Watsco Inc (WSO) 2013 Q2 法說會逐字稿

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

(Operator Instructions)

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

Sorry about that delay. We were waiting for the queue to get online. But in any event, good morning, everyone, and welcome to our second-quarter conference call. This is Albert Nahmad, President and CEO.

With me is Barry Logan, Senior Vice President and Paul Johnston, our Vice President. 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 for these various laws. Ultimate results may differ materially from the forward-looking statements.

Watsco had a terrific record-breaking quarter. We established new records for sales, operating income, operating margins, net income, and earnings per share. Growth rates were strong with sales increasing 11%, operating profit increasing 22%, and EPS increasing 29%.

Residential equipment sales grew at 14%. It was a key to our performances. This reflects a continued trend towards system replacements and better sales mix of higher efficiency systems. We also believe we gained market share again in our markets. We achieved higher selling margins during the quarter for both equipment and non-equipment sales, and SG&A was, again, well managed.

Our culture thrives on serving the needs of local customers with branch density and product depth being the two most important competitor weakness -- competitive weapons, I should say. Let me do that again, our culture thrives on serving the needs of local customers with branch density and product depth being the two most important competitive weapons. We also firmly believe our strategy of incentivizing performance through a combination of cash and long-term watchable equity creates a high and unique culture for our leadership to perform and build value with customers at a scale and commercial -- commitment to grow unlike any other company in our industry. All in all, a great quarter for our Company.

Now on to the specific numbers for the quarter. Revenues grew 11% to a record $1.12 billion, up 8% on a same-store basis. Residential equipment sales were up 14%, commercial HVAC equipment sales were down 6% following a plus 20% comp versus a year ago. Sales of other HVAC products were up 4% and sales of commercial refrigeration products grew 6%.

Gross profit increased 12%, gross margins improved 20 basis points at 23.8%, and SG&A increased 2%. Let me say that again. SG&A increased 2%, excluding new locations. Operating profit improved 22% to a record $105 million with operating margins increasing 90 basis points.

On a same-store basis, operating profit increased 21% with operating margins improving 100 basis points to 9.5%. EPS increased 29% to $1.48 per share. Now for the six months, revenue grew 11% to a record $1.8 billion, up 6% on a same-store basis. Gross profit increased 14%.

Gross margin improved 50 basis points and SG&A increased just 1% excluding new locations. Operating profit improved 28% to a record $136 million with operating margins expanding 100 basis points to 7.4%. On a same-store basis, operating profit increased 25% with operating margins improving 110 basis points to a record 7.6%. EPS for the six months increased 33% to a record $1.87 per share.

Now for cash flow and our balance sheet. We use $59 million of cash in the quarter versus $69 million last year. Cash this time of the year is used to fund the working capital requirements of our Business during the primary selling season. Cash flow will become positive as the year goes on, and our cash flow target for 2013 remains the same as always, to generate operating cash flow in excess of net income. That was $388 million at the end of the quarter, which is less than 2 times trailing EBITDA. We ended the quarter with a debt-to-cap ratio of 27%.

Now regarding dividends, I mentioned during the recent calls that we will continue to review dividend policy during the year and consider an increase depending on a debt position and in other perspective needs for capital. Now as for our 2013 outlook, we have increased our range to $3.65 to $3.80. We are still in the middle of our selling season. There is much execution left to do, but business is good. We are feeling confident that this will be a great year for Watsco.

Now one last item before we take your questions. Watsco will be hosting an investor analyst meeting on November 8 in Miami. We will send out a formal invitation and announcement soon. Please send Barry, our Investor Relations fellow, Barry Logan, a note if you would like to attend. It will be a great event. At a great event, members of our senior management will have fun telling you more about our Company.

Now with that said, Barry, Paul, and I will be happy to answer questions. Andrew?

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

(Operator Instructions)

First question comes from Matt Duncan of Stephens Incorporated.

Good morning, guys, congrats on a great quarter.

Thanks.

First question I've got and, Al, you touched on this a little bit in your prepared remarks, just kind of looking at the replace versus repair cycle. I know in previous calls you guys have talked about equipment sales growing faster than compressor sales, which is a good way to track that. What is, I guess, equipment, resi equipment was up 14%, what about compressor sales? What does that look like right now?

Paul, you want to take that?

Sure. Compressor sales, as they were in the first quarter, in the second quarter they were down.

