Watsco Inc (WSO) 2015 Q4 法說會逐字稿

Good morning and welcome to the Watsco fourth-quarter 2015 earnings conference call.

(Operator Instructions)

Please note that this event is being recorded. I would now like to turn the conference over to Al Nahmad. Please go ahead.

Good morning, everyone. Welcome to our conference call. This is Al Nahmad, Chairman and CEO, and with me is AJ Nahmad, President, and Barry Logan and Paul Johnston.

First, as always, the cautionary statement. This conference call has forward-looking statements as defined by SEC laws and regulations. They are made pursuant to the Safe Harbor provisions of these various laws. Ultimate results may differ materially from the forward-looking statements.

Now onto our news. Watsco enjoyed another great quarter and full year during which we established new records for earnings per share, net income, operating profit, operating margins, sales, and cash flow. And although the data is still preliminary, we believe we also gained share in our markets rewarding our manufacturer partners.

We also made substantial investments in technology during 2015, as we continue to transform our business to the digital economy, which is increasingly upon us. I can tell you our team is very excited about what we're doing with technology. It's great to see the tools we are providing our customers to help their businesses. It's great to see the efficiencies that are possible. It's great to offer our products and services through all channels, to meet our customers' needs. It's a great time in our Company's history, and we are very excited about it.

Now, highlights for the quarter. Our earnings per share grew 9% to a record $0.75. Operating income increased 4% to a record $54 million. Operating margins expanded 10 basis points to a record 6.0%. Sales grew 3% to a record $904 million, and increased 4% on a same-store basis. Also during the quarter, HVAC equipment sales increased 6%, including 8% growth in the United States. Other HVAC products were flat and commercial refrigeration products increased 4%.

As for the full year, earnings per share grew 13% to a record $4.90. Operating income increased 10% to a record $337 million. Operating margins expanded 40 basis points to a record 8.2%. Gross profit margins improved 30 basis points and SG&A as a percentage of sales declined 20 basis points to a record low. In 2015, sales increased 4% to a record $4.11 billion, and increased 5% on a same-store basis. HVAC equipment was up 7%, with 8% growth in the United States. Other HVAC and commercial refrigeration products increased 2%. We love earnings growth, and we love cash flow just as much. For the year, operating cash flow increased 53% to a record $221 million or $6.82 per share. And our balance sheet remains conservative with debt to EBITDA ratio of under 1 time.

In January, we raised our annual dividend 21% to $3.40 per share. We hope to continue our policy of increasing dividends, and we remain confident in our ability to generate strong cash flow while maintaining a conservative financial position, at a low cost of capital. Finally, as for our outlook for 2016 it is our practice to wait till we have some insight into our selling season before providing you our thoughts. With that said, AJ, Barry, Paul and I will be happy to answer your questions.

(Operator Instructions)

Our first question comes today from Matt Duncan with Stephens.

Nice quarter. I was hoping, obviously I know it's a little early in the year to be giving guidance, can you maybe talk a little bit about the sales trends that you are seeing so far in the year, and how things seem to be shaping up thus far?

For the most part, we're growing.

Pretty similar growth to what you saw last year, or is it noticeably different in one way or another?

No, just growing. That's all about I'm willing to say, because this is so early and March is of course twice as big as January so the big numbers --

Okay. Looking at the breakdown of the revenues a little bit, the other HVAC product sales growth continues to lag behind equipment. Can you talk a little bit why you think that is with what's going on there?

Sure, let's ask Barry or Paul. Who would like to come in? Barry, go ahead.

Sure, good morning. First Matt, our parts business is in that number and as equipment and replacement systems grow, that does impact and can impact our parts business. The trade-off is higher revenues and higher profitability, so it's not something we are particularly against.

Also, there are some commodity products that are in that. It's a small number, but it influences that particular part of our business. And it's something that has had some price pressure this year from that, but not margin pressure. Not profit pressure, so it's something that's affected sales more so than profits.

So I guess the summary would be that you're seeing replacements still grow faster than repairs, and that's causing the parts revenue decline, and then the underlying supplies revenue, so if you were to break up parts versus supplies, supplies are probably growing, parts are declining, and that averages out to what we've got in the quarter? Is that a fair way to characterize it?

That's a fair way yes.

We should ask you that question.

