Watsco Inc (WSO) 2015 Q1 法說會逐字稿

Good morning and welcome to the Watsco first-quarter 2015 earnings conference call. (Operator Instructions). Please note this event is being recorded.

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

Good morning and welcome to our conference call. This is Albert Nahmad, President and CEO, and with me is Barry Logan and Paul Johnston.

As always, first let me read 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 on to our call. Watsco had a great first quarter. The momentum from 2014 is continuing. We established new records for earnings per share, net income, operating profit, operating margins, and for sales.

We enjoyed another quarter of growing replacement demand and the continued movement towards higher efficiency systems. We also made further investments in our business in terms of products, people, and the launch of new technologies. All in all, we expect 2015 will again be a record year for our Company.

And now for the details of the quarter. A 35% jump in earnings per share to a record $0.65. A 32% increase in operating income to a record $47 million. A 110 basis-point expansion in operating margins to a record 5.8%. A 50 basis-point improvement in gross profit margin and a 60 basis-point decline in SG&A as a percentage of sales to a record low for our SG&A.

During the quarter, sales increased 6% to a record $809 million. HVAC equipment sales increased 8%, reflecting continued strong demand for high efficiency systems. Other HVAC products increased 2% and the commercial refrigeration products increased 5%.

Now on to our balance sheet, which remains conservative with a debt to EBITDA ratio of 1 time. Cash flow for the quarter reflects our typical seasonal buildup of inventory. We are again targeting 2015 cash flow that exceeds net income.

Watsco's outlook for the 2015 diluted earnings per share is within the range of $5 to $5.20, representing a prospective growth rate of 16% to 20% over 2014. This quarter's growth rate is higher -- meaning, again, this first quarter's growth rate is higher, but we will always be cautious until we have greater insight into the selling season.

I can't emphasize that enough. We're not into the selling season yet.

Regarding dividends, we increased our dividend rate in January by 17% to an annual rate of $2.80 per share. Our plan is to continue the policy of increasing dividends as we are confident in our ability to generate strong cash flow, while maintaining a conservative financial position and a low cost of capital to invest in our business.

Now with all that said, we will be happy to answer questions, that is Barry, Paul, and I. Andrew, we're ready for questions.

(Operator Instructions). Josh Pokrzywinski, Buckingham Research.

Just a quick question on the margin enhancement you guys saw in the quarter. Barry, if you could break down some of the parameters of that, whether it was price/mix, cost leverage, maybe just carving up those three buckets, and what you think the biggest driver of margin expansion was?

Sure, Josh. Well, obviously, there was price introduced into the market this year and that always helps the gross profit to an extent. Also, the sales mix moving towards higher efficiency is also something that can help margin as we get into the early part of the year.

It is early. Don't expect this type of continuation of improvement in margin as we get into the selling season, but it is a good start to the year.

And if you could just carve out the parameters, like what do you think was the biggest help?

Well, Josh, I wouldn't be able to say.

Josh, it's early. It's early. (laughter). We don't want to mislead anybody. It's still early. Let's wait until we get into the selling season.

No, I understand. (multiple speakers) backward-looking comment. Just trying to understand what was -- what was better than expected versus what was more in line, and (multiple speakers)

I will take it as a general statement. What you're seeing is that the Company itself is getting more efficient in its operations and more efficient in ability to generate revenues. It's more of an internal thing than it is an external thing, is my view in the first quarter. Now we will see what happens when we get into the selling season.

Got you, okay, that's helpful. And then, Al, you made a comment in the press release about first quarter being disproportionately affected by seasonality and general economic conditions. Is that a comment that you feel like the market overall has some pressure on it and you're performing well despite that, or (multiple speakers)

(multiple speakers). No, we would say that no matter what year in the first quarter.

Okay, so it really is just seasonality?

We just don't want to send a message that this first quarter is representative of the year, because it's too early. It's just too early. We just don't want to cause expectations that we don't know are going to occur until we get into the selling season.

And I emphasize I think what happened in the first quarter is more of an internal matter than it is an external matter.

Okay, and then just --

These investments that we are making are improving our efficiency in operations and our efficiency in the ability to generate revenue growth.

And just one last one, more mechanical. Could you give us the split between growth in resi equipment versus commercial equipment?

I think we did that, didn't we? Barry?

No. Josh, I would say that the overall growth rate at 8% is consistent across the residential and commercial businesses.