Okay.

So, that trend that you saw in the first quarter continues as the year is going on.

So, if you can help us understand what you guys think is behind the 14% growth in the resi market? How much of that is new construction versus the replacement market maybe recovering with existing home sales on the rise and there's obviously a lot of other things going on. But how do you break that out between the various market factors and the maybe market share you guys are taking?

Well, the last part is the most important part, market share gains. But specifics on the breakdown, Paul do you have a feel the that?

Yes. Residential new construction is growing at a very rapid clip and we feel we are gaining, definitely gaining share in residential new construction as well as gaining market share in the replacement market. Even though the new construction market is up materially, it's still a pretty small percent of our overall revenue, our overall sales. So, I think in total it is still, it's double digit but just barely double digit as far as what are equipment sales are.

It's certainly moved from the consumer and the aftermarket to replace versus repair.

Sure.

And which I think reflects consumer confidence.

Okay, then last thing and I'll hop back in queue. What type of revenue growth is attached to the $3.65 and $3.80 earnings guidance? You guys were up about 8% organic this quarter. Do you feel like you can keep that up the rest of the year?

We haven't prepared for that we haven't put that forward.

Okay. Thanks guys.

The next question comes from Ryan Merkel of William Blair.

Good morning, Ryan.

Good morning. So, I think you commented on the residential equipment was up 14%. What was the commercial equipment growth rate?

Go ahead, Paul.

It was down 6%.

It was down 6%. Okay. And then can you provide --

That is on top of compared to last year it was up 20%, over 20%. So, the comp is very difficult.

Okay. And then can you provide the volume versus price mix in terms of the equipment growth rate of 12%, I think it was?

Barry, do we do that? Barry? Is he not on the line, Paul?

Yes.

Can you hear me now?

Now we can, yes.

Okay. Ryan, if we benchmark it against the 11% total equipment growth, we did see a positive pricing in the quarter versus unit growth. I'd rather just keep it at that in terms of how much but we did see a little bit of positive price in the quarter.

Okay. Great. Then in terms of the parts increase. I guess we talked about compressor sales being down, so what was really up? Was it supplies for new housing applications? Or what was the driver in the other direction there?

Go ahead, Paul.

We saw -- we benched this among our suppliers to make sure that we are on target with our supply business. In particular, with a small rebound in the new construction market. And we are seeing upper single digit, low double digit growth in things like flex stuck grilles, registers, duct tape, that sort of thing. So, the supply business remains strong, the parts business is not as strong.

Okay. And then just last one. Do you expect same-store SG&A growth to be in the low single digits for the rest of the year?

Barry?

Yes, Ryan, we've said many times the infrastructure cost has been coming down over the last several years, this quarter is no exception. The only thing driving SG&A growth is variable selling expenses and performance-based compensation. Which we're happy that it's increasing because that dictates performance. So, yes, I think the low single digit is certainly achievable in terms of the rest of the year.

Great. Thank you very much.

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

Hello, Jeff.

Hi, good morning, guys. Barry, you said that you saw favorable price. Can you just give us a little more color on mix and just touch on what trend you're seeing in R22?

Sure. R22 equipment sales declined. So, consistent with the compressor decline, and that total is two things. Again, we've said before the replacement market, the system upgrades that's going on in the market is very strong. Again, by seeing lower compressor again and also the lower R22 unit sales. On the mix side, what we said in Al's comments is we did see a better mix higher efficiency systems. I would call it very slight, a very slight increase in mix. We will see how the rest of the season plays out, but it is a positive trend.

Okay. And then, where do you feel you're picking up shares? Is it regionally? Are you -- is it within the brands that you are selling? Just maybe a little bit more color on where you're picking up share and how you are getting comfortable that you are indeed seeing share gains?

Well first, Jeff, we don't have the data from the industry yet. This is our own sense of it, so caution you that this is what we think and go ahead, Paul.

Okay. We feel like we're definitely gaining share in residential new construction because our growth rate there is in excess of what new homes starts were for the quarter. When you get into replacement, it is our sense, obviously, that we are growing share in most every one of our markets because we are seeing sales gains pretty much across the board. And without exception, every brand had sales gains in the quarter.

Okay. Great. And then just final question, can you touch on what you're seeing from an M&A front? You've obviously cycled through a lot of carriage and UV opportunities and so as you shift back to looking back at independent distribution opportunities, what do you see in the pipeline?

