Watsco Inc (WSO) 2013 Q1 法說會逐字稿

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

(Operator Instructions)

After today's presentation there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mr. Albert Nahmad, President, CEO and Chairman of the Board. Please go ahead, sir.

Good morning, everyone. As you may have noted, I like to add leaders of the Company on these conference calls. And today we have Barry Logan, Paul Johnston and Ana Menendez. The new one is Ana Menendez. She is the Company's Chief Financial Officer. This way you get exposure to not only me, but several of our corporate leaders. First, the 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 for the quarter. Watsco had a solid start to the year, delivering record sales, operating income and net income, along with strong EPS growth. Operating margins increased significantly from the combination of sales growth, higher selling margins, and operating efficiencies. Residential HVAC products showed a 6% growth rate for the quarter, which reflects a continuing trend towards systems replacements and a better sales mix of higher efficiency systems. Our managers kept close watch on SG&A during the quarter.

Some of the markets had volatile weather during the quarter. And expenses were well-managed to produce terrific earnings growth. The ability to quickly match expenses to market conditions has become a way of doing business for Watsco. A remainder -- and this is important -- of the first quarter represents the lowest seasonal time of year for sales. So we are satisfied that we are off to a good start to what should be, what we believe is a great year for Watsco.

Now the numbers. Revenues grew 13% to a record $714 million, or 3% on a same-store basis. Residentially, HVAC equipment sales were up 6%. Commercially, HVAC was down 5% following a 20%-plus comparable a year ago. Other HVAC products were up 1%, and sales of commercial refrigeration products grew 7%. Gross profit increased 16%. Gross margin improved 80 basis points to 24.6%. And SG&A decreased 1%, excluding new locations. Operating income improved 53% to a record $31 million. Same store operating profit increased 40% within operating margin improvement 120 basis points to 4.4%. EPS increased 70% to $0.39 per share.

On to cash flow and our balance sheet. We used $17.5 million of cash flow to build inventories for the upcoming selling season. Our cash flow target for 2013 remains the same, which is to generate operating cash flow in excess of net income. We also remain conservative when it comes to our balance sheet. Debt was $322 million at the end of the quarter, less than 2 times trailing EBITDA, with a debt to cap ratio of 24%. As I said during our last call, we will continue to review our dividend policy as the year goes on and consider an increase, depending on our debt position and other perspective needs for capital. As for our 2013 fiscal year outlook, we estimate EPS in the range of $3.60 to $3.75, reflecting organic growth, accretion from Canada, and the benefit of increasing our ownership in the first Carrier joint venture by 10% last July. Now with that said, we are prepared to answer questions. Andrew?

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

(Operator Instructions)

Ryan Merkel of William Blair.

So, first, why give annual guidance early? Is there any increased visibility you have, or what was the reason for that?

Ryan, we can't win with you. (laughter) No, we are feeling pretty good about the year, even though there are weather volatility and all this other geopolitical stuff. But we're just feeling good, so we thought we would come out early.

Okay. And can you give us what is your organic growth assumption in the guidance? Is that something you can share?

Sure. Let's go to Barry.

Hi, Ryan. There is a good start to the year if you look at the last -- really, this last quarter, the revenue growth rate for residential is 6%. By the way, that is one less day in the first quarter. So, it's even closer to an 8% growth rate. So, that's a good start in what is the off-season. And we really do not provide specific revenue guidance, but I think that gives you some inference into the trend, what we saw in the quarter in terms of our confidence for the rest of the year.

Okay. And then, as I did some of my channel checks for the quarter, I was hearing things like weather was truly ugly. And so I'm just curious if you think that impacted growth this quarter?

Well, that's what we've tried to represent in the earlier comments that where the markets were impacted by the volatile weather, we did manage SG&A, which improved our margins. But it's not abnormal. Our coverage now is so great throughout the United States that I feel very diversified so that weather changes or weather volatility in one section of the market is over -- we have other markets that compensate for that. So, we've taken out, pretty much, volatility to geographic areas.

Okay.

That was our goal, was to diversify away from geography, diversify away from equipment brands. And those are two big goals that we've achieved.

Okay, and then just last one for me. What drove the year-over-year gross margin increase?

Barry?

Ryan, there's a few things. First, when the residential business does outgrow the commercial business, that's a pick-up in margin for the overall Watsco business. We also saw some price improvement, which helps margins in the big picture. There again, it's early in the year. I would not impute what you see in the first quarter for the entire year. But again, in the early part of the year, it's a good start.

