Welcome to the Watsco First Quarter 2019 Earnings Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. This event is being recorded. I would now like to turn the conference over to Albert Ahmed, CEO and Chairman of the Board.
Mr. Nahmad, please go ahead.
Good morning, everyone, and I hope everyone is having a beautiful spring day. Welcome to Wascos' 1st quarter earnings call. This is Al Nahmad, Chairman and CEO and with me is A. J. Nahmad, President Paul Johnson, Executive Vice President and Barry Logan, Senior Vice President.
Now before we start our cautionary statement, this conference call has forward looking statements as defined by SEC laws and regulations that are made pursuant to the Safe Harbor provisions of these various laws. Ultimate results may differ materially from the forward looking statements. Now on to our report, excuse me, I'm fighting off a cold. Now, Watsco produced another record quarter. Sales, operating profit, same store operating margins, net income and cash flow all reached new highs.
Results reflect better gross margins and flat same store SG and A. Our performance was achieved in adverse weather in certain markets, also difficult sales comparisons from a year ago and one less selling day during this quarter. Although it's very early, we believe 2019 will be another record year. We also continue to make investments. We have opened 12 new locations and that add more density in our markets.
And we have continued to develop, launch and iterate a variety of customer focused technologies. Over the long run, these innovations will transform our way of doing business. Now a few of this quarter's technology results. E commerce run rate is approaching 30% of sales and were $1,200,000,000 over the last 12 months. Furthermore, we surpassed 50,000 unique users in our mobile apps.
Next, sales growth rates for active users continued to outpace non users. Let me say that again. Sales growth rates for active users continue to outpace non users. Less year over year sales attrition is occurring with our user community. And finally, these results speak to one of our most fundamental long term objectives, which is to partner with our customer and help them outgrow the market.
That's what we wanted to do. We want our customers to outgrow the market. Now moving on to our balance sheet and cash flow. Our balance sheet remains very conservative and strong with an 8% debt to total debt to total cap ratio. Operating cash flow for the quarter was a record $53,000,000 and we again target cash flow to exceed net income this year.
In January, we increased our dividend by 10% to an annual rate of $6.40 per share. Interesting enough, 2019 marks the 45th year, I should say, consecutive year that we have paid dividends, 45 consecutive years of paying dividends. We often mention our 18% 30 year compounded annualized growth rate for total shareholder return, which is among the highest of all public companies as 18% and compounded growth rate of total shareholder return. But we want to note that our 30 year compounded growth rate for dividends is 23%. Future dividends increases will be considered in light of investment opportunities, cash flow, our financial condition and business conditions.
In April, we completed the acquisition of DASCO Supply, a great company that has operated in Northeast U. S. For 45 years. It is wonderful to now be a part of DASCO's family. I say it that way, part of the DASCO family, because that's how we look at it.
DASCO's names and culture will continue and will be led by the same team that made them successful. We continue to seek additional opportunities to grow our network. We believe an ideal time this is an ideal time for owners to engage with us and I hope they do. Our press release provides important details about our performance, and we will be happy to provide more color during Q and A. One last thing is to renew our invitation to visit us in Miami and learn more about technology journey.
Those who have visited come away with a better understanding of our culture and strategy. Now with that said, I want to turn to A. J, Paul and Barry for your questions as well as me. Anita?
The first question today comes from Steven Volkmann with Jefferies. Please go ahead.
Good morning, Steven.
Hi, good morning. Thanks for taking my question. Maybe we can just kick it off. We've talked over the last couple of quarters about kind of end market conditions in, I guess, Florida and Mexico specifically. But I think, Al, you also mentioned some weather kind of interruption.
So I guess, can you just give us a lay of the land of what you're seeing on your end markets?
Let's turn to our data guy, Paul Johnston. He watches that sort of thing.
Yes, we had if I can take them 1 at a time. Florida obviously was a unique market this year. The weather wasn't what it normally is, but still we had a very good year in Florida, or a good quarter in Florida. Mexico, we're still fair to announce what's going on in the political scene there. And as soon as that becomes clear, I think we'd have a better outlook as far as where we're going in Mexico.