Well, we're always eager to invest more in M&A. And I think the needle, to move the needle we have to do fairly substantial transactions. A $3.5 billion run rate, so with that caution that the smaller ones aren't going to move the needle, we still remain interested in doing larger ones. But I'm afraid I don't have anything specific to report to you, if I did I would report it in a separate press release.

One thing I would remind everyone of is that next July we do have a step up in ownership of our Sunbelt joint venture with Carrier, a 10% bump in ownership and a fairly material benefit and transaction for us that is in the pipeline.

That said, longer term we think with what we have we have very good prospects in the sense that we are going to focus on our export business and grow that. We hope hundreds of millions of dollars. We are good at it, we are probably the best there is in the Americas in that area. We also like the technology that is coming through for VRF regarding commercial buildings. We want to be very sizable in that market niche. We also see the recovery going on of systems replacements versus systems repairs. And that's a long-term prospect for us. So, there are a lot of things besides M&A that we have confidence that are going to continue to contribute to our long-term growth rate. And I just highlighted some of the ones that come to mind.

Okay. Thanks, guys.

The next question comes from Josh Pokrzywinski of MKM Partners

Good morning, Josh.

Good morning, how you guys doing?

Good.

Just a quick question here first on cadence through the quarter. It seems like, obviously, not to focus too much on weather but weather might have been a little bit of an irritant, April, May. Any color on how those ended up? And I guess then just the trend into June and July as weather has turned more favorable?

We do not really pay attention to the weather. We are a seasonal business. But I think you pretty accurately described it. In some markets the weather was negative in some markets the weather was positive. I think we just had a great quarter. And I think it's mostly our own performance within the industry regardless of the weather.

The consumer though is looking more outside of any kind of weather that there's a propensity to replace is driving the performance?

Yes, well said. Yes. And I think that's going to continue for quite a while. Don't forget we have been, from that perspective, in a negative market for several years. So, as that turns, and I think it is turning, we have several years of positive impact from that behavior by the consumer.

In any of the sense of the start to July? Any observation on 3Q?

Strong.

Okay. And then going back to the commercial market color. I understand down in the quarter against a tough comp. But any sense that there's been a downward inflection point there? Or softening? Or is that a pure comparative comment?

Let's ask Paul that.

Yes that's -- I don't think there has been any down turn in that market. I think the market was pretty flat for the quarter compared to we were down 6% in the first quarter, down 6% in the second quarter. And a lot of that was some new products that we added in 2012 that really spiked our comps.

So, I think maybe a little bit of it was timing as far as a lot of those are longer-term jobs that take awhile to be from the time we actually quote them, inspect them, until we deliver. So, it is not a lot of dollars difference quarter-over-quarter.

But longer term, as I mentioned earlier, in the commercial side we are very excited about -- now this is going to take many years, it's not going to come right at now, the technology of VRV to help us gain substantial market position in the US and the Americas, VRV technology, and we are gearing up for it, we're investing in it. And it will be awhile for we see a material impact, but over the years it's going to be huge for us.

Great, that is helpful. And then just one last one on the pricing comment, and I understand you do not want to get deep into it. But, obviously, the OEM has put in price increases to start the year. Any sense of how those stock at various queue levels?

Yes they did. That was positive.

Were they stickier at higher efficiency and maybe not as much at 13 SEER? Were there competitive differences there?

Do you know the answer to that, Paul?

No, I don't. I can look into that, Josh. I do not have that off the top of my head.

Got you. Okay. Thanks, guys.

The next question comes from Keith Hughes of SunTrust.

Good morning, Keith.

How are you all doing? Question on gross margin. Giving what was fantastic revenue growth here and some pricing. I thought it would have been up a little more. Where there some offsets that hurt you in the quarter on gross margin?

Barry?

Keith, we are not disappointed in gross profit, quite frankly. You have to consider the fact that equipment by its nature has a lower gross profit. So, the extent that has a terrific quarter, it's going to put some pressure on the algebra of our margin. But I can assure you that gross profit was up for equipment and it was up for non-equipment.

Are you seeing a difference in growth rates on the higher priced equipment versus more mid-priced equipment, thinking Carrier, specifically?

As we suggest, if mix increases, what we're saying is that the higher efficiency systems grew at a faster rate than the base level efficiency.

Okay. Thank you.

