Earnings Call: Q1 2021

Apr 21, 2021

Good morning, welcome to the Watsco First Quarter 2020, 2021 Earnings Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by 0. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I'd now like to turn the conference over to Albert Nahmad, Chairman and CEO. Please go ahead. Morning, everyone. Welcome to Watsco's first quarter earnings call. This is Al Nahmad, Chairman and CEO. With me is AJ Nahmad, who is the President, and our two Executive Vice Presidents, Paul Johnston and Barry Logan. Before we start, our usual cautionary statement. The conference call is 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 onto our financial report. Watsco achieved record first quarter results. Earnings per share grew 93% to a record $1.39 per share. Records were set for sales, gross profits, gross margin, operating income, operating margin, net income, and earnings per share. Now these results were driven by strong sales growth made at higher selling margins along with improved operating efficiencies. When we look at our product offering, we achieve double-digit sales growth in equipment, non-equipment, and commercial refrigeration. In terms of geography, growth rates during the quarter were similar for U.S. markets and international markets as a whole. For HVAC equipment sales stabilized and are now trending more positively. More important, this is not just about 1 quarter. Over the last 12 months, residential equipment sales in our U.S. markets have increased 15%, and we believe meaningful market share gains have been achieved. Looking forward, we expect business to be strong and that 2021 will be another record year of performance for our company. Adding more color, Watsco's industry-leading technology continues to gain adoption. That leads to new customer acquisition, so we believe development of greater market share. Now, a few important trends are also continuing. Active technology users continue to outpace growth rates of non-users. Customer attrition among active technology users is meaningfully lower compared to non-users. Our platforms used by contractors to make sales to homeowners gain more users. That, in turn, double the number of at-home sales presentations and increase sales volumes that flow through our platforms called OnCall Air and Credit for Comfort. The full potential of our technology investments. Headquartered in Chicago. TEC adds 32 locations. I must say that TEC is a great company. They are also off to a strong start this year, and we expect their results to be. We raised our dividends by 10% in April 2021 to $7.80. A follow-up to the record cash flow achieved in 2020. We believe our dividend is a good reason to own Watsco over the long term. 2021 marks our 47th consecutive year paying dividends. We have increased our dividends 19 of the last 20 years, from $0.10 per share in the year 2000. Let me say that again, from $0.10 per share in the year 2000 to today's annual rate of $7.80. With that, Al, Paul, AJ, Paul, Barry, and I are happy to answer your questions. We will now begin the question and answer session. Our first question comes from Joshua Pokrzywinski from Morgan Stanley. Please go ahead. Hi, Josh. Morning, Al. Morning, guys. Thanks for, thanks for taking the question. Hope everyone's well. I guess maybe just to start out here, you know, we're about to approach a point in time where, you know, comps start to get kind of squirrely and we lap, you know, some of the kind of early-day challenges of COVID before the industry realized that things were gonna be pretty solid. What is it that you think folks should focus on this selling season? Is maybe, you know, something that you have visibility into now or, you know, maybe a like a key performance indicator over the next couple of months? 'Cause I would imagine, you know, as comps get easier and then tougher, volume will be all over the board. What's your sense of kind of the health of the market? Because in theory, you don't have, you know, more than, I don't know, 4% or 5% of the market really fail any given point in time. You guys are up quite a bit and, you know, low seasonal factor. Just trying to tie out the strength today that probably isn't sustainable, understanding that, you know, comps kind of get wonky here. You know, what are you guys seeing today that gives you some sense of the health of the business outside of, you know, the seasonal dynamic? Well, let me just remind you, and then I'm gonna turn the question over to Barry, that over the last 12 months, we're up double digits in equipment sales. The last 12 months. That should show you something in terms of continuity. Barry? Yeah, Josh. Again, good morning. First, I think there's so much data floating around about the industry on as a whole, OEM data, shipment data, and of course our focus is Watsco data. You know, if you do go back and look at last year in the summertime, really the second and third quarter, things were choppy, but they were not volatile. I think same-store sales second quarter last year were down 6%. Not 16, not 26, 6. Yes, there is a comp that's kind of better as we approach this selling season, but not the volatility that I think most others in the industry are trying to tap dance about. For us, again, our seasonality is really now through October. The Sun Belt, the sun is out, it's summertime, and of course the technology, we have our partners, our OEM partners who we have worked with over the last 6 months going into this season and beyond with kind of a really a very aggressive stance on growth and share gain. There's some product launch going on that will be important as we get through this season and into next year also. Joshua, don't be too distracted by the amount of volatility that others have had when you look at Watsco going forward, 'cause that volatility