Watsco Inc (WSO) 2016 Q2 法說會逐字稿

Good morning and welcome to the Watsco, Inc., second-quarter 2016 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.

Good morning, everyone, and welcome to our second-quarter conference call. This is Albert Nahmad, CEO, and with me are AJ Nahmad, President; Barry Logan, Senior Vice President; and Paul Johnston, Executive Vice President.

As usual, 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.

Watsco's performance over the last several quarters has been remarkably consistent. This quarter reflects the late start to the summer selling season. June's performance was strong, with record sales, profits, and margins, but it was not enough to offset softer conditions in the early part of the quarter. July's growth rates so far are in the double digits and we intend to make hay as the third quarter progresses.

We have produced terrific cash flow over the last 12 months, with operating cash flow of $337 million or 150% of net income. This comes out to over $10 per share in cash flow. We believe that some of this improvement in cash flow can be attributed to the recent implementation of supply chain technology.

Given the exceptional cash flow, our continued confidence in our business, and our low debt, we raised our dividend 24% to $4.20 per year, effective with our dividend payment in October.

We continue to invest in technology to transform our business into the digital age. Our annual run rate for technology spending is now approximately $23 million. During the first half of this year, incremental technology spending had a $0.04 impact, $0.02 for the quarter.

It is still early, but technology is having a positive impact on our business and customers. For example, after about -- after three years of work, we now believe Watsco is the largest and best source in the industry of digitized HVAC product information.

That effort continues as we add more and more data to maintain our position as the leader in providing customers a reservoir of useful information. With this digital capability, an increasing number of customers are adopting our apps and using e-commerce to gain information, speed, and efficiency.

Our employees are leveraging data analytics to gain greater information into operations using our business intelligent platform. More of our 563 locations are implementing technology that fulfills orders more efficiently and saves our customers time.

Now to have more conversations about Watsco technology, we invite you to our investor conference to be held on December 9 this year in Miami. Details will follow and we hope many of you will attend.

And now for the details for the quarter. Sales declined 1% to $1.21 billion and were flat on a same-store basis. Sales of HVAC equipment declined 1% and other HVAC products decreased 3%. Sales of commercial refrigeration products increased 8%.

Operating income declined 6% and EPS declined 2%.

Now on a year-to-date basis, sales increased 2% to a record $2.07 billion. Sales of HVAC equipment increased 2%, while sales of other HVAC products were flat. Sales of commercial refrigeration products increased 7% year to date. Operating income declined 2% to $168 million. Net income increased 2% to a record $90.2 million and EPS increased 1% to a record $2.54.

Cash flow was strong and led to debt reduction of $166 million over the last 12 months. Our balance sheet remains conservative, with a debt to EBITDA ratio of under 1 time.

With that said, AJ, Barry, Paul, and I will be happy to answer your questions.

(Operator Instructions). Robert Barry, Susquehanna.

Any incremental color you might add on what you mean by up double digits? Is that 10% or would you have said in the (multiple speakers) at that level?

Yes, it is a little over 10%.

Got you. And in June and into July, can you comment on how mix and pricing are looking?

That's a tough one, Robert. But I will let Paul Johnston take a shot at that.

Yes, it really is hard to get your arms around, especially July, but at least through June, it was the 14 SEER product -- I think that's what you are trying to reference -- was holding steady.

In terms of the pricing on it?

Yes.

Yes.

And then, maybe just on the balance sheet or cash flow from operations, it looked a lot better in second quarter versus recent years. Inventory seemed to be down a lot. I don't know if that just reflects the strong finish to the quarter or are we starting to see some benefits from the IT initiatives readout there?

Well, the latter is occurring. There are benefits on our new technology regarding inventory systems. But that's only been adopted now by one of our units, which is probably about 15% of our overall revenue, so it had an impact. But in addition to that -- Paul, you want to talk about the inventory mix?

Yes. Obviously, we sold off the remaining inventory we had for 13, so we had a nice reduction in 13 SEER inventory, and as we put 14 SEER back into inventory to replace the 13 as we sold it off, we didn't have to put as much in. So we have actually been able to have a reduction in SKUs.