Jeff, don't forget that in new construction there are incentives for builders to put in a higher efficiency equipment over the base of SEER equipment. So, that also helps the mix. You would have thought differently. You would have thought they'd go for the least expensive base equipment, but there are incentives for them to go to the higher efficiency equipment.

It is, basically, in the trail over time as this remodel recovery that you've been discussing, as that comes in that's going to be a, even on equipment, a better sale than what we see from the builder of grade, correct?

Well said. Well, I don't know that it's better because the builder is already going into the higher efficiency, but it certainly will help our mix.

Got it. Thank you.

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

Good morning, David.

Thanks. Good morning, Al. Just question on -- I hate to keep hitting the growth equation here. But we look at that 11% growth, obviously, it's made up of price mix and units and sounds like the impact of mix from what I think Paul said was very slight. The price increases though I was under the impression those were not insignificant, so I'm try to gauge that. Is it safe to say that of the 11% growth in HVAC that more than half of that is units? At least, can we say that?

Okay. Paul, if you can answer it, go ahead.

I think that's a Barry question? I think Barry was the one who had that number.

Yes, more than half the growth rate units, yes.

I like your persistency, what you're saying. ( Laughter )

I'm just trying to drill down here. So, then beyond that, I think in the past you've given us data on what percent of your equipment sales were 13 SEER and then 14 and higher. Is there any chance we get an update on that this quarter versus maybe what it was a year ago or last quarter?

That's a little bit proprietary, Dave, I don't remember giving out that level of data.

Okay. And then the final question is, you touched on the weather already. I am just wondering if, anecdotally, if you look obviously most of your markets are in the Sunbelt, but if you look at the few that are in the Snowbelt and Canada. Is there any anecdotal data you can give us in terms of differentials in growth rates that would imply that would've been even better had the weather not been what it was in the northern part of the US?

I would not reach that far. I would just say that we do not like to think of ourselves of a weather company, we like to think of ourselves as a market share gainer because of our ability to provide high-density of branches to provide convenience to the contractor. And, secondly, the product offering. We probably have a larger product offering than our competitors in all markets. So, I just don't want this to become a weather story. You know that the weather has been bad in certain markets and you know it has been good in other markets. And I think that is pretty predictable in future years as well, it's going to continue.

Where we make a difference is in the things that I just stated. The high-density and the product offering. As well as the incentive system that only we can do by providing equity to some of our leaders and they sure work hard to get that equity.

That's fair enough. Okay, thanks very much, guys.

(Operator Instructions)

Next question from Jason Feldman of UBS.

Good morning.

Good morning, Jason

Inventory levels looked about consistent with prior years adjusted for sales. How do you think or how would you characterize some of the inventory levels related to demand today? Are you about where you would want to be?

Barry?

Yes, with the strength in the quarter the inventory that maybe above an overhang we saw in the first quarter plowed through in the second quarter and inventories I think are in very good shape.

Okay. On the M&A front, when you are looking at various options over the course of the next year or so. With the Sunbelt, the Carrier Sunbelt JV option coming up, does that limit your flexibility over the course of the next year?

Not at all. They're not reputations to our remaining activity, none at all.

Okay. And then, lastly, you kind of touched on this before, but SG&A as a percentage of sales kind of at a record low. Sounds like it's expected to grow substantially slower than sales.

Yes, we do believe that.

So where do you see the EBIT margins being able to get to in the year to medium term?

Well, I think we've stated publicly we'd like to get to the10% EBIT margin. So, we have a nice opportunity ahead of us. I have not stated when we expect that because we really don't know. We just like the progress we're making towards that goal.

Thank you very much.

Next question from Mark Douglass of Longbow Research.

Good morning, gentlemen.

Good morning.

Thank you for taking my call. With the commercial HVAC, you mentioned that the very difficult comps there. When did the comps abate? Or do they this year with '12 really strong? And then I think you mentioned that the commercial is -- the market in general is relatively flat. Is there rumblings in the market that it's going to improve in the second half or what do you think in the second half?

Paul, do you have a sense for that?

We are just going on the idea that it's going to remain flat. We're not really hearing anything that shows that there's going to be a commercial recovery in the near term for us. So, our guys are -- we're trying to add new products like Al said and we're trying to get new opportunities for our people out there because if the market's going to be slow, obviously, we want to be in share and gain presence in it with new products. So, that's it.