The last thing for me, just on the technology investments that came in at about $18 million during the year, I think it was a $0.13 impact, can you comment at this point on -- I know you had said at the analyst meeting that it would probably grow in 2016. Is it still too early to have some idea, maybe AJ that's a good question for you, since you spend a lot of time on this. What should we expect from the technology investment side this year?

I think it's fair to assume that the technology investment will grow. To what degree, I don't think we would say, but we are certainly are not shrinking the technology investments.

All right. Thanks.

The next question is from Keith Hughes from SunTrust. Please go ahead.

This is Keith Hughes.

Are you on the speaker?

Yes, can you hear me?

There is an echo. You have to pick up.

Is that better? Back in the technology spend, it was a fair uptick here in 2015, are we going to see it to that magnitude increasing in 2016? And I guess in terms of revenue that could potentially drive, when would we see any of that coming into the results?

Go ahead, AJ.

Similar answer to the last question, which is the magnitude of the spend and the rate of the increase of the spend I don't think is something we want to get into. As far as the impact that technology can have, it's not just on revenue, it's revenues for sure, but it's also profitability in terms of our operating efficiencies, and also customer loyalty. We think we are enhancing the customer experience in a way that probably our competitors can't honor or will not.

As for timing of those, it will be gradual. This is not a flip the switch and everything is rosy. It's an evolution much more than a sprint. I don't want to say you're going to see all the impact on this day or that day, necessarily.

Okay. If we could get some of that in the future, that would be really helpful, because it is impacting the numbers here. The second question, AJ, with your promotion to President, from a management structure, how are things going to run different in the next year or two, than before the move?

Do you want AJ to answer that or me?

Whoever knows the answer.

The answer is the same as always, AJ is part of the succession plan we've had in place for quite a while, and the way we manage the Company in corporate is we have what we call a hub and five us first participate in it daily, and we bring in the co-Chief Operating Officers from time to time. We help them with strategy, we help the Co-COOs with anything we can think about. It's a wonderful system because the five are very experienced and very successful, and as you can tell from the results, and that management system will continue.

Keith, I think that's important, from my perspective. What I'll tell you, the chemistry set that we have had over the last several years, and you know many of us, and the difference in personalities we have, that chemistry set has been successful, and that is what is in place today and that's what moves forward. I think with AJ in particular, because the technology initiative is so important, it was very, not just a succession plan but also we to bring significance to what's going on throughout Watsco. That chemistry set, I realize that's not a scientific way of putting it, but it's very critical to how we operate, and that doesn't change going forward.

Thanks very much.

The next question is from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Sorry, I jumped on late. Did you give any color on how you're thinking about 2016. It seems like most of the OEM's are talking about this continuation of trend of mid single digits, but how are you thinking it is shaping up, and any comment early in the year?

What I said earlier that you which is that we are growing. Is anybody on?

Mr. Hammond, are you finished with your question?

Just a follow-up on that, can you just maybe comment early in the year, how it's trending? Maybe how you saw or didn't see dislocation from some of the more seasonably warm weather?

It's early. You missed when I also said March has twice the impact of January, so we don't want to comment on numbers and things like that, we just want to say that we are growing, because otherwise we would be speculating, which I don't want to do.

Okay. Maybe just update us on M&A pipeline? We've had a quiet period here Anything you see changing on the horizon?

Well, it's the same answer that we've provided in the past. We are very eager to acquire more businesses, but they have to be of some size, in order to have an impact. Also, sometimes, we will do a smaller transaction when we see a real clear path for adding a product line that would enhance the growth substantially, and so we are still at it. When we have an agreement or intend to do something, we'll announce it.

Our next question is from David Manthey from Robert W. Baird.

First question, in terms of the seasonality in the fourth quarter where everyone experienced choppy conditions, could you tell us what percentage of sales are furnaces, and did you see anything in the heat pump area that was plus or minus, given the mild winter weather?

I don't think we've done that before, Barry? Broken it out like that?

Not really. First we are Sun Belt driven Company, David, so first of all, that tells you where heat pump is what drives our business, no matter what the quarter is. If you look at the last almost two years, you see very strong consistency across all quarters, especially in the US market. So there's nothing that stands out or was peculiar as we entered this year.

Got it, okay. I would echo the comment in terms of, if there is any data points that you could provide to give us a feel for the success of the tech investment, that would be useful.

