Watsco Inc (WSO) 2017 Q1 法說會逐字稿

Good morning, and welcome to the Watsco First Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

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

Good morning, everyone, from sunny Florida, where I have a really bad cold. But nevertheless, let's go on with our conference call. This is Albert Nahmad, Chairman and CEO. And with me is A.J. Nahmad, President; Paul Johnston, Executive Vice President; and Barry Logan, Senior Vice President.

As always, 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 delivered record sales and net income in the face of strong year-ago comparisons and varying seasonality across our markets. Sales improved toward the end of the quarter, and April trends have accelerated to double-digit growth.

We have added approximately 150 new customer-facing employees last year over year -- let me say that again. We have added approximately 150 new customer-facing employees year-over-year, expanding our capacity to sell products and serve customers. They have a short-term impact on profits and margins, especially during a lower-volume period like the first quarter. Strategically, these are long-term investments to drive growth and build market share for our vendor partners.

We are pleased to increase our dividend to an annual rate of $5 per share beginning in July, supported by a strong cash flow and continued confidence in our business. Our balance sheet remains conservative with a debt-to-EBITDA of under 1x, and we continue to look for M&A opportunities. We cannot predict whether transactions will occur, but rest assured, it is an important focus of the company.

Results also reflect controlled investments -- continued investments in several innovative technologies to transform our business and that of our customers. The annual run rate for tech spending is approximately $23 million.

As a reminder, we have launched 3 primary technology platforms: first, e-commerce and apps using the industry's most data-rich catalog of product information; secondly, business intelligence to enable more insightful decision-making throughout our organization; and lastly, supply chain, warehousing optimization to improve speed, create efficiency and reduce operating cost.

We are seeing progress with our technology, but we know it will take a lot more time to get traditional customers and employees to adopt and become fully immersed in what we are -- excuse me, what are truly net technologies for our industry.

Now on to financial results. Sales increased 2% to a record $872 million with 3% growth on a same-store basis. HVAC equipment increased 3%. Other HVAC products increased 1%, and commercial refrigeration products increased 5%. Gross profit increased to -- 3% to record $219 million, reflecting a 10 basis point expansion in gross margin. SG&A increased 5%, reflecting an increase in tech spending and the new headcount mentioned earlier. Earnings per share was flat at $0.71.

Now as has been our practice, we will not provide at this time a specific outlook for the year due to the seasonality of our business. We do, however, expect 2017 to be a record year for Watsco.

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

(Operator Instructions) The first question comes from Robert Barry of Susquehanna.

So just wanted to clarify the double-digit growth. Is that for the company overall?

Yes.

And so equipment would be tracking higher than that?

We didn't give a breakout between equipment and sales and that's any other things.

Got you. I was just curious how things tracked during the quarter because when you reported 4Q, you said Jan, Feb to date were tracking up mid-single. Were things kind of slow and then reaccelerate?

That's the -- good question because it deals with the principle that this is a very seasonal business. And it's very difficult to sort of decide by quarters what the value of the performance is. We've known that for years. The analysts don't seem to care. They seem to put out their own estimates. But we know that seasonality could change quarter-to-quarter, year-after-year.

Well, what was the seasonal headwind this quarter? Was it warmth in the north? Or how would you characterize it?

We have not characterized it. We've said, in various markets, seasonality has come late in terms of demand. And it's just one of the things of the industry. I don't think we're the only ones. Particularly, since we're in the aftermarket mostly, new construction participants in the industry have a more steady pulse on it.

Got you. Maybe just one more for me on the SG&A and how you expect that to track. I mean, I have to go back a few years in the model to see SG&A growing 5%. I think you're perhaps lapping the toughest comp of adding -- or making the incremental IT spend. But how should we think about that SG&A growth tracking at least in the near term?

Well, I think we've demonstrated that's where we are now. I mean, we're always going to look long term, and if there's more investment in technology or more investment in the hiring people to take care of our customers, we're going to do it. But for now, we see this going as it is.

Got you. Is it the IT spend steady now this year? I think you referenced $23 million, which I think...

Yes, yes. Well, it's up $1 million for the quarter.

The next question comes from Matt Duncan of Stephens.