But, yes, pretty normal, small seasonally small quarter and both markets performed well.
What was Florida up for you this year, this quarter?
We don't get into exactly what each one of our marketplaces do.
Okay, fair enough. And since you called out weather, do you have a rough estimate of what you think that might have cost you in the quarter for growth?
No, that's that would be a $1,000,000 question. That would be very, very tough to predict how much impact weather has. There's so many other different pieces of what we do in our business with the parts business, the supply, the new construction, the replacement market. It would be totally a wild guess.
Okay, fair enough. All right. Thank you, guys.
The next question comes from Jeff Hammond of KeyBanc. Please go ahead.
Good morning, Jeff.
Hey, good morning. Hey, just wanted to kind of go through the 2 buckets. 1, the investment spend you called $1,500,000 incremental or $0.03 in the Q1 tied to the Alert Labs acquisition. Can you just talk about how see that trending through the year and what you think the full year kind of investment spend headwind is?
Well, I'll turn that over to Mr. Ajay.
Thank you. Yes, we're excited about the Alert Labs acquisition. It's a bet for us. It's speculative, but we believe that the products are bringing to market, which are just coming online now, should be great for our customers and great for their customers. And judging by the initial reactions to the contractors that we show these tools to, we're excited.
We are investing there and we'll continue to invest as well as the other technology programs. And as I've said, over time, where we see opportunity that has a great return on investment opportunity, we're going to go for it. These are investments that we don't expect to pay off in the next month or quarter, but over the long term. And we are a long term company, so it's consistent with our philosophy.
Is there a way to quantify what is that $1,500,000 run rate you had in the Q1, is that the right way to think about the headwind through the year?
I think so.
I think it's Yes.
I think that's a good conservative way to look at it.
Okay. And then conversely, I think you talked about some productivity initiatives that help same store SG and A flat for the quarter. Can you just talk about what you're doing there and how that progresses as you go into the selling season from a cost save perspective?
Mr. Logan.
Good morning, Jeff. Well, yes, obviously with 5 75 locations as we ended the quarter, really I would say in the fall of last year after the selling season, we really went into a deep dive into data using the BI platform that we have and really simply challenge the status quo with data across our across the whole number of branches that we have in Watsco. So during the fall and into the early part of this year, the business unit leaders use the data, made decisions, made changes, and it reflects in the SG and A to start this year. How that plays out in season, obviously, is a matter of the growth rate that's throughout the season. But in terms of repositioning cost, using the data platform we have and being aggressive in that sense certainly showed itself
about inventories in your channel as you head into the selling season? Thanks.
Barry, I don't like to talk about going forward anymore, but what do you want to say about it?
Well, again, it is always too early to make a call in the season. In terms of growth and growth rates in April, again, it's a very narrow slice. I'll say we feel better. I'll say it that way. And but we need to feel extremely well all the way through the fall and but so far so good early in April.
The next question comes from Brett Linzey with Vertical Research Partners.
Please go ahead. Hi, Brett.
Hey, good morning everyone. Hey, just want to come back to the comment in the release about accelerating several technology investments. I think you said 12 new locations in the quarter. I mean, are you starting to pull forward some of the deployment actions that you would have expected later in the year? Are these actions that were even kind of outside 2019 that you're trying to accelerate and pull into 2019?
Well, I can't give you a precise answer. I can tell you that our decentralized management we We don't oversee that. We support it. That's one of the reasons we're so strong in the local markets. So I can't tell you what fits in mind unless somebody else had data.
Paul, do you have data what you've heard already from the field?
No, it's just exactly what our people had seen last year as far as market changes where they needed to position a new branch. And obviously, the importance is to get that branch in place and get the employees in place before the season actually starts. So generally speaking, if you're going to have a branch open for 2019, you've got to have it open in the Q1.
Okay, great. And then just shifting to the revenue line, you had flat same store sales in the quarter, 2% equipment growth. We just heard from Carrier that they saw 5% growth in their North America residential business. Maybe just help us bridge that disconnect. I know Carrier is obviously a big vendor for you guys.