We are one of those few companies that likes price increases.

Right.

I mean, we still want to be competitive in the market, but if the market moves with prices, we do better.

Great. Nice quarter. Thank you.

Matt Duncan of Stephens Incorporated.

The first question I've got, Al, on the growth rates that you gave for residential commercial equipment, et cetera. Were those total Company or were those same-store?

I think we reported both ways. Are you talking about the equipment? Excellent question. And once again -- Barry.

It's on a same-store basis.

Okay, very good.

Remember, that's one day less in our quarter than the comparable to last year.

Sure. On the Carrier Canada business, I know when you guys first bought that, the profitability was a little below what you had hoped for. Can you talk a little about what you have been able to do --?

No. Those questions were asked before. We're not going to comment on specific units.

Okay. Do you have any view on how much a lift in residential construction may be helping your equipment sales, and parts and supply?

Excellent question. Let me turn, to get a little diversity in the questions here, to Paul Johnston.

Okay. Yes, first quarter we got a nice lift from residential new construction. It's still a small piece of our overall business, but it was enough to offset maybe some weakness that we had in the replacement business.

Okay. So, Paul, the replacement business, do you think it was down year over year? I'm assuming weather would have played a role in that, if so.

Yes, it probably was down a bit.

Okay. And the last question I have -- can you talk a little bit about mix, both in terms of 14 SEER and above versus 13 SEER? And then, what are you guys seeing in the mix for R22 versus 410a right now?

Go ahead, Paul.

Okay. We saw some definite improvement in the higher SEER products in the first quarter. Like I say, it's a very small quarter to get any trends off of, but we definitely did see those. Better news, I think, we saw in the 13 SEER product -- we saw a little bit of a pick-up in the Mid Tier 13 SEER. As you remember, last earnings call we talked about not only was it going to 13 SEER, but it was going to the low-end of the 13 SEER.

And as far as the dry charge, it is still is not even a blip on the map. It's very, very small. It hasn't grown. Hopefully, we're going to sing the death knell of that product line.

Paul, is the EPA allowing more version R22 production this year than had been originally assumed? Does that have any impact on anything?

They did allow for more version to come in. I think we're up to around 63 million pounds, is what the allocation is for 2013. Higher than what we wanted. Higher than what the industry wanted. But still you've got an 80-million-pound demand out there. So, it still leaves a nice gap. I don't think it's going to revitalize the dry charge unit sales in the marketplace, just because we have a few more million pounds of 22 than we anticipated though.

Okay, very helpful. Thanks, guys.

David Manthey of Robert W. Baird.

First off, there was a rundown of the four different product categories. Can you give us what percentage of sales each of those categories were this quarter? Usually you give that data.

Do we do that, Barry, usually?

Yes, we do.

Go ahead, please.

Yes, 61% is the total HVAC equipment. And 4% is the commercial refrigeration. And the remainder, 35%, is the non-equipment HVAC.

Great, okay. And then, of the non-equipment other HVAC segment, could you remind me, what percentage of that is approximately related to new construction versus repair parts? And if you just want to give me bigger than a breadbox, that would be helpful.

Yes, Dave, it's a guess. I mean, if we sell a box of duct tape, we don't know necessarily where a box of duct tape goes. And that would be an example in that category, or a thermostat, or a piece of copper tubing. So, it's not something we necessarily track. Our good guess would be around 20% of the supplies business, would be a good guess. Equipment would be less, supplies would be something more.

Okay. You're saying 20% is related to -- what is the 20%, Barry?

20% of the supplies business.

Is new construction?

Yes, that would be a good guess.

Okay, all right. And then the gross margin -- so you discussed a little bit in terms of the mix implication there, and you said not to necessarily extrapolate. Could you talk about where you think pricing came into that? I mean, is a good chunk of that gross margin improvement something that -- as the price increases went in early in the year, you were able to capture some of that in GP, and that will burn off as we move into the selling season? Or any other help you can give us there as it relates to pricing or mix on GP.

Again, the price --

Paul? You want that, Paul? Barry -- okay, go ahead.

No, go ahead. I'm sorry.

Go ahead, Barry.