Got you. All right, thanks, guys.

Mike Sang, Morgan Stanley.

Just quickly on guidance, a follow-up to the last one. Could you break out the assumptions for sales growth and margins within that $5 to $5.20?

Well, we don't (multiple speakers) -- but go ahead, Barry.

Mike, we really don't provide the building blocks, if you will. It's our guidance for the year. That's what we are looking at from an overall earnings growth rate, and if you look at historical years, you can get a good sense of what it takes to build that type of earnings growth rate.

Okay. And then, I know it's early in the year, but last year you gave guidance in the second quarter. This year, you are doing it in the first. Is that -- maybe that's a function of last year being particularly tough, but --

It's a valid question, but we have done it both ways. And one of the reasons I wanted to do it in the first quarter is we don't want to -- I want to repeat myself. Because we had such outstanding results in the first quarter, we didn't want to mislead people that we expect that to occur for the rest of the year, because we just don't know. So we provide the guidance.

Got it. But that's not because you are seeing anything particularly helpful in the first couple weeks of April that gives you more confidence?

No, we like April.

Okay. And then, lastly, just in terms of how you are thinking about inventory going through the selling season, I think you alluded to the step-up this quarter being seasonally normal, but to the extent you are thinking differently about stock either in SEERs or if there any change in tone from the OEMs?

No, generally speaking we are expecting a better year, so we took in greater inventory to meet what we expect to be a nice demand going forward.

Fair enough.

I don't -- I wouldn't attribute anything to any particular kinds of SEERs or anything like that, just generally speaking. We increased inventory to meet what we think demand will be going forward.

Thanks a lot.

Matt Duncan, Stephens Inc.

Congrats on a nice quarter. So, Al, just to follow up on the comment you made about April. You said you're liking April so far. Is it pretty in line with that 6% growth rate you saw in the first quarter?

Matt, you are so smart. I don't want to mislead anybody. Let's just say it's strong.

Okay. Fair enough. (multiple speakers). Yes, I get it. April is still early in the season, so I certainly understand.

On the iPad apps, where are you guys in the process of rolling those out to the operating units and what's the feedback you're getting from your contractor customers so far?

Well, that's constant. We are rolling out updates to the app constantly, and I can't say that this quarter was any different than others. It's just a routine process for us to update apps.

And are they helping? I think so. Helping the contractor, which is our goal.

Sure.

Help the contractor be more efficient and help the contractor enjoy his relationship with us more and more. It's a competitive tool.

Absolutely.

We want to be the best there is for the contractor world.

Okay.

It's an ongoing process and we will continue to invest to further development.

Sure. On the other HVAC product growth still lagging behind the equipment, I am sure that's probably largely a function of the growth really being driven by the replacement market, but is there any other thing going on there that we should be thinking about for the reason that growth is a little slower than the equipment?

You mean the 2% on non-equipment? Paul, you have an answer?

Yes, the 2% versus the 8%, yes.

Yes, I don't think there is much to be read into that. It's been trending like that for the last couple years, and we have seen a continuation of that trend.

Okay, so that growth rate would probably tick up if we saw a more meaningful lift in new construction, correct?

And also if we -- when we get into the weather of the season, we will find out exactly what that impact is on the replacement side also.

Got it, okay. Thanks, guys.

But the truth is that we consider ourselves mostly in the replacement business.

Sure.

The new construction business at most gets to be 10% or 15% of our revenue.

Right, okay. Thanks, guys.

Mark Douglass, Longbow Research.

Can you discuss -- did your OEM suppliers, did they push through price increases at the beginning of the year? And if so, what was the relative amount?

Paul?

Yes, those price increases were announced in the fourth quarter of last year. I think we explained that in the last call. Generally in the 3% to 5% range, some a little higher, and it's hard to get a point-to-point comparison with the new 14 SEER product that is coming out.

Okay, yes, that was my other question, then. It is probably very early on with the implementation of the regional standard. But from what you saw in the prebuild in the fourth quarter, what would you say that the inventory levels look like on the 13 SEER intended for the southern region? About a year's worth or one season's worth of (multiple speakers)

No, I would have no idea what the industry has for 13 SEER product sitting in the field.

Okay, and then, what was Canada like? Was that a real -- was it a pretty tough headwind with the currency?

We don't break out our business into areas. We don't want our competitors to be informed.