On the topic of April, my recollection is that last year, you guys got a little bit of a late start to the selling season. So can -- I want to make sure we don't get carried away and extrapolate that double-digit growth rate out if we shouldn't. What is the comparison like in the month of April year-over-year? And is it going to get a little tougher as the quarter goes on?

Barry?

No. I think April, again, in context, is the smallest month of the quarter. So you're right, we shouldn't get too far ahead of ourselves, but I thought it was important to report the trend. Also, I think, given the way that what we would see in May and June -- yes, we do have to wait to see how it plays out, but my memory is April a year ago was just okay. And so I think it's good progress so far this quarter.

Okay. That helps. On the sales force additions, you called out that those are happening to help market share and drive growth. And it's part of why your SG&A, obviously, outgrew sales this quarter. Can you talk about what those salespeople are targeting? Is this maybe part of a larger plan to help drive market share along with the technology investments? And now that you've got the mobile apps in place, are these people going to go out and work on educating the contractor base in these markets and help explain the advantages of using Watsco as a distribution partner (inaudible)?

Yes, that's part of it. That's part of it. But it's generally also the idea that we want more hands to deal with customer needs. But yes, this adoption of our technology is not going to be easy. When you figure we have about 88,000 customers, these are companies, and each of them has several employees doing installation and repair work in the -- out in the field, you can imagine that's hundreds of thousands of people that we have to get into the adoption. And we're going to be patient about it, but we're investing, as you said, the people to help that process as well as everything else that the customers need.

Okay. And the last thing for me, cash flow remains very good. You took the dividend up again a nice 19% increase there. I think on the last call, a lot of us felt like you sounded -- you, Al, sounded more positive in terms of the potential for M&A. Does the increase in dividend change that in any way or (inaudible)?

No, absolutely not. No. I mean, when your EBITDA is just less than 1x, it's -- or you did the other way around, it's really a very powerful balance sheet. No, we believe that we can take on any transaction of any size in this industry. And now if you get out of the industry, who knows, but in this industry, we can handle anything. And we'll always be postured to do that.

And Al, does that run the gamut from another distribution business? Another JV perhaps? Or maybe even buying manufacturing, would that...

No. I would start by -- not manufacturing, we're not going to do that. And I do think that we have the -- I don't want to speculate on this because I'd be misleading you. If something comes along in the similar pattern of manufacturer, distributor, dealer, customer, our technology is very appropriate for that. And we'd have to look at it carefully. But we're not going to do anything like that unless it's of some size.

The next question comes from Chris Dankert of Longbow Research.

I guess first thing is thinking about the SG&A again, added about $2 million in the quarter. I guess that run rate -- is that the run rate going forward we should think about? Or did those kind of hires kind of roll on so the number could be a bit higher in the rest of the year?

Barry?

It's a -- it will not be $2 million per quarter. It's something -- if you look back, some of these people were hired last year. And just from a comparison point of view, this quarter, the $2 million is probably the full amount that we'll see.

Got you. Got you. And then I guess if we could get A.J. in the mix here. Just any comment on the app adoption rates? I think last quarter, you kind of highlighted some of the user increases, the online transaction increases. Any more color around that?

Only that the trends have -- yes, the trends have continued. The app usage and e-commerce usage continues to increase. As mentioned before, we're talking about a large scale here, with 90,000 contractors in all our contracting businesses and all the employees in those businesses. So still early days, but usage is increasing. And where there is usage amongst our apps and e-commerce, it's very positive for the company and for our customers.

Got you. And then just one last, if I may. The additional hires, was part of that fueled by kind of having greater analytics and a sharper view on the company, is that part of what drove the hiring?

Well, that's an interesting question. Barry, you want to deal with that or Paul?

Sure, Chris, I can. I think, first, the way a distributor adds capacity to its business is what Al mentioned, that's by having people serve customers, either sell things or help in any way a customer's growth, and in this case and in our case, develop technology with our customer in mind. So I think all that is part of the strategy is capacity to -- the capacity to do more of those things in our local markets. As far as the people that we don't tell you about is where is the analytics helping us save money or gain efficiencies in our branches in our business. That's going on in the background as well. But that won't mature -- that kind of operational efficiency side of this technology equation probably won't mature until sometime much later. But for now, it was important to get in front of customers with technology, with products, and as I say, add capacity to what we do every day.