Got you. Thanks, guys.

Matt Duncan, Stephens.

Just looking back on the quarter, is there any way you can tell us, April and May, how much were they down? How much were you up in June? Just trying to see the trend line here of how things are trending in the business with July now up into the double digits?

Why don't we give you a little bit of color in June, because we have that data available. Barry?

First, on June, we did see what I would call mid single- to high single-digit growth in June, and as we mentioned, in July it has gone to double digits.

Okay, so Barry, then, as we look at the third quarter, which lies in the double digits, it seems like when things got started in June, you were seeing, let's call that, 5% to 8% growth. Should we be expecting something in the high single digits, then, for the third quarter, given that it is starting off so strong again? And really, the point of it is, are we going to make up for lost time? Is that essentially what's happening right now or do you think the July growth rate is really an indication of what the day-to-day market is like right now?

Well, I think --

Good luck on that one, Barry. I'm listening to this answer.

(laughter). I will answer it this way. Matt, what we do know is it was a late start to the season and the strength and momentum that we see in June and July is occurring, and it just proves that, that the season did start late in our markets.

In terms of what it looks like for the third quarter, we don't know. We sell on demand. August is almost equal in size to July, and there can't be insight into August until we start to creep forward toward the rest of the season. But in terms of momentum, we can see -- we can definitely see what's happening in June and July.

Sure. And as you dissect the late start to the season, was it really across the board? Were there some geographies that were more pronounced than others, some business units that were more pronounced than others, or was it just an across-the-board late start?

It was very much across the board, Matt.

Okay, fair enough. And then last thing for me, just on the gross margin, it was down a little bit year over year with sales down. Should we just assume that that's the impact of less overhead absorption within the business or are you seeing any kind of change in mix that might explain it? Talk a little bit about what's going on with the margin there.

Paul, you can deal with that one.

Yes, we obviously -- we sold off our 13 SEER inventory in the quarter, but the baseline of our business, we are not seeing a deterioration in the margin.

Okay, very helpful. Thanks, guys.

Ryan Merkel, William Blair.

I guess just a follow-up to the last question on gross margin, it sounds like it was just selling down SEER 13. I was just curious if you saw price competition increase, just given the slow start to the quarter?

Paul?

No, we really did not see -- generally, we are not seeing that happen. Very fortunate.

Okay. It's a good sign. And then just as it relates to other HVAC products down 3%, is that primarily a weather issue, too? Was there anything else going on?

We hate the words wet weather issue. We talk about seasons. It is just part of the slow start.

Okay (multiple speakers)

If you think about it this way, last year first quarter we had an unbelievable start with a 35% earnings-per-share growth rate, and people thought, well, why don't you extend it to the rest of the year? But we know better. This is such a seasonal business. We don't like to put out quarterly estimates because we know this. This is the history of the industry. Things move around all year long, but generally speaking the year ends up very good.

Okay. And just lastly, as it relates to the mobile app, are you in a position to just tell us how many users you have now? And then, has the early experience been that customers are ordering more at higher margins? Is this something you can share at this point?

Gee, that's pretty closely held information. I will just generalize it. Several thousand are on it, and I won't comment on margin.

Okay, fair enough.

I can tell you there are more orders -- more items on the order on e-comm than they are the traditional way.

Right, and that's what we all would have expected, so it's good to hear. Okay, thanks, Al.

Jeff Hammond, KeyBanc Capital Markets.

So I think in the past, you have historically commented on guidance. You didn't really say anything in the prepared remarks.

That's right.

Clearly, the first half is running flattish. Do you -- just with the weather normalizing here, do we get back to double-digit earnings growth here in the second half, or how do we think of any kind of guidance frame?

Well, the season has started late. Sometimes it starts early and sometimes it starts late. This year, it is late, and all we have visibility to is the first part of July and that is roaring. It is just up double digits across the board and we are very pleased.

Is that up double digits, is that just on equipment or is that for the full business?

The whole Company is up.