Okay, thank you.

Ryan Merkel, William Blair & Company.

Nice quarter. So I want to step back and I recognize the first quarter, you don't want to extrapolate that, but 2014 was a strong year and you mentioned that the strength has continued, albeit that it's early. But if I step back, is there really four drivers here? Is it pent-up demand? Is it the SEER mix improving, OEM price increases, and then internal initiatives? Is that what's really driving things or did I miss something?

No, I think you've got it. Paul, is there anything you want to add to that?

That's great. I tell you. I wrote those down. (laughter). That's spot on target, Ryan.

Okay, I wanted to make sure I wasn't missing anything.

And then, secondly, can you just talk about SEER 13 equipment demand or growth versus the higher SEER stuff? And then, the second part of that question, are you seeing the price of SEER 14 pull down towards the 13 at all?

Once again, it's way early.

(multiple speakers) back with the 13.

Yes, it's way early to develop a price trend on that. We are watching it. We have not seen anything yet to indicate any change, but then again, the pullthrough hasn't been great enough to even indicate that. So it's -- once we get into the replacement market, we will have a better idea of what those trends are.

Okay, and then, lastly, sometimes you answer this question, sometimes you don't, but on the equipment side, can you just give us a breakdown of the 8%, how much was price versus mix and volume?

No, I think we covered that already. Somebody asked that question earlier.

You answered how much of the 8% was volume versus price/mix? Okay, thanks.

No, no, I don't think we got into that detail. But we did describe our price increase on the equipment.

Right. Okay.

Ryan, I would say this. The growth rate is mostly driven by unit growth, which is what we want. That's where -- that tells us that we are executing in the field and getting business. Price and mix add to that, but the predominant share of that is unit growth.

Thank you.

(Operator Instructions). Jeff Hammond, KeyBanc Capital Markets Inc.

So, Barry, I think you mentioned early on that you didn't think that the margin performance, at least from an incremental margin, would sustain. I just wanted to better understand that comment, understand if there is any kind of aberrations in the gross margin or SG&A line, performance that would -- you wouldn't see trending into the selling season.

If Barry said that, I don't know, I would not agree with that. But, Barry, you go ahead and explain it, what you meant.

Sure, and I think if we look at 15 years of first quarters where we have price increases implemented into the field, there is a benefit to us that we enjoy in the early part of the year, and how long that sustains itself into the selling season is something, again, that we're going to watch and see. I am certainly -- would like for that, but, again, it's just part of the cautiousness that we should talk about this early in the year.

Okay. And then as I do the math on the JV income minority interest, I guess, it seems like your growth -- your EBIT growth in the Carrier business was significantly higher than your base businesses. I am just wondering if -- a lot of that internal -- the internal change is being driven by some of the Carrier initiatives or if there is anything unique going on there?

It's across the board. Our investments in our efficiency developments is across the board with all our business units.

Right, but just from a performance standpoint, it seemed like the Carrier businesses were a standout. So is there anything --

No, they're all performing well. I don't think Carrier Enterprise is performing any better than anybody else.

Okay, I will follow up on that off-line. And then, just on -- I guess because you do within your filings break out international, at least as a mix of the business, can you just talk about the international business, whether it's in detail of Mexico, Latin America versus Canada?

It's running about 15% of our overall business.

Okay, and how is that trending vis-a-vis the total Company?

Business is good internationally, as well as domestic.

Okay, thanks, guys.

Keith Hughes, SunTrust.

One, FX, can you give us any idea how much FX affected the quarter?

Barry, go ahead.

Yes, Keith, really it's immaterial, and given the size of the markets where we have currency, we're still almost 95% US dollar based, so it's really not a material conversation, Keith. That's why we don't break it out.

Okay, second question for Paul. Outside of equipment, are you generally seeing inflation in the other materials that you purchase and resell, and if there is any areas of deflation you have seen, if you could call those out for us?

You know, it's been pretty steady with the commodities. They are small. They are not material to the whole business, but copper refrigerant had been pretty stable. We are seeing some increases, obviously, in the parts and components side, which is good.

And any -- you don't use a lot of petrochemical products, but is there anything --

No, no, we don't. We don't get into that.

(multiple speakers). Thank you, guys.

Walter Liptak, Global Hunter.