simply was not as great for us last year. Got it. That's helpful. Hey, Josh, this is AJ. Oh, sure. I have to add, Josh, if you know Watsco, and I know you do, you know that we're a long-term company also. While, you know, quarterly performance is important, you know, we invest in our business with the distinct goal of continuing to separate ourselves from our competition over the long run. That's the thesis of all these technology investments we make, and that's playing out. The more customers are using more of our technologies, the customers that are using our technologies are growing faster, they're attriting less, they're just better customers. It's also a byproduct of that is the M&A story. There's more M&A conversations that are spurred by the technology that we have and being able to leverage it in other businesses. I just wanna keep just the focus remains the long term. It's not just a quarter-to-quarter business. Well said. Got it. That's helpful. Maybe just to follow up on that technology point, AJ. You know, one of the things that's kinda gotten, you know, distributed out of that is you guys have been able to control inventory, you know, perhaps a little bit better in recent years. I think broadly across the industry, you know, inventories look a little high. What's your sense on either availability out there from the OEMs and, you know, kind of fill rates and, what maybe some of those high inventory levels that, you know, some of your competitors may have, means for price realization if, you know, if folks find themselves with a little extra on their hands this year? I think Paul would be best. Yeah. Yeah. We've, as you know, we've invested heavily in technology also internally, and we have invested millions in being able to analyze our inventory and make sure that our inventories are reaching the right spot at the right time via the demand that's being created out there. We work very closely with our OEMs to make sure that our inventories are in line with what our demand is. Yeah, it's been a tough, you know, 12 to 15 months, you know, so far, you know, working those through. So far, our OEMs have worked very hard with us. As far as what the industry has for inventory, I think there's been a little increase in inventory, you know, among a lot of distributors out there. I think a little of that is more emotional than it is data struck, but I don't think the inventories in the field right now are really out of line with what the demand would be through, you know, through most of this summer, given that this is gonna be a normal year, if it's a normal year. Got it. Okay. Appreciate the color on that. I'll pass it on. The next question is from Jeffrey Hammond from KeyBanc Capital Markets. Morning, Jeff. Hey, morning, Al. Good morning, everybody. Just on the margins, you know, really impressive on both, you know, SG&A and gross margins. I know, you know, this one Q and four Q can sometimes be, you know, a little bit different given the seasonal light. Just walk me through what drove the big increase in gross margins and how sustainable you think that is as you go into the selling season. Barry? Sure, Jeff. Well, again, it's a progression. You know, the margin story, gross margin story I think started improving last spring and carrying through, you know, 12 months later. Again, I'm gonna tell 12-month stories even though we're analyzing a quarter here, 'cause I think these have all been progressions that have happened over periods of time to where we are. It is what we call selling margin, as we said in the script. Selling margin meaning simply the market we make on pushing products through the channel. That's a blocking and tackling exercise throughout our marketplace by salespeople. We saw an increase in performance-based pay this quarter, for example, which is sharing commissions and sharing some of that profitability with people that have earned it. That's part of the SG&A increase, which is a good thing. As far as the overall fixed cost structure, again, I use the word progression once again. We've seen fixed costs stay relatively neutral over the last three or four quarters. This one's no different. It shows up in the incremental margin that was achieved this quarter. Again, for the last few quarters, very similar achievement. Okay, great. The non-equipment piece had spent a number of years kind of, you know, flattish to growing low single digits, and you've seen 2 quarters of uptick. Just wondering what's driving that, and again, you know, how sustainable you feel that is. You know, because it seems like we're shifting a lot more to replace versus repair. You know, I didn't know how much is, you know, you're still seeing a robust repair environment, or is it, you know, parts associated with new construction, et cetera? Thanks. Paul? Yeah. You know, I've never figured out, you know, when we switch from repair to replace and back and forth. I think, I think both of them have a dynamic to them that are not related to each other. You know, we're replacing units, you know, as they break. But at the same time, there's another 100 million units out there that aren't being replaced that do need maintenance and repair. The, the parts sales, you know, have started to pick up again. We've increased our focus, obviously, in those. Yeah. That's obviously helped us, you know, start growing that market again too. AJ, you wanna add something to that? Yeah. I was gonna say that's the right word, Paul. It's focus. I mean, our leadership is very focused on parts and supply sales now, and they're using data, and they're using our optimization tools around pricing and inventory in understanding customers' needs and getting the right product at the right place at the right time at the right price. It's focus, which is, I'm very proud to say, delivering some results. Okay. Thanks, guys. The