On the price increase, it does impact the earlier part of the year more so than the proportion for the rest of the year, just in terms of how the price increase is executed. Again, don't want to give the data as a guess. Pricing is probably in the 20%, 30% range of the change. And again, that is what would tend to diminish as the year would go on. The product mix, both in terms of SEER and residential versus commercial, if that trend sustains itself, then that has a longer-term benefit to gross profit.

Great, okay, thank you. That's helpful.

And then the final little question is in relation to dragging these segments down to EBIT margin. When you think about the incremental variable SG&A costs related to the other HVAC stuff --the thermostats, ductwork, registers, that sort of thing -- versus HVAC equipment. Is there any reason to believe that there is more parity between equipment and non-equipment at the EBIT line? Or is there still a profitability gap for you, so that if the mix shifts towards systems, that it would be somewhat dilutive at the EBIT line as well to margins?

Well, we do earn more on non-equipment in terms of margins. What is the overall impact -- Paul, do you have a sense for that?

I don't have an exact number on that. We've never tracked that all the way down to the EBIT line. But obviously there's a lower expense to selling the supply business than there is to sell the equipment, as far as sales coverage and that type of thing.

Okay. Well, thanks very much, guys.

You bet.

The next question comes from Josh Pokrzywinski of MKM Partners.

Can you just give us a bit of an update on what you're seeing so far here in April? And then I have a question on the commercial business when you're done with that.

Well, I'll give you a general impression -- looking good.

Fair enough. Are we feeling like weather is normalized enough to have a view on kind of underlying demand or is that --

Well, I don't like to -- Watsco doesn't like to comment on weather because we don't want to be a weather-driven business. We are diversified geographically. When weather volatility impacts us one place, we have something else going in a different part of the country. So, we're not going to comment on weather. We're just going to tell you that it looks good. And we're feeling good about the year.

Right. I guess I meant the question more from a weather agnostic perspective of -- have you seen at least enough noise come out of that to where you feel like that's a market comment and not a weather comment? And that seems to be your answer is that, yes, it feels good.

Yes.

Okay. And then on the --

I mean, it took a while to diversify away from being focused on a single geography. And that we have accomplished. That was a goal, a long-term goal. And now we operate throughout the country. I know we have folks in the Sun Belt, but the Sun Belt goes from coast to coast. So, we're taking the weather dimension out as much as we can.

Got you. And then, on the commercial business, obviously down on the quarter for equipment --

Those are comps primarily, because last year it was up --

Right. That's what I was trying to get at is, how much of that do you feel like is -- what's your sense of how the market is doing -- kind of better, worse, about the same?

Good question. Go ahead, Paul.

Part of the commercial business obviously is project driven for us. And so, we had some good comps last year. Obviously, we were up 20% last year in the first quarter. This quarter some of our business was down. I don't think it was market related in our particular case. I think we're making good traction there. As you know, this is a business that we entered into full throttle about two years ago. So, we're more concerned about our activity within the market as opposed to what the market actually is doing there now. But I'm not taking -- down 5% in the first quarter, it could be a matter of a project slippage or a project moving out -- not getting concerned at this point.

From one quarter to another is what he means. The cut-off of the quarter. There may be projects that might have been delivered in the prior year just before the end of the quarter, which this year being delivered at the beginning of the second quarter.

Right. And I guess to the extent that there's a notion out there that nonresidential construction is getting better, Paul, would you say that that's fair, based on what you're seeing? Or is it still too early to tell?

It really is too early, Josh. Right now, like I say, our business is good in this area. And because we've been in it for two years, I think we're more concerned about our own internal metrics of growing against ourselves, as opposed to what the total --

Because of the share gains that we are expecting.

Understood. Fair enough. Thank you.

Jeff Hammond of KeyBanc Capital Markets.

You mentioned the res HVAC equipment and then commercial HVAC being down. I just want to make sure we are clear, because in the past you gave HVAC equipment, HVAC non-equipment and commercial refrigeration. So, can you give us the growth rates on those three buckets?

The HVAC equipment is up 3%. And that is the composite of the residential and commercial.

Okay, great. And then, non-equipment?

And I think that was in the script, but I'll give it to you. It's up 2% for the non-equipment.

Okay. And what is the rough mix of HVAC equipment now commercial to residential? That's 61% that's HVAC equipment. What's the rough split?

Well, I was just looking. About 20% is commercial.

Okay, great.