Is it simply just channel loading and channel dynamics, the furnace side, any color you could provide there?
Paul?
Yes, it definitely is. They're reporting what shipments are to their distribution and we're reporting what sales are to the contractor who actually is installing the units either in a new home or in a replacement mode. So yes, that's what you find is because of the high demand that we have in the June, July timeframe, most OEMs are going to have higher sales in the front part of the year and then their sales will level out. Conversely, a distributor is going to have lower sales in the Q1 and higher sales in the Q2.
I mean, I'll also add that in the quarter, we also had a one less selling day. If I adjust for that, it's right around 4%, our equipment business for the quarter. So just keep that in mind.
Okay, good. All right. I'll pass it along.
The next question comes from Ryan Merkel with William Blair. Please go ahead.
Hi, Ryan.
Hey, good morning, everyone.
How's the weather there?
Not great, but I'm curious if Chicago will take it.
All right.
So, Sorry. First question for me, I wanted to ask about gross margin expansion in the quarter. What were the drivers and then can it continue?
Barry?
Ryan, good morning. We have a simple thing we track called selling margin, which is our markup on the products that we buy and resell, and that was up the full 20 basis points that you see in the financials. So that's simply being a good merchant in light of some price increases. There are more price increases that came in, in March that will play out for the remainder of the year. But I would say just good blocking and tackling on buying and reselling products as a merchant.
So maybe the rest of the year kind of flat, maybe up 10 basis points for gross margin, is that fair?
Yes, Ryan, it's always a seasonal call again based on what's going on in the market. So I'm not ready to speculate on that, but we like the way that you're starting.
Okay. And then on SG and A, just curious, what do you think is a reasonable range for SG and A growth in 2019? And let's assume that organic sales are up 4%, 5%?
Barry?
All right. Well, again, I've said this historically that about 60 percent of our SG and A is more variable than fixed. In terms of correlation to growth rates in sales, that's how I would look at it. In terms of the present state and the current state, again, Ryan, we started the year in a very good aggressive conservative posture with cost. As Al said, our culture is to have our business unit leaders operate our business.
It's not done from our level, it's their level. And if they want to add costs or add people or deal with customers that in a more effective way, they're incentivized to drive EBIT growth. So just know again, it's a more conservative posture to start the year and again our business unit leaders were the ones that pulled that off and it's a good starting place.
Okay. That was more color than I was actually expecting in those two questions. Thank you.
So you deserve more color, Ryan.
I really try. All right. Let me just ask one non financial question. So is there any risk that the reduced headcount could hurt service levels?
Well, that's a very good question. But again, corporate is not making headcount reductions. It's the people that are in the local markets. And I think that they will adjust headcount as they see fit. If the consumers or the customers require more personnel, it will do it.
It's not a fixed system. We believe that they're smart in what they do, our field leaders and they'll deal with what's required.
Okay, good. Thank you.
The next question comes from Robert Barry with Buckingham Research. Please go
Nice to see strong performance on the SG and A front. So going back to the same store sales being flat, I'm sure your guys are not happy with that. I mean, what do you think you can do to get that going?
Well, we gave some explanations or I did, I gave you three reasons. And Barry's further developed it that if we had one less day, which would dramatically change what you're asking about. So I think we're fine.
Okay. Do you get that date back in Q3?
I'm sorry, what?
In Q3, do you have an extra day? I think
you get it back in Q3. Eventually, yes, it all catches up. That's correct.
Okay.
And also don't forget that last year was a very large Q1 across the board in the industry.
Right. No, fair enough. Okay. Any buying ahead of those March price hikes? I saw the inventory was
Yes, absolutely. I'll let Paul give you some details on it.
Yes, we certainly wait, but there's a good reason why we have a powerful balance sheet. We use it as merchants to be able to buy forward a bit. We don't do it in an extreme manner. We just do it in a prudent manner, which we can move the inventory through. So yes, we did buy some inventory beforehand.
And also sometimes they notice logistics from OEMs, where they don't have the drivers or the trucking that they need. So we just to be conservative, be able to support our contractor customers, we'll buy ahead, so we can assure our customers of having the product they need.