next question is from Jeffrey Sprague from Vertical Research. Please go ahead. Morning, Jeff. Hey, good morning. Good morning, everyone. Thanks for taking the question. I was wondering if we could talk a little bit more about consumer behavior. Maybe it was partially addressed in that repair versus replace. It looks like mix is still shifting higher and maybe you could just provide a little bit of color on what you're seeing the consumer appetite to pay more for energy efficiency. I wonder if, you know, with all the price though that OEMs are pushing through the channel, on the flip side, do you see any, you know, kind of tension in the ability of the consumer to digest some of these price increases that are coming through? Excellent question. Ari or Paul, either one of you. Yeah. I'll give it some color, Jeff. Welcome back, by the way, Jeff. Well, first, I You know, the contractor is largely the player that is going into a home or now going through our technology into a home and saying, "Here's what I think you should do," to the homeowner. That contractor's confidence, what they're able to close the job for is very critical. That drives a lot of other people's sales, including us and the OEMs. That contractor focus, the customer-facing technology that we talk about is where a lot of this conversation is heading, we think, is the advocacy for high efficiency, the capability of the contractor to go ahead and recommend and install it and help his business as well. That's the first fundamental to understand about our technology. What we're seeing in the market also is almost one of the best credit environments we've ever seen. When I say credit, I mean the credit we extend to contractors to go out and grow their business. We're seeing one of the very best metrics on past due receivables, write-offs, things like that, which no one ever asks about. Our credit profile with our customer right now is an all-time really performance level. Again, that goes to the confidence of the contractor that we think is going in and making these deals with homeowners and pulling through product, and we're helping them do it. Paul, I know you have some color as well. Yeah, I do. You know, it's not just the high efficiency that saves the contractor or the consumer, you know, money on their electric bill or their heating bill, but it's also all the comfort attributes that you get from the high efficiency products. It's also the indoor air quality products that we are associated with a lot of the high efficiency products. Those are also having a big play with the consumer right now. We're hoping for 50 years of following this, that, you know, finally this is a market segment which is going to continue to grow, indoor air quality and indoor comfort. And I- And you gave me- I was just gonna add, I think the OEM price, you know, question you have of whether those prices, you know, those pricing actions influence, you know, ultimate outcomes, I don't think very much. If you think about what happens all the way through the channel with the profitability and pricing of an installed system, it's really goes back to that contractor/homeowner, I think, capability to get it done at that level. Yeah. I was just gonna ask as an add-on. You gave us the growth rate of above minimum standard. Could you share what % of your revenues now or volumes are kind of above minimum SEER level? Boy, Jeff, I appreciate the curiosity. It's not something we put out there, no. Oh. Great. I'll leave it there then. Thanks, guys. It's the minority of the business still, that's the good news. I will add, you know, just I guess I'm the technology guy, and Barry mentioned it earlier, when contractors use our OnCall Air platform to sell in the house, that dynamic flips. It's no longer the minority of the systems they sell are high efficiency. It's the majority of systems they sell are high efficiency when they use the tool. Pretty fascinating dynamic. Interesting. Thanks, guys. The next question is from David Manthey from Baird. Please go ahead. Morning, David. Hey, good morning, everyone. let's see. From a contractor customer standpoint, could you tell us what number of customers you had at the end of the year 2020 versus year-end 2019? Do you wanna know the number of customers we have? Yes, sir. Is that what you said? Well, we published those estimates in our public. We believe we're doing business with about 90,000 contractor businesses, and that's grown. It hasn't declined. Okay. It's a growing number. Sorry. On the penetration of OnCall Air, what I'm kind of getting at is in terms of the uptake there, where do you stand today? I know you talked about retention rates of your customers and so forth. Could you tell us what kind of penetration you think you have with that technology today and where that compares to a year ago? Well, certainly not even close to where we want it to be. AJ, color? I was gonna say the same thing. It's not enough, but growth rates are almost triple digits. It's just about getting it in front of more contractors, showing them the value of the tool, and when we do get them to a demo of the tool, they not almost always, but they sign up a lot of the times. The conversion rates from a demo to using a tool is very high. When they use the tool, it's a great win for them and a great win for us. It's still very small numbers, relatively speaking. Could you at least tell us if it's a single or double-digit number? Of what? I'm sorry, I don't understand. Of total % of customers? % of contractors. single % of our total customers. Yeah. It's a single %, single digits. Good. Okay, great. Yeah. I mean, Dave, just to help you, I mean, it's in the press release. About $105 million of business was driven on behalf of our contractor into the channel, you know, on his books, so to speak. Using the