The next question comes from Ryan Merkel of William Blair & Company.

So first question for me. Can you break out the sales performance in the U.S., Canada and Latin America, if you have it handy?

I don't think we do that in that much detail, but I think we can give you international versus domestic. Barry?

It was a very narrow range of growth rates. So if you look at the overall growth rate and break it into pieces, both international, domestic, even commercial, residential, it's in a very narrow range of what was reported.

Okay. And then parts and supplies, obviously, it's been soft for some time now. Is there any hope that we can get that back to mid-single-digit growth? I know commodity...

You nailed it right there. There is always hope. And yes, we're very focused on it, and the improvement is slower than we'd like, but it seems like we're improving.

Ryan, I'm going to set a trap for ourselves, which I don't want to do. But if I take the non-equipment, the 1% growth rate in other HVAC products, part of seasonality is replacement parts sales. Seasonality meaning if it's a warm winter, we're going to sell less replacement parts for furnaces. And that did occur this quarter. So if I take the 1% growth rate and break it into parts, replacement parts versus supplies, which means everything else, there actually was a nice growth rate in supplies; I would say progress in supplies. The parts sales were lower and tempered the growth rate that you see in the press release.

Got it. Okay. Is there anything you're doing company-specific to try to accelerate the growth in non-equipment?

Well, we're very focused on it. We're motivating and incentivizing for growth, and we are working with the vendors very closely because the vendors want us to grow in that area as well. It's a focal point.

Okay. And lastly for me, a lot of questions on SG&A, but I'm just wondering, are you going to be able to return to delivering year-over-year operating margin expansion as early as 2Q? Or is it going to take a little longer for these new salespeople to start to deliver a return?

See, I think that's too much in the future to forecast that. I mean, obviously, we'd like to be optimistic, but it'd be a pure guess. Let's see how it develops.

How long does it take for the new customer service people to break even?

Well, I've never had a question like that. Paul, you're pretty good at this hypothetical.

That's hypothetical. All these salesmen are not just selling equipment, they are selling -- they're focused on different elements of our marketplace. So you've got people that are focused on parts, supplies and equipment. So it's -- it would vary based on what their individual forte was.

This is A.J. I'll just add that with our new technologies, we have a lot of visibility and insight into performance at an individual level, and we could be much more proactive in making changes or additions and subtractions as needed.

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

So okay, so this quarter you called out the $0.06 of headwinds. I just want to -- so it sounds like, Barry, from your comment that, that goes down to something closer to $0.02 with continued spend as we move forward. I just want to understand how much of a headwind we see going forward.

Yes. I mean, the way we look at it, Jeff, if it costs us $2 million in the quarter, will it cost us $8 million for the full year. That's kind of what we're -- that's the point of the question and the answer is no. I mean, some of this was added aggressively over the course of last year. And this -- comparatively, this quarter, it's probably the largest it will be. I don't know what it will go down to, but it won't be an $8 million impact in this year.

Okay. But it's something you'll continue to call out in terms of incremental spend? Or it gets small enough?

Yes, we'll see. We'll see how material it is. Obviously, in a quarter like this, any kind of incremental spending shows up pretty -- is pretty visible in the slowest quarter of the year. So I thought it was important to call out this quarter. And we'll look at it each quarter for materiality.

Okay. And then just on the headcount spend. Is a lot of that really tied back to the tech initiatives? Or where particularly is some of this headcount add going? Because I know you've gotten a lot of questions on kind of the supplies. I just want to understand where some of the headcount is being added.

Well, Jeff, I'll answer it this way. I'll give you one market, I won't say what market it is. But the -- one market, in particular, has been an 8% to 10% growth rate in sales for the last few years. EBIT margin is well above the Watsco average. How does that leader continue to grow, continue to add capacity, continue to add sales and share to an extremely successful business? And in his case, about 17 of the people we're talking about is in that single market. So it is us giving encouragement to our leaders to go out and develop markets beyond the current performance. And that incremental spend does not show up in incremental income that day, obviously, but it's important for us to continue to do that, especially reward performance like that. Now, there's always now a technology thread going through that conversation because those sales guys need to be in front of customers talking about it and teaching it, but it's really a bigger picture in terms of, again, adding horsepower and capacity to our markets.

