Earnings Call: Q1 2018

Apr 24, 2018

Good morning. Welcome to the Watsco, Inc. First Quarter 2018 Earnings Conference 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 zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Albert H. Nahmad, Chairman and Chief Executive Officer. Please go ahead, sir. This is Al Nahmad, Chairman and CEO. With me today is AJ Nahmad, President, Paul Johnston, Executive Vice President, and Barry Logan, Senior Vice President. As we normally do before we start, the usual cautionary statement. This conference call has forward-looking statements 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 the performance. I'm pleased to report that Watsco delivered another record quarter. It's a good start to what we believe will be another record year. Sales, operating income, net income, and earnings per share reached record levels. Our performance includes continued investment in Watsco industry-leading technology platforms, as well as 140 additional customer-facing employees to expand sales and customer service capabilities. Once again, we raised our annual dividend to $5.80 per share, effective this quarter. 2018 marks the 44th consecutive year we have paid dividends. Interesting to note that we often mention our 19.3% 25-year compounded annual growth rate for total shareholder return, which is among the highest for all public companies. It should also be noted that our 25-year compounded annual growth rate for just dividends is also 19%, which we consider to be highly attractive as well. Future increases in dividends will be considered in light of investment opportunities, cash flow and financial conditions and business conditions. Our balance sheet remains conservative with a debt-to-capital ratio of 6%, and we are positioned to take advantage of most any size investment opportunity that may come along. The detailed first quarter results. Revenues grew 6%, driven by an 8% increase in HVAC equipment sales. Operating income increased 11%. Operating margins expanded 20 basis points to 5.8%. EPS increased 25% to a record $0.89 on net income of $34 million, which includes lower taxes or a lower tax rate. year-over-year, we have reduced debt by $191 million. Regarding our technology. The theme of our customer-obsessed technology strategy is simple. When our customers win, we win. Our focus is to help customers be more efficient and more profitable and make it so good to do business with Watsco that they only wanna do business with Watsco. That was a mouthful, I think you get the idea. Time is money for our customers, so our mobile apps deliver mobile enabled information and solutions on any device, anywhere. The run rate for e-commerce sales stands now at close to 30%, and we're very focused on increasing that. Customers do not have business hours, so our apps and e-commerce platforms provide information and order processing at any time, day or night. For example, over 25% of our e-commerce orders are outside conventional business hours, an indication of their value throughout the entire day. Customer require products in minutes, not hours, and certainly not in days. We have built and are deploying technology that improves order fill rates with speed and accuracy. More locations have adopted our proprietary software, and we expect our entire network will be live by the end of the year. Customers also require technical assistance throughout the day. We have developed the industry's largest amount of digitized product information and have mastered over 650,000 SKUs from well over 1,000 suppliers. That's taken us several years to do and will continue to add to that 650,000. Our technology is a long-term mission. It will take time to scale across the 563 locations that we operate, the 250,000 contractors and technicians that we serve, and 7 million transactions that we process and fill each year. On May 18th, Baird and Watsco are hosting a technology summit for institutional investors to update our progress and provide more insight into our long-term thinking. It will be a fun and informative day. AJ, Paul, and Barry and I are happy to answer your questions. The first question comes from Ryan Merkel of William Blair. Please go ahead. Morning, Ryan. Hey. Morning, everyone. Congrats on the strong top line. Thank you. I wanna start with gross margins being down a little bit year-over-year. I think a few of us were expecting something a little bit higher, just given the strong price backdrop. What were the puts and takes this quarter? Barry? Good morning, Ryan. How are you? Well, first again, we had nice growth rate in our equipment business, which just algebraically has a lower margin than the non-equipment business. There's some algebra there in the numbers. There certainly was price this quarter. It is reflected in the equipment growth rate. Overall though, the real baseline of your question is the mix between the equipment and non-equipment side of the business. Then just the follow-up, was price cost a positive? I think possibly you could have bought ahead of some of the price increases and had a little boost there. Yes, price cost was positive for the quarter. Okay. All right. For my second question, I'm just hearing that some of the OEMs have announced a midyear price increase, and I'm wondering what you're seeing from some of your important OEMs. Could you speak to the amount of the increase and possibly the timing? Paul? Yes, we have been seeing price increase announcements coming from most of the major OEMs. They range, it's pretty much up to 6%, 7%, 8%. You know, obviously they're not gonna realize that full amount. They're much smaller on the when you get into the real nit-nitty gritty of what we actually sell. Okay. Just maybe lastly, just historically, have