Yes, really it goes back to your sales question. We want to make sure we have every product that every customer needs on every day and every location. So in this What
is our completion rate, Mr. President, on that? What is
the date of Yes. Since the implementation of our demand planning inventory optimization tools, our customer service levels in terms of order fulfillment rates have gone from in the neighborhood of 92% to 97% plus. And that's a factor of using math and science and data to make sure that again we have the right products at the right place at the right time to match the expected demand. And we can use our balance sheet as needed to ensure that and that's what helps customers feel comfortable that when they walk into our stores that day, we'll have what they need.
Got it. Just lastly for me, I saw that you promoted Steve Rush to COO. Can you maybe comment on what he's going to be focused on?
Steve Rush, our 20 year veteran, everywhere we've asked him to go, he does he leaves a trail of success and he now will focus rather than on individual units, he'll focus on the entire operation. He's good. He will support the co Chief Operating Officers and their leaders in doing even better. He's a veteran and the operations report to him.
And anything in particular he's focused on, any initiatives or kind of his priorities in that role?
When he tells me, maybe I'll pass that on to you. Maybe A. J. Knows. Go ahead.
His mission is again back to that first question, it's growing sales and growing EBIT, right? It's the blocking and tackling, it's the making sure that the local leadership has what they need and has their teams organized the way they should have them organized. And again, he's done this very successfully in our company for 20 years and he can be a tremendous resource for the divisional and subsidiary and divisional and regional and local leaders who are making decisions every day, they can tap into us with them. But that's his mission is drive sales and EBIT.
Great. All right. Thanks guys.
The next question comes from Josh Pokrzywinski with Morgan Stanley.
Hi, good morning guys.
Good morning.
Just to follow-up on a
couple of questions that have already been asked. Paul, I know talking about 2018 that a lot of the divergence in growth that we saw across the industry was largely geographic. Your home state in mine being pretty big outliers relative to the Sunbelt. Do you think something similar to that happened in the Q1 or do you think it is a little bit more evenly spread this time around?
I think it was very evenly spread this time around. The Q1 is not an in season quarter any place in the country except for some furnaces. So really, if something is going to play out, if there's going to be variances, we'll start seeing those in May June.
Right. And just Josh to be still abstract, but somewhat specific and just having fun saying it that way is if you take the growth rate account for the selling day difference, then ask a question U. S. Versus international, Latin America versus U. S, commercial versus residential, the bandwidth of growth rates this quarter was almost in a very narrow range consistent with the overall growth rate.
So when Paul said it's pretty spread evenly, that would add some depth to that comment.
Yes. The way I look at it, I've always looked at it is Watsco is a steady grower. We sometimes grow faster than other times, but we always grow. And as long as it can be steady and year after year, which we are, and grow our network and provide additional growth that way through M and A or additional share market gains, We should continue to be steady, steady growers, sometimes faster, sometimes slower. But that seems to be our profile.
And I think that's pretty healthy.
That's helpful. So just following up on the inventory questions and the decision to bring on a little bit more to start the year. I guess, how do you guys interpret that in terms of or how should we interpret that in terms of your outlook for industry pricing this year? I mean, I guess you've seen some of the metals prices come off. You have a major supplier out there who's still working to get production back online.
So maybe some folks want to take some share. Do you think pricing is going to have kind of an above average year in 2019 where you would want to buy ahead or is there something else we should think about?
Paul?
Yes, I think last year was the price year, the year of the price, the year of the tariff, the year of the commodity run up. So I think we saw a lot of pricing actions. Oh my God. So we saw a lot of that price action last year. This year in Q1, we've seen some of it.
I think it's going to be it's going to slow down now because you're not seeing as much fluctuation in the commodity prices. You're not seeing as much fluctuation coming from the steel. Like you said, it came off a little bit. So I'm just hoping for a nice steady. I guess, buying forward has 2 meanings for us.
1 is, as A. J. Stated, to make sure that we have the product available, and we have it in the barn and ready to go for our contractor customers. Yes, it is a nice little hedge against the price increase that some of the manufacturers had announced. But basically, I don't see this year as being as volatile or as an amazing as what we had last year in the way of pricing.