We understand that and it's a reasonable question, but we don't want to start doing that until we have something significant to report. We just want to give you a few of our goals. Our goals are really to be the biggest and best in the digital economy and in our industry, to be the leader of that development in the industry so we've employed 169 people in technology, our run rate of spend is $20 million, and we really think we're on the right track, and as I said earlier in the conversation there is a lot of excitement here. We are think we are onto something that long-term will make a huge impact, not only for Watsco but the industry. We are very comfortable with what we're doing.

As it relates to the comment you mean regarding share gain in your markets, if I were to slice and dice that, could I interpret that as being anecdotal evidence that maybe some of these early applications are having success?

That's more related to the bread-and-butter business that we've historically been doing. We've been consistently growing market share, based on the numbers that are reported to HRI. We saw another growth and I attribute that to a lot of hard work by our people in the field and a lot of support and hard work that was provided to us by our OEM partners.

Okay, final question if I could. Thinking about the model, including the investments and everything else, over the past three years, your contribution margin has come in really consistently in that % to 18% range. Is there any reason to believe you'd be much outside that, given the growth we're seeing and how you are running the business today? Nothing seems to have changed all that much.

You meaning operating expenses?

Yes.

We think long-term, we're going to reduce it even further.

So you are still targeting double digits overall for the year?

I hope we are talking about the same thing. Operating expenses as a percentage of sales.

I'm thinking about contribution margin, meaning change in EBIT divided by change in revenues, and that number has been 15% to 18%. But as you continue to layer on higher profitability sales, that should drive that 8.2%.

I see what you mean, sure. Yes, if you want to hear a long-term goal, a very long-term goal, we want to get into double digits with EBIT margins. I think what we're doing with the investments in technology, we have a reasonable shot at it. That's why we are so excited about the long-term. Not only efficiencies internally but what we are doing for contractors to make them loyal, and improve their efficiency, and all the other channels we are opening up to the customer through the e-commerce and that sort of thing.

Sounds good.

David, I'll add to that, about 67% in the past several years of our costs are fixed. You have rent, facilities, people and facilities, and so on. Our ability to grow and grow gross profit margin in the last three or four years has created what you said, which is 15% to 18% contribution margins. The challenge we are giving our team is how do we reduce that operating cost while doing all of this, and increasing our capability to raise that margin higher? We've done it with a lot of spending, and the question is let's accelerate the ability to do more of it.

Okay. Thank you, very much.

Our next question is from Josh Pokrzywinski with Buckingham Research.

A couple questions for me. First, you've seen some of the OEMs need to come back for another round of price, in Canada given some of the currency moves, and I guess maybe noting demand there is a little weaker as well. Anything going on there that you would care to update us on, and I guess specifically on the pricing environment?

Paul, why don't you comment on the general pricing environment.

The general pricing environment, if you look at it not just in Canada but across the board, we haven't really seen much in the way of price pressure, downward price pressure, on our product splits right now. We have been increasing our prices right along, as we see opportunities to increase prices. Once again, we will work with our OEMs and our non-equipment vendors to be able to manage price in the marketplace, and Watsco will always be competitive in the marketplace, and that's the position we are seeing right now with us.

I'm sorry if I missed it earlier, did you mention how Canada performed in the fourth quarter?

No, that's not a disclosure we like to make, for competitive reasons. But I will say generally speaking the domestic business is doing better than the international business, in terms of growth.

Just one last one, I think as an extension of this transition to the Sun Belt, and there had been a thought with the base being a little higher, that the opportunity to upsell would be better at the contractor level. Is that something you are seeing more and more, or start to take hold as we truly transition into 14 SEER, and is there any number you can attach to that?

It is really early to find any indication that we're seeing up sale beyond the 14 SEER. We have just completed the 2015 where everybody was telling through their 13 SEER product and transitioning to 14 SEER, so I think that's a trend we will see later on this year, probably when we get into the selling season, if that occurs, Josh.

Got it. Would you expect it or is that, are you still --?

I can dream of it, but I can't expect it. I can hope for it, but I can't expect it.

Fair enough, Paul. Thank you.

Our next question is from Walter Liptak with Seaport Global.

I wanted to ask about the outlook, a lot of investors are concerned about the slowing economy, and I wonder how you think about a slowing economy, and how you would change your outlook or change your business given the stock market has been weak, and so much international weakness?