Okay. And then some of our checks are picking up some share dislocation with Carrier. I just didn't -- I wanted to get your read on that. And then just more broadly, how that plays into price, where -- do people start to get more price competitive? Or do you see better discipline with some of the inflation?

Barry?

Well, I think, first, there is a market share story that is difficult to tell or see if you split it between the replacement market and new construction. New housing, obviously, is growing. It's something that can be targeted as an individual market with aggressive pricing that can matter to market share. For us, that's not our preference. Our preference is to grow our replacement business. It's higher-margin. It's more repeat business long term. And we don't have the advantage of, let's say, lower input costs and a deflationary environment to take advantage of that.

As that firms up, obviously, we can begin to compete in that space. But more importantly, as things firm up in terms of commodities and things like that, we can get inflation, we can get price increases through the market. I would say, in the first quarter, there was some progress toward pricing that needs to sustain itself through the selling season for it to be an opportunity, but for us, I -- we can't be beholden to a new construction market as what is a high-margin business that we operate. But we do like the idea that there is a bias toward inflation. It's something we can take advantage of, especially in our aftermarket.

The next question comes from David Manthey of Baird.

Yes, speaking of other competitors, it seems like these PartsPlus locations is helping Lennox gain share relative to the market overall. And I just don't know if you're seeing any impact from those locations. And just conceptually, I believe that Baker started out without any equipment whatsoever. And I'm wondering if it makes sense for you to offensively open locations in new geographic markets that are just parts and supplies. Or would the manufacturers not go for that?

It's not what they want, the manufacturers, is what we think best serves the customer. And certainly, we like selling everything that a contractor needs from a single location. That's always been our policy. I don't know why you even suspect it would be different.

I'm just wondering, while they put limits on your ability to sell equipment out of the same location, they wouldn't have the same restriction on part...

No, no. I mean, they could be -- think of it from the contractor's point of view, does he want to go to different places to get parts and supplies and a different place to get the equipment? That's the way it used to be quite a while ago when I first got started with this, but the convenience factor of having what he needs in one location, to us is what -- is the big idea. And we're good at it. We're probably better at it than anybody else.

Okay. And then the theory around the apps was that in the future, the long term, that you would need fewer people because the technology would help alleviate some of that. And Al, your comments about things taking longer for traditional customers to convert, does that imply that the uptake isn't as strong as you thought it would be? Or is...

No. No, we always knew it was going to be long-term, always. We have tried to tell you, this is years before adoption, but that doesn't stop us from continuing to improve the software and the apps that we do. But we believe that the economy is becoming digital more and more. That's not a new thought. But we think in our space, it's very important for us to lead in that since we have the capability of doing that and improve our competitiveness, but we're not looking at short-term results. We're just looking at long term. We're just not that focused on short term, although we've had records -- record after record, which is nice. But really, this is a long-term game for us.

Can I add? This is A.J. I mean, that theory of our customer-facing technology to remove people from our organization is -- that's not really it. It's about being better service providers for our customers, having more product information at their fingertips, making them more efficient in the field, making it easier to do business with us and outcompeting anybody else in the space, so they only want to do business with us. It's more about driving sales than taking out costs on the customer-facing side.

All right. Fair enough. And then on the tax rate, I assume you adopted ASU 2016-09 this quarter. And what effective tax rate should we be looking at for the remainder of the quarters this year?

Barry, I hope you got those on your fingertips.

I do, I do. Yes. Where that applies to us, David, is it impacts the tax rate by almost 100 basis points for the year. And it relates really to the dividends that are paid on restricted shares and the tax deductibility of those dividends in our earnings.

(Operator Instructions) The next question comes from Robert McCarthy of Stifel.

I wanted to just touch base perhaps on kind of what you're seeing in terms of the health of the consumer overall with the kind of your traditional metrics around delinquencies? And also, just any of the -- you look at Home Depot sales, you look at other things you hear about things in the quarter, how are you feeling about the health overall of kind of the consumer in the context of the replacement market?

Why don't we let Paul answer that? Paul Johnston.

Yes, as you know, we don't sell to the consumer. We sell through the contractor to the consumer. I guess anything that we would have that would reference that would be general things that you would also read in the paper as far as existing home sales are off-the-chart, inventories of existing home sales available for sale are at one of their historic lows. That would indicate to us that if people are still buying existing homes, that's a good sign for a replacement market for us. So right now, I feel really good about them.