Good quarter, and I wanted to go back to the margin discussion. In some ways, I was prepared for more investment in the first quarter, and so I guess -- and that's into the people and technology and the efficiencies that you are working on. And so, I wondered about any timing because it seems like you absorbed any incremental investment this quarter pretty nicely. I wonder if there is any timing issues on when it goes through during the year.

Well, it's sort of like this, Walter. We are not out of the investment mode. We added another 25 people in the first quarter, and I think we're going to continue the investment frame for quite a while.

Now, when is some of that investment paying off? I think that's what we are seeing is some of that, but it's not measurable. It's just the whole idea that we are getting more efficient in our operations and more efficient in our ability to gain share and produce revenue.

That's really an ongoing thing. We are not going to stop investing, and quite the contrary. If anything, I will step it up.

Okay, that sounds good. So is the first quarter the low point in terms of investment and then it steps up as you get into (multiple speakers)

No, it doesn't work that way. We just keep -- and where we see we want to beef up our sales force, we do that, but that doesn't matter what time of the year. And, of course, technology is an ever-increasing investment. So, it's not related really to the time of the year; it's just where do we have need and then we take actions to take care of it.

We are still going to be adding people is what I'm saying in the rest of the year. It's not -- we are not over it in the first quarter. It's just something that we do on an ongoing basis.

Okay, good. And then in terms of the benefits, you said they're not quantifiable because if you are growing, you don't know if it's from technology or if it's from the sales adds, et cetera?

That's correct.

You just know that you're growing.

Yes.

Okay. Okay, very good. Thank you.

Steve Tusa, JPMorgan.

I guess just on the higher efficiency, you said efficiency was a positive. Do we think about this year as like -- because it was more of a prebuild than a pre-buy, more of just a continued steady pace of efficiency increase, and then next year you see more of a skew towards 14?

No, I don't know about --

We didn't say that.

I think the consumer -- and again, we don't look at short-term swings. It doesn't matter to us as it does perhaps to (multiple speakers)

Yes, I am talking about the year, for your view of the year.

We believe that the movement by the consumer to higher efficiency is a long-term, is a long-term trend.

Right, but, I mean, can that -- but that doesn't necessarily -- like that continues to march forward this year, right? Because you did say that higher efficiency was a -- you didn't mix down in the quarter, you mixed up, and you expect that to continue over the course of the year?

Yes, yes.

Okay. We were -- we are hearing from --

Manufacturers are also keen on increasing their efficiency, so, as I said, I think this is a long-term trend. There is no end to the technology development by the manufacturers of equipment to improving efficiency. They are at it and so that trend, I think, is starting with manufacturing and going on through distribution because the consumer wants it.

Right. Right. So, we are hearing actually that April is pretty strong, even up double digits. Is that what you are saying? Was it good? When you say it's good, is that (multiple speakers)

I don't want to mislead anybody. Let's use the word strong. It's only a few days, but I like it.

Got you. And then just lastly, on the -- I didn't quite catch this, but what do you think -- not in your own business, but what do you think -- can the market growth rate repeat what it did in 2014 in 2015? It seems like the stars are aligning a little bit here for a good year. What's your color on the market?

Yes, I think the market will be bigger this year than it was last year. I would agree with that.

I mean, I guess from a growth rate perspective. I would hope it grows. (multiple speakers)

I couldn't tell you that. I couldn't tell the growth rate.

So how do you guys set guidance without a sales growth rate?

Well, because we have been doing this for a long time and we just -- this is our sense of what we are going to do.

Okay, so there's no growth rate that is -- that you're going to give us that underlies and supports that?

No, we are not going to provide growth rate numbers. But don't forget. The premise is that we are getting better at what we do.

Right, what do you -- (multiple speakers). I am sorry, you're getting better at what?

We are more efficient.

Yes, yes, so the margin -- so the margin improvement is obviously a driver.

Yes.

Okay. And one last question, you said 3% to 5% OEM price increases that were put through, and then that's -- you feel pretty comfortable that it's the commensurate degree of stickiness here?

It has stuck. Those increases made last year have stuck this year.

Okay, great. Thanks a lot.

Charles Redding, BB&T Capital Markets.

Thanks for taking my call and good quarter. I was just wondering if you could drill down a little further on the commercial side. Are there particular end markets that are proving relatively strong here, and where could you see added opportunities here in the coming quarters?

Wow, that's a heckuva question. Paul, do you have a sense for that?

