that branch to service customers. And it's been -- always been one of the most enigmatic and difficult cost to manage because of the diversity and really the proliferation of small carriers and so on. So with technology, it's brought a better technology to, as A.J. says, math and science, to every branch and we're just starting, but it's a progress.

Got it. That's really helpful. And if I can just kind of pull the thread on that, that last mile delivery, just a hair more. We've seen ride share moving a little bit more into the freight share with thinks like Uber Eats. And we've heard some distributors tote the idea of using a service like it to deliver parts to contractor customers in the field. Is that an idea that, from a flex standpoint, you've considered? Or is it that more appealing to competitors that don't have 400 trucks at their disposal?

I will take that. This is A.J. It is something that we will be experimenting with. There is a number of providers out there. Uber is just one of them. We have been way ahead of this. And -- but I think we are also uniquely positioned to take advantage of that offering if there is an interest from our customers because of our technology platforms, not to be redundant, but you heard the statistic that over 50,000 unique users used our mobile app this quarter. Right? Those are screens where our customers can place orders and choose how they want to receive their product, either by pickup, traditional delivery or they can get it potentially "hot-shotted" out to them via either one of our trucks or a third party. So if and when that does become a real option, I think we're uniquely positioned to win with it.

The next question comes from Blake Hirschman with Stephens.

Just real quick on DASCO. Just kind of want to see if you can share any more color on the deal announced a few weeks back, whether that's around the strategy behind it or anything by the way of multiple paid or estimated accretion?

Well, we're not going to respond to valuation, but we're going to respond to our enthusiasm for having a company with a great history for 45 years joining our organization and very eager for growth given the useful tools that we can provide, not only in technology but with product offering. And they will take whatever they want from product and technology as they wish it. We don't want to disrupt what they do so well. So yes, it's a positive, and it's a positive in the region where we don't have that much business yet. Let's hope that it's the beginning of something much larger in that region.

Got it. And then, lastly, on the footprint, just how should we be thinking about the plans with openings versus closures this year outside of additional branches brought on with DASCO. That's it from me.

We answered that. Paul?

Yes. I mean, our people are opening branches where they need to open branches, where there's customers and where there's upside market opportunity for us. And so that decision is really being made at the local level, and it's been implemented at the regional and local level.

This is A.J. I'll tell you one more thing about DASCO that's interesting, is I get asked often what will this industry look like in 5 years or so. And my answer is that there's going to be the haves and the have nots and the differentiator is going to be technology. And that's going to be true at the distribution level and at the contractor level. Because as you look out, it's going to be based on the customer expectations. Whether your customer is a contractor or a homeowner, they're going to expect a different level of service, a different level of attentiveness, a different level of speed, which is all only possible with technology. And the DASCO team sees that, they recognize that. And part of the -- a lot of the conversations that we've had with them over the last several months has been centered around, we know that technology is key today and is going to be even more fundamental going forward and we want the support and the help of Watsco to help us get there and to achieve and to help us continue to support our customers and grow. So that's another angle of the whole technology story.

The next question comes from David Manthey with Baird.

Is it safe to say here that there's a lot of minor puts and takes this quarter with days and weather and price and things? If you just look at equipment units, is it pretty safe to say they were fairly flat against a tough comp?

Barry?

Yes, that's right, Dave. Probably -- again, if I account for the loss of a day, if I account for that, slight growth in units and some growth in price and mix. But I think what's more important is what I said earlier, is that if I look across markets and commercial, residential and so on, very consistent growth and dynamics across all the different flavors.

Yes. Okay. And then, to drill in on other HVAC products, Paul, maybe you have some details you'd be willing to share as it relates to either construction-related products or repair products, any trends you're seeing one way or the other there?

I don't really understand the first part. Construction-related products?

The duct work and things that would only go into a new construction versus...

Yes. That continues to be strong. That's been good for us and that's on the off-season we always have a consistent sales level that we are able to provide on the installation type product. So new construction, although a small portion of our business, still was good in the first quarter. Excellent.

Relative to new home construction trends, you feel at this point you are holding share today?

I think we have done very well in new construction in the first quarter.

(Operator Instructions) The next question comes from Patrick Baumann with JP Morgan.

I just had a quick one for you. Or maybe 2. The HVAC products and refrigeration products businesses were down a little bit in the quarter. Just wondering if there was anything unusual like store closures or something like that driving that or is it just kind of the way they are in the market in the quarter or things like that?

Paul, wasn't pricing part of that refrigeration?

Well, on the refrigerant, it was on the refrigeration products themselves. We had some -- it was basically flat. Our refrigeration sales are basically driven by -- a lot by the ice and reach-in cooler business and it all ties back to how many store openings there are and how many hotels and motels and restaurants. Refrigerant is kind of an odd animal. The refrigerant itself was down in the first quarter and that was because we had a huge price run-up in the first quarter of last year that we saw come back down in the first quarter and then in the last 2 weeks, we have seen it go back to where it was again. So just a volatile situation, but not a big piece of our business.

Okay. Understood. And then, maybe I think, Al, you mentioned towards the beginning that it being an ideal time for owners to talk to Watsco. Just wondering if you could maybe unpack that comment a little bit in terms of what you're referring to.

Well, those of you that follow us know that we are an M&A company. I think we're well over 60 transactions. And we have a terrific balance sheet and we want to do more of it because I think we can help others grow and keep their culture. We're very unique in M&A that way. We don't try to change cultures, we don't try to change leaderships. We just want to support and to do more and provide capital, provide additional products and technology and whatever else they might need. And I think that eventually, and we're already seeing it, more kind of distributors are -- want to -- are attracted by that and reach out to us or we reach out to them. And it's all, I'm enthusiastic that the time is on our favor. Now, I cannot tell you what we are going to do the next quarter or this year, no, I can't do that, but I can tell you that I think that it's -- the time is on our side. As long as we continue to invest in technology, as long as we maintain our decentralized structure and all those things, our M&A should be active.

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

First, Anita, I want to thank you for doing such a great job, monitoring this call. And I hope you'd be here the next time. And then, I want to thank all our listeners and for your interest in our company. We hope to have you on our next call. Thank you.

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