tool. Using our tool. I think last year was over $300 million as a full year. Okay, it sounds like a lot, but it is a fraction of the overall installed market that we're servicing every day. There's a lot of room ahead of us. Okay. Finally on the TEC acquisition, how should we think about seasonality of that business? Should we be thinking sort of 30% in the second and third quarter and 20% first and fourth, ballpark? Barry? Yeah, I would say 30% second, third, fourth. Sorry, second, yeah, 30% each second, third, fourth quarter and 10% first quarter. Okay. Thanks a lot, guys. Sure. The next question is from Ryan Merkel from William Blair. Please go ahead. All right. Good morning. Hey, great quarter. Great to see. Thank you. First off, tell us what you're seeing in the commercial market. Are you seeing kind of demand starting to come back here? Paul? Yeah, we're starting to see, excuse me, a definite uptick in the commercial rooftop units. Will it be at the same magnitude that we saw the rush back on residential? We're not sure yet. Okay. Great. The federal government is pushing for retrofits in schools and things like that that would impact the demand as well. Right they are creating or have created incentives to change HVAC systems to be reinstalled in schools, and I think eventually to even larger buildings than schools. Right. That's all part of the Biden's big plan for the infrastructure. Yeah a big block of money in there for school rehabilitation. Also we're seeing other legislations starting to move through Congress where, energy credits will go to commercial, buildings for improving their energy efficiency also. Yeah, I'm pretty optimistic about what's coming with commercial. Yeah. Okay. I was actually gonna ask that question next, but you answered it. I was also gonna say the ESG trends and then, you know, a lot of population migration south again. Seems to me HVAC industry is seeing some pretty long-tailed trends that could be helpful. Yeah. Okay. And then on the TEC deal, was that also largely driven by, you know, the family wanting, you know, the technology? The second question would be, now that you've planted a flag there, do you think you could close more deals up north? Is that, is that how it works? Well, those are two questions, and since Barry Logan has successfully succeeded with TEC, I'll let him answer that. When I say successfully, he was the point man for Watsco. You know, thanks, Al. Ryan, first on TEC, it's been a 20-year relationship, not in the last 12 months. We've been building this and working on this for a long time. It is a family business, and as such, multi-generations of family as well as multi-siblings of ownership. I think they reached their own conclusion as a family of the right timing and the right desire to sell at a given time. So, talking to us exclusively for all this time, you know, is a great compliment by them from them. Technology is what really, I think, brought things into light. As you know, we bought the Philadelphia Carrier distributor about 2 years ago. These guys are friends. They've been peers for 20, 30 years. The family's known each other for longer than that. That was one of Pierce's primary reasons for selling, as documented in our annual report last year. Skip and Brian Pierce are good friends and shared notes and made my job easier the last 12 months getting this done. Technology has a lot to do with why both companies, after 80 years, joined Watsco. I think, as AJ said earlier, these kind of dynamics are not just these 2. There's more to come, at least in terms of conversation and meaningful dialogue beyond just, you know, selling the business. It's joining the Watsco technology story. Then we've asked Skip and his team to find other acquisition candidates in their markets. As part of their growth plan is to go out and use their own relationships in their local markets to grow, and that plan is set. If you met Skip, which you're in Chicago also, I'd be happy to introduce you to him. You'd meet a very big personality that really can't wait to help us grow and TEC grow as well. It's a great acquisition. I'd like to add to that. Technology certainly is of interest to people that own businesses, but it's also the culture. We have a long track record of respecting the legacy of the companies that we buy. We don't change their names. We don't manage them. They manage it themselves. We're in the background. We provide financial support, technology support, whatever they call that they need. We're not about to even start to disassemble what they've already accomplished. Quite the contrary, we just want them to go and get bigger and support it. That's a very big deal for people that have created great companies and don't wanna see their legacy destroyed. I was just gonna add to the pre-the previous question on commercial. Nobody does commercial better than TEC, and we are eager and excited. They will teach the rest of our business units a lot on that front. That's a wonderful opportunity as well for the company. Appreciate it. Thanks. If you have a question, please press star, then one. The next question is from Stephen Tusa from J.P. Morgan. Please go ahead. Hi, Steve. Hey, guys. Good morning. Good morning. Here we say [Foreign language]. Yeah. Could you just give us an idea of what commercial actually did in the quarter? You noted it was kind of, you know, stabilizing, getting better. What was commercial actually in the quarter, year-over-year? Equipment. Paul. Well, yeah, commercial, as far as a variance, was basically flat. Okay. However, we're, you know, a lot of that was influenced obviously by the larger applied type products not being flat. They're still suffering a little bit. The unitary products are definitely showing growth, and we're starting to see some rebound on the VRF and some of the other