By the way, it might be helpful to let you know that it's a non-equipment business starts to grow at a faster rate, that's going to be an indicator of new construction down the road. What would you say, Paul, about an eight-week lag?

About an eight-week lag, and our supply business only runs about five times bigger on R&C versus a replacement job.

Okay. So, if you take -- if you extrapolate your commentary that new housing was strong in the first quarter and replacement was slightly down, should we start to see an acceleration --? (multiple speakers)

Did you say that, Barry?

I did.

I thought Paul had said that.

Paul. I don't think that's an accurate comment. I think we're still in a replacement-driven business in the first quarter.

Definitely.

No, it's the replacement business that contributed to our performance more than the new construction. The new construction is still -- overall, it may be, I don't know, less than 15%, probably more like 12%. So, no, the impact is coming -- as I continue to say, we are basically and fundamentally a replacement-driven business. And we do take advantage of new construction; our shares there are very good. But it's not ever going to be -- have the impact of replacements. And we like that because the overall industry market is still and will ever continue to be in the replacement business.

Okay. And then just on the outlook. How are you thinking about just the replacement market from an industry perspective within your outlook? And then also if you could comment just on how much this commercial comp issue may impact the year, and does that continue?

Gee, that's a lot of forecasting. I don't -- it's hard to -- it's a good question, but it's hard to give the answer to that. I just feel good. I mean, not great -- good. Great will be when the industry starts to grow at a much faster rate, which we used to have. And that's what we think is what the pent-up demand is all about -- that we're still expecting down the road. Paul, have you got a better answer than I just provided or --

That's an incredibly difficult question, Jeff. I wish I had the right answer to that.

But I guess good kind of equates into a normal kind of replacement growth as opposed to pent-up -- you're not really counting on a lot of pent-up replacement demand.

Well, we are counting I would say more this year than last year. But still not to the levels that we expect when the pent-up demand lets go.

Okay. And you mentioned the dividend in the release. When will you address the dividend again?

It's an excellent question. You know, we like increasing dividends. That's been our history. We paid the special dividend at the end of last year because the tax rates were changing, and I think our shareholders appreciated that. And then we reinstated a smaller dividend. And we are just looking for an opportunity to start again on increasing dividend policy. And I would say, the specific answer to your question is -- let's wait through the third quarter, I would say, unless something extraordinary happens before then.

Okay, great. Thanks, guys.

Rohit Seth of SunTrust.

First on the acquisition market.

Could you take it off the speaker, please?

Yes, please.

I'm sorry. Can you hear me better now?

Oh, much better, sure.

Okay. Sorry about that. It's Keith Hughes, SunTrust. Two questions. One on the acquisition market. If you could kind of characterize what you're seeing there now. I know we are seeing a lot more building product and consumer-durable deals and a variety of sectors coming to market.

Yes, you know, for us on the acquisition market, we changed our thinking. We need to do large transactions. And, well, I'm not too excited about what we see. I know that I was more excited than -- on the previous call. But I'm not as excited about that. I think this will probably be a -- this year will be driven, and well driven, by what we already own.

And could you comment on pricing? Any price increases from your suppliers, and acceptance of that into the market?

Go ahead, Paul.

Yes, we had several price increases, as you know, in the fourth quarter, with several of the OEMs. And most of them have been rolled out. And we saw some impact of that in the first quarter.

Do you think we will see a greater impact in the second quarter?

I don't think we will see a big impact in the second quarter. I think we pretty much have seen what the price increases have rolled through so far are going to continue to be in effect in the second quarter and third quarter.

That's certainly true, Keith, of the equipment. The OEMs and the equipment, I think, are done.

Yes.

The other, the non-equipment guys, you may see a little bit of that.

I guess my question was on the positive benefit from that for you.

Yes.

Did you think you would realize that in the first quarter --

Well, it might last a little bit longer in the first quarter. But it's not -- we don't expect equipment price increases through the end of the year. Is that correct, Paul?

Yes, that is correct.

Yes. OEMs, I don't believe, are going to do that. Now, on the non-equipment, which we also benefit from, if the market absorbs the price increases, that's a different story. They are much smaller manufacturers. Generally, the market does absorb those price increases.

Thank you.

Keith, I do want to make one comment on the acquisition, just a reminder.

Sure.