Okay. And then, I noticed if you back into the JV income, the JV was down 10%, the legacy base business was flat. Any kind of reads or color for why the disparity between the two?

Barry?

Again, there is the international business in the JV and that would have a disproportionate performance relative to the domestic, so that's the only reading I would give there.

Okay, so the domestic -- JV one, I guess, was consistent with the legacy business.

Yes.

Okay, okay, great. And then just on the non-equipment side, any of that weakness tied to any deflationary pressures around copper, refrigerant, or anything?

No. Jeff, this is Paul. No, we have not seen any deflationary pressure. Copper products are holding steady and moving up, and obviously refrigerant is going up. So, we are not seeing that right now. Steel prices are up. It's pretty good right now.

Okay, thanks, guys.

David Manthey, Baird.

As it relates to the technology spending, if the technology tools that you have developed now are in the early stages of the launch phase and implementation, does that imply that at some point we will hit peak IT spending levels as it relates to those initiatives?

Why don't we let AJ answer that?

I would tell you -- so these technology programs, they are not develop a technology and then we stop the program and see how they go. They are continuous improvement programs internally, and the software we are developing and the platforms we have bought, it is continually making them better and more useful for our customers and for our teams internally.

So, I don't know. If there is a peak level where we see opportunity to invest and there is an opportunity for return, we will invest.

Okay, so even out over the next three to five years, as you look at the timeline and the -- your plan for technology, you don't see a peak in spending at any point in the next three to five years?

No, no, we don't think of it in that term. We think of it as where there is opportunity and it can make an impact and we prove the impact, we are very comfortable investing those dollars.

Okay.

And we support that because what we are doing is transforming the Company, and we have the scale to do it quicker and better than anyone else.

Well, and maybe this is a topic for the December analyst meeting, but --

Sure, that's a good point, come on down.

I will be there. But I think -- it might help investors if you explain some of the metrics that you're looking at and how you are determining that you are having success with these investments.

Yes, that's a good point. We will have conversations about that.

Okay, that's great. Thank you.

Then just as it relates to the flow of the quarter here, looking at the mid single- or high single-digit growth in June, and it is my recollection June would be about half of the second-quarter revenues, that implies that April and May were down that amount? Is that correct?

Barry, do you think you want to answer that or let it go?

That's the algebra, so.

Mathematically correct, okay. That's all I have this morning. Thanks a lot, guys.

Brett Linzey, Vertical Research Partners.

Just coming back to the full-year framework, obviously your visibility very limited on the topline, given the short lead of the business. But just in terms of what you can control -- productivity, SG&A leverage, can you frame for us how we should be thinking about incremental gross or operating leverage in Q3 and then really into the heating season, just to help us frame the year?

Barry, you want to take a shot?

Sure. First, culturally, you should know that our leaders are all driven incentive-wise to grow profitability, and at this point where you see flat profits for Watsco, none of the leaders are happy because they are not accruing a bonus and they want bonuses. So, culturally, there is a lot of pressure and a lot of intensity in the field to drive profit growth.

As we used the expression in the call about making hay, that's the revenue line, but there are plenty of activities going on in the field in terms of cost structure and reacting to what's going on in the short term here. So I think, again, profit growth is not just revenue driven. It's also operationally driven and there is a lot of that going on in the culture right now.

Okay, and I guess shifting just to the $0.06 tax benefit on the FASB changes on share-based comp, how should we think about that windfall into the second half as we sit here today?

It is actually very little. It is -- the timing of vesting of our restricted stock plan that creates the tax benefits was really driven into the first half of the year. There is not much to come in the second half of the year, so you should not impute very much at all into the second half of the year.

Okay. And then, I just want to come back to the HVAC equipment category, down 1%. I guess, are you able to unbundle that in terms of volume, then price and mix? Presumably, you got some price in the quarter and mix should have been positive. Were volumes down mid-single digit? Is that the way to think about it?

Low single digit.

Low single digit, okay. All right, great. That's all I had. Thanks a lot.

Joshua Pokrzywinski, Buckingham Research.