products. On the VRF? Okay. Right. Got it. Was the traditional commercial unitary rooftop, the rooftop stuff flat to down? Is that, you know, was a lot of your growth driven there by VRF? No, actually, unitary, it was up slightly. Okay. Can you just give us an idea of kind of when the last OEM price increase that you see currently goes through, what kind of the rough dates of that currently is? June one. June one, okay. Is that the vast majority of those guys? Yeah, it is. Yeah. They've all publicly announced. Yes, June one. There's 1 in April and 1 in May. Okay. Was there actual price realization for you guys in the quarter? What was that? Barry? Yeah, there was a small amount of price in residential and in the market. You look at the 18%, you know, overall growth rate, couple percent in price, the rest is units. Got it. Then what is the supply status of the major OEMs? I mean, are they all back up and running? I know 1 or 2 had some supply issues last year. Are they back up and running yet? Do you expect them to be back in full force by the time, you know, the season really cranks up? Go ahead and answer that, Paul. Yeah. Okay. Yes, you know, they all had glitches, you know, with. You know, during this entire period, but I would say right now they're probably in the best shape that they've ever been. We still have some things we're not out of stock, but some things we have to work harder to obtain. It's becoming a little bit more normalized now. Okay. Then one last one for you. What were your sales into housing like to I don't know if you kind of differentiate that between, you know, builders and, you know, those bigger housing customers. Can you differentiate between those two at all? We really don't, you know, differentiate too much from that. It's not a great percentage of the business. Yeah. Okay. It hasn't grown that much. Yeah. Sorry, Barry, one more follow-up there. What was pricing last year for you guys? It was very, very negligible, Steve, last year. Okay. Okay. Got it. As the year wound up, it was almost no price in terms of the residential equipment business. Got it. With all units. Yeah. I would assume you still have some kind of, I guess we're just trying to still parse out the strong selling margin. I mean, was any of that due to kind of, I mean, price cost is the wrong way to put it for you guys because you basically pay for the units, that is your cost. Was any of that due to kind of inventory dynamics? You know, stuff you had on hand before all these price increases are going through? Like, should we assume the gross margin stays this way, or is it gonna kinda narrow over the course of the year? Well, it's one of our major focuses, again, is being able to maintain and grow our gross profit. We've got a lot of initiatives in place to make sure that we can continue our growth in gross margin. That's our plan. Okay. Great. Thanks for the color, guys. I really appreciate it. The next question is from Christopher Dankert from Longbow Research. Please go ahead. Morning, Chris. Hey, morning everybody. I guess thinking about the tools you've been talking about here, is the real focus, you know, on developing, you know, new technology tools, or is the opportunity really more, you know, deepening penetration at this point? I'm just trying to think about where, you know, the incremental investment dollar goes. Is it really more on, you know, continuing to build out that tech team or is it more about the actual rollout at this point? Good question. AJ? It's both. It's absolutely both. I think we've built some fantastic platforms, and the customers of ours that are using them are enjoying great success as for themselves, and they make them better customers for us. We are developing additional feature functionality on those platforms, we are constantly assessing and trying and experimenting with new things that might also be good for our customers and our business. It's just who we are now. We, you know, it sounds cliche now maybe in 2021, but we like to think of ourselves as a technology company that just happens to sell HVAC. It's not gonna stop. We are just constantly looking at and trying new things. When we say technology, you know, that's really an umbrella term. We mean people, process, technology and modernization and experimentation and innovation. It's just technology is a catch-all for continuous improvement. Got it. Got it. Thanks. Then, you know, sorry to bring it back to this, Barry, but I think you kinda teased a new product introduction later in the year. Anything you can give us on that? Are you talking about, you know, tools you guys are introducing or is this from your suppliers that, you know, new products are being rolled out? Well, I shouldn't have teased because I don't wanna show my hand now, Chris, you know? Well, we'll try and keep you honest in the future here, I guess. That's right. Part of any OEM relationship is to find either segments or products or features or benefits to launch into the market and gain share. That's what we're doing, and so we're going to keep it quiet. You know, when we say product, it really is going out and addressing segments and markets or price points where we feel there's market share opportunity, and we've got some very aggressive partners that are helping us do that. Got it. Well, I can't blame a guy for trying. Thanks so much, guys, and good luck here. Absolutely. There are no more questions in the queue. This concludes our question and answer session. I'd like to turn the conference back over to Albert Nahmad for any closing remarks. Once again, thanks for your interest in our company. We are, as AJ Nahmad has said, always focused on long term, and we hope your interest will continue for the long term. We'll see you the next quarter. Bye-bye. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.