I guess as a follow-up, in terms of M&A activity, Al, do you think this current environment with maybe some creeping policy uncertainty is going to delay some M&A activity for you as people get a better...

I hope not, I hope not. I'm very eager to do M&A. And I'm out there, and we're not -- we never look at calendar issues, I mean, unless they're real serious. No, we have the ability and we have the desire to increase our M&A. And just keep your fingers crossed for me.

Yes. And then the last question is in thinking about and this, hopefully, is pedagogical and somewhat pedantic but I think it's important to the investors is, maybe you could just contrast kind of your model versus traditional industrial distribution in terms of the threat of e-commerce and what Amazon represents. And why it's so different? And why the barriers are so much higher? Because it just seems across so many industries today the eruption of e-commerce is such a salient trend. And maybe you could just talk about why your model is so differentiated.

Well, I'm going to let A.J. answer that. But I can tell you this, nobody has the data that we have in this industry, and it's taken years to prepare. But I'll let -- and I think having the data with products and -- which can be so helpful to the customer and the way we do business is a key. But I'll let A.J. deal with that.

It's certainly a big ingredient. 600,000 SKUs now we've mastered in our space. I don't think anybody comes close to that, and that's a continuous effort of continuing to master more and more products and maintaining that database is a full-time challenge for a lot of people here. We certainly think about the threat of Amazon and others a lot and make sure that we're well positioned. One note is on the distribution side today, and I know this can change tomorrow, is that Amazon does not like to handle the size of products that we handle. 5x condensing unit is not delivered very easily by drone or by FedEx or UPS for that matter. So that gives a little bit of comfort at least for today.

Another is that these are technical products. We do business with 90,000 customers and contractors, and many of them, if not all of them, require our input on design and engineering and technical advice in diagnosing these products, which -- that expertise is valued in a big way by our customer base. And I don't think that's going away anytime either. So it's certainly something that we are aware of and that we watch and that we play offense against. But today, I think those factors contribute to a little bit of a breathing room there.

I was going to add one thing to that just out of some common sense to that is we're spending a lot of money in our warehouses outfitting it with product fulfillment software that lets our guys pick, pack and ship in 8 minutes. We want a customer to call us and then have the order ready in 8 minutes. And they can come by or pick it up or whatever it might be. So to A.J.'s point, a technical order, a diagnosis that was required to even create the order. And by the way, we want to get it to you in 8 minutes. And the fulfillment of that whole stream, I'm not saying is ever impossible, but that's what -- that's the reality of any competitive environment for that kind of order.

Is it also just the OEM and the exclusivity around that? I mean, obviously, private equity, there's been a hit. There's been a constraint on them getting involved in your space. So do you think that applies to Amazon as well in terms of just distribution as a whole?

For sure. I think brands are a big deal. I mean, where we do business with the brands of equipment that we do business, it's our brand. It's not available to Amazon or anyone else. And the Rheem brand, the Carrier brand, the Goodman brand, I mean, these things are very valuable. And I don't know how somebody overcomes that, but I agree that we should be constantly aware of such threats, and we are. The brand is a big deal.

This is Paul. Not to beat this thing to death, but there's 2 other aspects to it also, and that is local code. It's not just about the equipment and what the specifications have to be to meet local governmental codes, but also on all the other components that we sell, it's different and unique in different parts of the country. It's different and unique within a state and a municipality as far as -- some of this equipment can't even be delivered to a customer unless they have a license to handle refrigerant or they have to have an actual permit that they represent to us that they have -- they've permitted this sale with the city. So there's a lot more to it than just moving a box from a warehouse to a homeowner.

And just to follow up on my first question. Maybe you could just speak, Barry, to the relative health in terms of delinquencies with respect to the dealer network or any kind of metrics to track there.

Sure. Again, it's something we look at on a quarterly basis over a long period of time. In the current quarter and the current profile of our customer paying us is actually well below any long-term average in terms of risk, so it's very healthy. You'll see in our filing bad debt expense is down year-over-year, quarter-over-quarter, so that speaks to that.

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

Thanks very much for your interest in the company. We look forward to speaking to you again in the next 3 months. Bye now.

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