Just on the pricing trends in the quarter, I guess, with steel looking to be a little inflationary looking in the back half of the year and into next year, are you getting any sense from the OEMs the appetite for price? Or clearly, sitting in your shoes, you guys don't mind price increases at all. But are you getting the sense there is some debate in terms of how that looks?

I don't think so, but, Paul, you want to take a shot at that?

Yes, it's early. Everybody is in the middle of the season right now and we're all pushing for sales, so the conversation really hasn't started about where we are going with the price of the product going forward with the OEMs. I am sure we will have those discussions later in the year.

Got you. I guess looking back historically, given that on net over the past, I don't know, three, four years, these guys have enjoyed a pretty nice price cost gap, would you expect them to go to the market for more price, just based on history?

I certainly hope so.

Fair enough. And then, I guess maybe to come back to 2Q and the trends therein, I get that a late start on weather is always going to be an impact with a seasonal business such as yours. But what did you see on mix trends or any other behavioral indicators at the customer that would inform the health of the market beyond anything on the weather side, whether it is, I don't know, trade up to higher efficiency or repair rates or just any other anecdote?

One thing that we want to remind everyone is that we consider ourselves primarily and fundamentally an aftermarket distributor. The new construction business, which is always a lower margin business and always very cyclical, is only 10% of our business, and that's by design. I mean, we will take whatever new construction comes when we can get it. That is an OEM general effort and we will certainly fulfill whatever the OEM arranges.

But we believe that the future is our aftermarket business, considering there are 89 million installed central cooling systems in the United States, and that's what our culture is, grow in that market. Stay out of the cyclicality business, which is new construction.

Right (multiple speakers)

(multiple speakers) not stay out, but just not emphasize it.

I guess even within the replacement market, though, you can have ebbs and flows in consumer confidence or mix. I guess that's what I'm getting at is that (multiple speakers) a headwind, what else is going on in the (multiple speakers)

Well, what happens to demand for aftermarket is when consumers lose confidence, they have a tendency to replace, and of course we will provide the replacement compressors or whatever else the system needs as distinct from -- I am sorry, they will service it as distinct from replacing it.

So we feel that in the revenue line, this is what happened after 2008, but when consumer confidence normalizes, they go to replacement rather than repair. And that's just the nature of the business, but the repair business is also very profitable.

I would like to add one thought, Josh, to what you are driving at, also. As you said behavioral, what behavioral things are going on, well, mix obviously is one. We're still seeing improved mix beyond the 14 SEER product group.

The other thing that I have had in the past is we have 88,000 customers that owe us $600 million, so we give credit to our customers. We service that credit. We help our customer grow his business. The health of that portfolio remains in a very, very high-quality state, as good as it has been in our careers, so that tells us that our customer is healthy and that end market is healthy. That is a key indicator for us.

Got you. Appreciate the color, Barry. Thanks.

Charles Redding, BB&T Capital Markets.

Just wonder if we can drill down briefly on the strength in refrigeration. It looks like a pretty solid total here, just given the early quarter weakness. Any drivers here and maybe how we think about potential catalysts over the next couple of quarters?

Paul?

Yes, it was -- we had an excellent quarter in refrigeration. It is a very small percent of our total business, but a very important one. We were driven primarily by our ice machines, which had an excellent quarter. And we hope this continues.

And then maybe any update on either Central America or Cuba? How do we think about upside here just in terms of spending power or willingness among the consumers there to replace or retrofit existing units?

Latin America as a whole, as you know we have branches on the ground in Mexico and we also have branches in Puerto Rico. Puerto Rico revenue and profits are down, but it is not a material impact on the Company. Mexico is surprisingly strong for us. It seems like whenever there's a little bit of a dip, it comes back even stronger.

Then our export business, we export all over Latin America, is steady.

I am really pleased with what we are doing south of the border. The Canadian market has a little bit more of an issue with currency and we're doing the best we can with that.

Okay, I appreciate the time.

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

Thanks, again, for your interest in our Company, and those of you that want to have technology conversations, please come down in December. We will try to make a nice day for you. Bye.

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