And then when do the comps get easier again?

Probably next year.

Next year. Okay. That is helpful. And then last question, there was some issues with getting the regional standards adopted this year.

Good point, yes.

Legal battles. Does it look like next year that could potentially come through? Or is it going to be a challenge to get those moved through the legal system?

Go ahead, Paul

Yes, the legal battle continues. It's a suit that was filed by HARDI, which is a group of independent air-conditioning distributors to challenging the procedure that the EPA went through in order to establish these regional standards. I think it is a little bit like what we went through with the change to 13 SEER efficiency. We are reaching a critical point here where people have to either put their inventory in place assuming it's going to go through or not. And the OEMs have to do something or not. So, I think it becomes a moot point as time goes on if there is no settlement whether HARDI is successful or unsuccessful with their legal suit.

Okay.

That's a lot of uncertainty in other words.

It is.

Okay. Thank you.

Next question from Walt Liptak of Global Hunter.

Good morning, Walt.

All right, thanks. Good morning, guys. Just a couple of follow-ups, I guess. On the SG&A keeping at this low level. Can you talk about a couple of things that you're doing to try to restrain leveraging that overhead cost? And if there's anything coming up in the back half of the year, compensation or any true-ups that we should be aware of?

I don't think there are true-ups but go ahead, Barry. Give him a more comprehensive answer.

You know, Walt, it's, again, it shouldn't be any surprise in your SG&A in the second half. About two thirds of what we spend, what I'd simply call facility costs, rent, the people in our branches, the delivery trucks that deliver products, and again, fairly fixed in nature. And the rest of what we spend is a lot of compensation on sales people that's are fully commissioned. On performance based comp, which is largely our earnings growth rate generates a lot of what ends up in our composition structures for our leaders in our field. And, again, the moving pieces are pretty simple and simple to see and look forward to. So, and adjustable based on performance. So, no, it should be, again, a fairly consistent second half based on what you see in the first half.

Okay. And if I can just try to start a new one. You had a nice quarter and the way you presented everything is all very positive. But I wonder if you can talk at all about some of your suppliers? Anything in short supply with the pickup that is happening? Or are you getting better service of mix from any of the different OEMs?

We have had no supply issues with any supplier. Unlike some of the other products you're hearing about, I'm sure you're talking about the survey that was done by the National Home Builders on the components that are in short supply for building new homes. We are not experiencing that and if you read the survey, you found that the one product that wasn't in short supply out of the 24 that they selected was HVAC, so --

Okay. Fair enough. Thank you.

Next question comes from Jeff Hammond of KeyBanc.

Hey, guys. Just a couple quick follow-ups. One, you mentioned in the release raising the dividend later in the year. How are you thinking about just raising the quarterly dividend versus considering another special dividend?

Good question, Jeff. I think we are going to consider only raising the dividend rate, not a special dividend.

Okay great. And the, Al, you mentioned VRS technology, can you just expand on what you are doing today? How you are going to market? And where you see the growth opportunities within that sub-segment?

Well, I will give you my view and then let Paul without diverging too much comparative information, you can follow this up. Jeff, it is one of these technologies that has been around the rest of the world. But is just barely in recent years entering the United States. It is a very efficient way to provide climate controls to commercial buildings. And I just think that the building market in the United States is ready to start doing even more than they have been doing, historically.

And eventually, I think we're going to see some big numbers from it. And I want to be the leader in the US market, we want our Company to be the leader. That doesn't mean we don't have a lot of competition, but I do believe that we have the resources and the focus to get there and, therefore, I think it will have a big impact on our operating results in the years ahead. So, Paul?

Yes. You've looked at it, Jeff, it is great technology. It is a great solution for the small chiller, the large rooftop unit. And it's something that as Al has indicated, we are drilling into, we're looking at what the resources would have to be number one as we are number one in the other product lines that we sell and we're going to be number one in VRS and VRV when it starts working on totals.

Well, we're sure going to try.

We're going to bust our you know whats to make it happen.

Jeff, I do not think that's a short term -- you're not going to see short term results in this. It's more of a longer term. But when it comes, it will be very solid and very significant.

Okay. Appreciate it. Thanks.

(Operator Instructions)

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

Well thanks for listening and we always appreciate your interest in our Company. And I look forward to having another great quarter and to talking to you about it about three months from now. Thanks again. Goodbye.

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