We obviously do have a second option to buy 10% more of Carrier Enterprise, our Sunbelt-Carrier enterprise joint venture, July of next year. So, it is a date-certain, and an announced-certain in terms of making what we consider a good, meaningful contribution to earnings in the Company beginning in July 2014.

I assume your intent is to exercise that when it comes due; is that correct?

It is our intent.

Thank you.

Sanjay Shrestha of Lazard Capital Markets.

Can you actually give us some more color in terms of the mix between the high-efficiency versus the low-efficiency product [won] in this quarter, expectation for this year? And as we start to sort of think about the high-efficiency product going forward, what do you think is going to be the customer uptick rate is going to be? And how does that end up impacting your overall revenue and margin along those lines?

Well, I think that we have seen a correlation between consumer confidence and sale of high-efficiency product. If consumer confidence is high, their tendency is to spend more for efficiency savings. If it's low, they want to just get by with as little as possible to keep the cooling or heating going on in their residences.

Paul, have you got anything more than that?

Yes, it's been fairly stable here for about the last five quarters, as far as what the mix is between 13 SEER and all else. And as I indicated earlier, the only good news we had this quarter was we are starting to see a migration up to the Mid Tier of the 13 SEER. But outside of that, like Al said, it's all about consumer confidence and how they feel about their income.

Sure. One follow-up on that then, guys, right? I know you briefly mentioned it in your prepared remarks. But this whole notion of the pent-up demand in this industry, right? So, the expectation is that it starts to sort of release a bit here this year. And if consumer confidence stays up, it sounds like we are finally at that tipping point where we could really see a pretty meaningful growth --

That's being -- forecasting more than we are prepared to stand by now. We are just seeing some elements of that. We always report there are 80 million homes that have equipment that eventually has to be replaced. But I would not say conclusively that we have spotted a normalization of the industry growth rate in the after market. It's just too early.

Okay. Fair enough. Thank you so much.

(Operator Instructions)

Steve Tusa of JPMorgan.

Within the non-equipment stuff, were compressors down in line with that number, or up in line with that number?

Barry, do we answer that kind of question?

Generally we haven't, Al.

Yes. We would rather not provide that sort of information.

And I guess you talked about pricing. You said the OEMs have already put most of their price increases through, with copper going in the direction it's going, and the commodities down --

Good question, yes.

Do you sense that your customers are going to start to maybe push back a little bit more? Or --

Well, if they do, I think the OEM will react. If they don't, the OEM will do very well, I guess.

Do you think the OEMs would ever, like, take price down?

Well, I think every distributor has a relationship with the OEM. It depends on who they are and what their competitive posture is at that particular distributor. In our case, we are very share-market-driven. And we have historically had good support from the OEM as we drive share gains. I don't think that -- there may be an exception to that, but all OEMs will participate in wherever the market pricing is so we can gain share.

Are you seeing any impact from Daikin-Goodman yet? Anything to speak of, as far as what's going on in their communications, or how they --

I don't think Daikin has released any product yet, so it's all still good [menden], no.

No real change there?

No.

And sorry, one last question. What is the organic growth assumption in your guidance?

Barry, did you provide that, or do you want to provide it?

Steve, really we are providing an earnings outlook, not specific guidance on the top line.

Okay. Is there any reason from a comparisons perspective it should be a lot different than what you saw in the first quarter?

No, I think I made that --

(laughter) That's good, Steve.

All right. Well, that's all I've got.

Don't forget, Steve, which was brought out earlier -- the first quarter this year has one less day.

Right.

So, I don't know, we might have either beat or at least met, I would say, revenue expectations in the first quarter, had they been comparable days.

Sure, okay. Thanks a lot.

Matthew Dodson of JWest, LLC.

What's the name of the company?

JWest, LLC.

Okay.

The EPA had the issuance of R22 on March 28. Have you seen any price increases -- or decreases, excuse me -- for R22 since then, or has it stayed pretty much flat?

It has stayed flat.

And then, what is your expectation of R22 going forward, and how will that affect your replacement market?

What do you mean by your question?

Do you mean in the equipment sales? Is that what you were --

(multiple speakers) -- gas, or what are you talking about?

Yes, so if R22 goes back down, how will that affect your replacement market in your R22 equipment sales?

It really won't.

No impact at all.

The two are really not related.

All right.

Andrew?

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

Well, as always, thanks for your interest in our Company. And we look forward to more conversations at the end of the second quarter. Goodbye now.

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