No, I really don't. Like I say, it's not -- even on commercial, it's not a big quarter for us, so I really can't say there is any direction that I can point us in as far as strong versus weak sectors right now.

I would say it this way, that it's become a dependable part of the business over the last several quarters. There was some choppiness a couple years ago, but it's become much more dependable and consistent, and as Paul said, it's early, but it certainly has become more dependable over time.

Okay. And is it fair to assume that inventory turns on the commercial side are pretty similar to residential, that you really don't keep a material level on stock on hand for any appreciable period?

Barry, do you have a sense for that, or Paul?

We certainly stock commercial products to fulfill the demand cycle of replacement, just as we do in residential, so there is nothing peculiar or different about commercial versus residential at all.

Is it possible to get any sense for this kind of work?

It is a replacement market that we are working in, Charles, so, yes, we do keep inventory out there.

Of course.

It's just packaged equipment. It's rooftops and packaged equipment.

Do you get a sense as where commercial backlog stands, given lighter inventory turns. Do you -- at least in terms of historically speaking?

Charles, there is really not a material backlog. When we talk about the replacement market, our backlog might be a half an hour after a phone call is made. So, it's a very short-term, quick emergency replacement business. Backlog is not really a measurable thing in our business.

Got it, all right. Thanks.

And that's how we compete, because of our balance-sheet strength. We perhaps can carry more inventory to meet replacement demand than our competitors can.

Okay, great. Thank you.

That's fundamental to our strength.

Dave Manthey, Robert W. Baird.

First, could you talk about R-22 prices, if you haven't already? What are you seeing? Do you expect prices to move higher this year?

Paul.

Yes, the price already moved in the fourth quarter. Do we expect it to stay high? Quite frankly, Dave, it's a very, very small piece of our business.

Yes.

R-22 refrigerant sales, it is almost untrackable.

Okay. And what about the -- did you see any benefit from fuel year over year?

It's not a material.

Material, okay. One last immaterial question here, Cuba, as an export market. Five years from now, immaterial or is there any potential there?

Any what? I couldn't hear the question.

I was half serious on it. I am just wondering, are you looking at Cuba as a potential export market for your international business?

Of course, if it opens up, we are right next to it. There are 11 million people living there and they probably need a lot of air conditioning. Don't forget our current market is North America and the export market and our locations in Mexico, so it's a much larger market than we are presently service and 11 million people against, I don't know, 500 million, 600 million is not -- of our existing market is not a big number, but the need may be greater there because they are so underdeveloped.

Then we have to see whether they can afford to pay for things, so if it develops, we will be -- we're their neighbor, so -- and if we're allowed to do business there, we certainly are not going to ignore it.

Right. Okay, thanks a lot, Al. Thank you.

Walter Liptak, Global Hunter.

So we have talked a lot about -- a little bit about the strong balance sheet, the cash flow, and I wondered what the M&A environment looks like. I know it's -- outside of Carrier, it's been a little while since we have seen acquisitions. (multiple speakers) what your appetite is and what the environment is like?

We are interested in M&A, but the situation for us is that at our size, it's very difficult to see an M&A activity at this moment that would move the needle much for us. But if it comes along, we certainly want to have and do have the balance sheet to do almost any size, but there is nothing of size that is imminent that I am aware of or I have a sense for, not for lack of looking and not for lack of trying. But we bought 67 companies more or less and many of them were smaller businesses. That's not the sort of thing we probably would do today, acquire smaller business. What I hope we can do is when we do M&A to have something of some size.

Okay, I understand. Thank you.

Steve Tusa, JPMorgan.

Along that same line, the appetite for the OEMs to restructure their distribution, are you seeing anything there?

I wish you would get after them, Steve. We would love for them to -- get after them. Tell them that they should turn over their distribution to us.

Nobody listens to me.

Trust me, I would love to do that. We would love to buy manufacturers' distribution assets in the Americas.

I guess the final follow-up is how is the weather down in Florida right now?

Well, you don't want to know. Well, actually in the Northeast, it's also very good, so it's beautiful. Come visit.

So the weather is good?

Yes.

86, sunny, and humid. We love it.

All right, that's a good takeaway. That's my takeaway for the call. Thanks a lot, guys.

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

Thanks for your interest in our Company and we look forward to talking again at the conclusion of the second quarter. Bye-bye.

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