That's a good question. We have been through slow economies in the past. After 2008, we did see a slowdown of our business, however the cash flow increased substantially, and we were also able to make the biggest investments we've ever made in the 41 years I have been managing the Company. So it brings an opportunity sometimes in M&A, and certainly brings out more cash flow which sometimes we've done in the past has increased our dividend even at a better rate because of that.

Okay. I'm sorry, go ahead.

I was going to add one comment to that, just to bring in a thought. If you think about our suppliers, we are the largest customer of most of them, and their dependence on market share growth and overall growth is through us. I think any kind of slowing economy gives us the opportunity to have our partners come to us and work with us, and be partners to grow the market. So I attribute that as important.

That's true.

Sounds good. On the technology budget, I wonder if you could refresh us on how much incremental spend is there in 2016, and if the economy does slow, is there some flex on that?

Of course there is, but we are not going to say that we are going to do one way or the other. We are in an investment mode because we believe in the long-term pay-off.

Okay, thank you.

The next question is from Charles Redding with BB&T Capital Markets. Please go ahead.

This is Payton Porter on for Charles Redding. You in the earnings release, you called out residential and commercial markets, I'm wondering if you could elaborate at all, or give us some color on some of those end markets, where you are really seeing strength. Are you seeing strength in construction, both residential and nonresidential? Are you seeing strength in various geographic regions? Anything that you can give us from an end market perspective?

We can give you some response that not information that's going to help our competition, but generally speaking, Barry?

First, we do see consistency in trends for commercial and residential across the board. There is not one versus the other. It has been very consistent all year, and that is true today. Secondly, as I said earlier, we are a Sun Belt company, and we love the Sun Belt, and it's growing and it's been a good consistent safety place to be, given use of the products, and also, I think the growth in the economy that's going on in the Sun Belt.

Perfect. Just kind of on a regulatory perspective, is there anything that we should be really watching out for, is there anything that you are keeping a close eye on just from a regulatory standpoint?

Let's go to our regulatory guru, Paul?

What we are looking at now is what's going to be the higher efficiency ratings that were going to be getting in 2021. We're also looking at what's going to be going on with new refrigerants that have less global warming potential to them, which we know are on the horizon, and everybody is working on. Finally, we are at the final stages at the Montreal protocol. We are finally going to see R-22 eliminated from the marketplace by 2020, and this year is going to be a light year as far as the ability for our manufacturers to bring in R-22. So a lot of good things going on. All those are good things, because they're all changing the marketplace, and generally Watsco thrives on change in the marketplace.

Excellent. Thanks a lot.

(Operator Instructions)

The next question is from Chris Dankert with Longbow Research.

Real quick, following up on analyst day, e-commerce really accelerated through 2015 for you. At this point, are you willing to break out the impact on Q4, and what percentage of sales are from e-commerce right now?

AJ?

No. I would say that the trends are positive, and have momentum but we're not ready yet to get into specifics.

I want to add one comment, because it has been asked a few times, and I want to get it off my chest, so to speak, about the investment going on in technology. For those of you that have known us for 20 years, we are very careful, and very selective, and very disciplined and very cautious about how we spend money. And the growth in spending has been 100 decisions made over two or three years, and we're not betting the ranch and haven't bet the ranch on anything. So yes, we're going to spend more money in 2016, and yes, we can change our mind or adapt to what is going on, and we will, but I just feel like everyone wants a number, and just look at the track record of the Company and understand that we are very careful in what we're doing.

I would add to that, Barry, that as a Company, we do have big goals, they are all very measurable goals, all our business leaders know what those goals are, and are working towards them. This is about adoption and implementation and usage of the technology, not just technology for technology's sake.

Thanks, guys. One quick housekeeping question. As far as selling days for the year, can you give us those by quarter?

Barry, do you know what he is referring to?

Good question, I want to assume that the first quarter has an extra day because of Leap Day, but Chris, I will have to look at that. Obviously, it's not something I've got sitting in front of me.

Fair enough, thanks.

At this time I'm showing no further questions so this concludes our question and answer session. I would like to turn the conference back over to Al Nahmad for closing remarks.

I just want to thank you all for interest in our Company. We certainly hope not to ever disappoint you, and we hope to continue to build the Company. Thanks again. Bye.

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