Yes. And that's A. J. I would add that our buy aheads are already complete. The summer season is starting now.
So I think as far as our inventory goes, this is peak.
Okay. Thanks for the color, guys.
The next question comes from Chris Dankert with Longbow Research. Please go ahead.
Good morning, Chris.
Good morning, everyone. Thanks for taking my question. In the press release, you guys highlighted some freight optimization. I guess, what was the impact of freight in the quarter? And just is it just renegotiation of contracts?
Or what is going on in that optimization?
I think that's A. J, do you want to take that or you want Barry?
Yes. Barry, maybe you have the actual numbers. I'll tell you that the process is again, it's all about challenging the status quo, like Barry said earlier, right? It's another part of our operation that's been done largely the same way for a long time, but now we're bringing data and tools and technology and wisdom to doing it all better, right? Using our trucks more efficiently, measuring and tracking mileage, using third parties, being more aggressive and using more data that's more available through technology to select low cost carriers.
And this is a multifaceted approach to how we can attack and be more efficient with our freight spend, which is a large number for us, one of the biggest spends across our SG and A. So it's a lot of effort going into it, which again will take time to scale itself across our operation. But Barry, I don't know what the impact was this quarter off the top
of my head.
Again, we'll just first, it's about a $60,000,000 number annually. And in the quarter, you can do the math. And for this quarter, again, very flat in terms of trend. And it's I don't think it's been flat in my career in terms of relative year over year changes. So again, what it is, by the way, is last mile delivery and last mile freight.
It's moving things from our branch within 20, 30 miles of that branch to service customers. And it's been always been one of the most enigmatic and difficult costs to manage because of the diversity and really the proliferation of small carriers and so on. So with technology, it's brought a better technology to the as A. J. Says, math and science to every branch.
And we're just starting, but it's progress.
Got it. That's really helpful. And if I could just pull the thread on that last mile delivery just a hair more. We've seen rideshare moving a little bit more into the freight share with things like Uber Eats. And we've heard some distributors toy with the idea of using a service like this to deliver parts to contractor customers in the field.
Is that an idea that from a flex standpoint you've considered or is that more appealing to competitors that don't have 400 trucks at their disposal?
I'll take that. This is A. J. It is something that we will be experimenting with. There's a number of providers out there.
Uber is just one of them. We've been way ahead of this. But I think we are also uniquely positioned to take advantage of that offering if there is an interest from our customers because of our technology platforms not to be redundant. But you heard the statistic that over 50,000 unique users used our mobile app this quarter, right? Those are screens where customers can place orders and choose how they want to receive their product either by pickup, traditional delivery, or they can get it potentially hotshotted out to them via either one of our trucks or a third party.
So if and when that does become a real option, I think we're uniquely positioned to win with it.
Thanks guys.
Next question comes from Blake Hirschman with Stephens.
Just real quick on DASCO, just kind of wanted to see if you care to share any more color around the deal announced a few weeks back, whether that's around the strategy behind it or anything by way of multiple paid or estimated accretion?
Well, we're not going to respond to valuation, but we're going to respond to our enthusiasm for having a company with a great history for 45 years joining our organization and very eager for growth given the useful tools that we can provide not only in technology, but product offering. And they will take whatever they want from product and technology as they wish it. We don't want to disrupt what they do so well. So yes, it's a positive and it's a positive in a region where we don't have that much business yet. Let's hope that it's the beginning of something much larger in that region.
Got it. And then lastly on the footprint, just how should we be thinking about the plans with openings versus closures this year outside of the additional branches brought on with DASCO? That's it for me. Thanks.
We answered that. Paul?
Yes. I mean, our people are opening branches where they need to open branches, where there's customers and where there's upside market opportunity for us. And so that decision is really being made at the local level and it's being implemented at the regional and local level.
This is AJ. I'll say one more thing about DASCO that's interesting is, as I get asked often, what will this industry look like in 5 years or so. And my answer is that there's going to be the haves and the have nots and the differentiator going to be technology and that's going to be true at the distribution level and at the contractor level. Because if you look out, it's going to be based on customer expectations, whether your customer is a contractor or you're a homeowner, they're going to expect a different level of service, a different level of attentiveness, a different level of speed, which is all only possible with technology. And the DASCO team sees that.
They recognize that. And part of the a lot of the conversations that we've had with them over the last several months has been centered around, we know that technology is key today and is going to be even more fundamental going forward. And we want the support and the help of Watsco to help us get there and to achieve and to help us continue to support our customers and grow. So that's another angle of the whole technology story.
Got it. I appreciate the color. Thanks.
The next question comes from David Manthey with Baird. Please go ahead.
Good morning, David.
Hey, good morning, everyone. Hi, Al. Is it safe to say here that there's a lot of minor puts and takes this quarter with days and weather and price and things? If you just look at equipment units, is it pretty safe to say they were fairly flat against a tough comp?
Barry?
That's right, Dave. Probably, again, if I account for the loss of the day, if I account for that slight growth in units and some growth in price and mix. But I think what's more important is what I said earlier is that if I look across markets and commercial, residential and so on, very consistent growth and dynamics across all the different flavors.
Yes, okay. And then to drill in on other HVAC products, Paul, maybe you have some details you'd be willing to share as relates to either construction related products or repair parts, any trends you're seeing one way or the other there?
I don't really understand the first part, construction related products?
Well, ductwork and things that would only go into it, new construction versus fair value.
Yes, that continues
to be strong. That's been good for us. And that's on the off season, we always have a consistent sales level that we are able to provide on the installation type product. So new construction, although a small portion of our business, still was good in the Q1. Excellent.
And relative to new home construction trends, you feel at this point you're holding share today?
I think we've done very well in new construction in the Q1.
The next question comes from Patrick Dallman with JPMorgan. Please go ahead.
Good morning, Patrick.
Good morning. Thanks. For taking my question. Appreciate it. I just had a quick one for you or maybe 2.
The HVAC products and the refrigeration products businesses were down a little bit in the quarter. Just wondering if there was anything unusual like store closures or something like that driving that or is just kind of the weather in the market in the quarter, things like that?
Paul, wasn't pricing part of that in refrigeration?
Well, on the refrigerant, it was on the refrigeration products themselves that we had some it was basically flat. Our refrigeration sales are basically driven by a lot by the ice and reaching cooler business. And it all ties back to how many store openings there are and how many hotels and motels and restaurants. Refrigerant is kind of an odd animal. The refrigerant itself was down in the Q1 And that was because we had a huge price run up in the Q1 of last year that we saw it come back down in the Q1.
And then in the last 2 weeks, we've seen it go back to where it was again. So just a volatile situation, but not a big piece of our business.
Okay, understood. And then maybe I think Al, you mentioned toward the beginning that it being an ideal time for owners to talk to us. Just wondering if you could maybe unpack that comment a little bit in terms of what you're referring to?
Well, those of you that have followed us know that we're an M and A company. I think we're well over 60 transactions and we have a terrific balance sheet and we want to do more of it because I think we can help others grow and keep their culture. We're very unique in M and A that way. We don't try to change cultures. We don't try to change leaderships.
We just want to support them to do more and provide capital and provide additional products and technology and whatever else they might need. And I think that eventually we're already seeing more independent distributors are want to are attracted by that and reach out to us or we reach out to them. And so I'm enthusiastic that the time is on our favor. Now can I tell you what we're going to do the next quarter or this year? No, I can't do that.
But I can tell you that I think that it's the time is on our side. As long as we continue to invest in technology, as long as we maintain our decentralized structure and all those things, our M and A should be active.
Okay, got it. Makes sense. Thanks and good luck this season.
Thank you. This concludes our question and answer session. I would now like to turn the conference back over to Albert Nahmad.
First, Anita,
I want to thank you for doing such a great job monitoring this call, and I hope you'll be here the next time. And then I want to thank all our listeners and for your interest in our company. We hope to have you at our next call. Thank you.