mid-season price increases generally sticking pretty well? Is that the history there? I think this is gonna be a trial balloon. I've been in the industry many, many years and it's unusual for us to have a mid-season price increase. I can't remember the last one, so I have no basis to say whether it'll hold or not. I hope it does. Okay. Thanks a lot. Appreciate it. The next question comes from Robert Barry of Susquehanna. Please go ahead. Morning, Rob. Hey, good morning. This is Mike Yang on for Rob. Hi, Mike. I was just wondering, can you comment on how growth is tracking so far in 2Q? No, we're not gonna do that because first quarter is unusually, as it is every year, not a tell-tale about what's gonna happen in the rest of the year, so we're not gonna do that. Sure. No problem. Just to follow up, to what extent did hurricane rebuild activity help the quarter? It's not a big impact because our distribution is so large that any single area that requires a lot of attention during a hurricane or other nature's disasters doesn't really affect the overall. It helps a little bit locally, it doesn't, it's not big enough to impact the overall business. Great. Thank you very much. The next question comes from Matt Duncan of Stephens Inc. Please go ahead. Morning, Matt. Morning, Al. Obviously, very, very nice HVAC equipment sales growth in the quarter, and I think that does in part anyway, explain what's going on with gross margin. On the equipment growth rate, can you tell us how much was price, how much was volume? Kind of as a follow-up to that last question, was there any noticeable difference in growth rates geographically? Did you maybe see things grow faster in Florida as you might be getting some benefit, which I would think is gonna last a while if you are from hurricane recovery? Well, generally, we don't like to give territorial information because we don't wanna invite our competitors. Let's see if we can answer your first question. Barry? Hey. Morning, Matt. No, it's again, pretty healthy unit growth and price and mix. All three were positive. To get to the 8% you know, growth rate for equipment domestically, a slightly higher growth rate than that. In each case, there was a healthy amount of all three in this case. Okay. You know, again, we need to remind ourselves it is the first quarter, and imputing something like that conversation for the rest of the year is, you know, just we need to be conservative about that. It was a good start to the year for sure. Yeah. Along that vein, I mean, to follow up on the question about the second quarter, you know, the weather in April has been cooler in a lot of places in the country. I assume it's possible that that is having a little bit of an effect. I just wanna make sure that we get ourselves level set correctly for what type of revenue growth rate you believe is reasonable in the business. Obviously, this was a very good quarter from that perspective. To be clear, it sounds like I'm hearing we shouldn't extrapolate that forward to be safe. Well, those are your own conclusions. You shouldn't do either one. You should just understand that we don't wanna project anything because we're coming off one of the Traditionally, the seasonal quarter of the first quarter doesn't indicate what's gonna happen, you know, during the rest of the year. Okay. We're not asking you to conclude anything. Sure. Last thing, just on SG&A cost, you guys had talked about. Adding heads this year, we saw that in the first quarter. Can you update us on sort of how far along you are in the headcount additions and what's planned going forward? Barry? Sure, Matt. Well, first, over the last 12 months, we've talked about 100, about 140 people being added. I think that number is beginning to mature in terms of, you know, year-over-year comparison. I wouldn't expect there to be incremental impacts, you know, from this point forward, at least not anything material. This is all built on certain of our business units and their leadership, adding people to better serve markets, customers, also some opportunistic chances to actually get some competitive employment going in certain markets that they felt was important, and our job is to support them and then to watch what develops. That's been a span of about 1 year now, 2 of our business units in particular that are making those investments. As the season plays out, we'll, you know, we look for the growth that was the purpose of those investments. Makes sense. Thank you, Barry. Appreciate the answers, guys. Sure. The next question comes from David Manthey of Baird. Please go ahead. Hello, David. Hi, good morning, Al. Back to the manufacturer price increases. We've seen a lot of those come through, but haven't seen anything out of Carrier. Maybe I just missed that or UTX. Have you had any discussions with them? Do you expect the Carrier brands to follow the mid-single digit price increases that everyone else has put through? Well, I think they have announced a price increase, and I'll let Paul answer that. Yeah, they've announced price increases on both Carrier, Bryant, and ICP, it's gonna be mid-single digit. Okay. It is. It's not going to be. Yeah. It is. Yeah. Great. Okay. Thank you. Then, you know, Barry, when you talked about the price mix, I'm not sure that you gave us a number. Could you give us a number? Is it 1%, 2% quantitatively? David, I very purposely didn't give you a number. Just so you know. I'm point blank about it. Again, we don't wanna get into too much competitive information and just know that there was a nice dose of each in the growth rate for the quarter. I wanna say this too, just to reflect on what I said. Probably every April for the last 20 years that we've had this call, you know, we've said that, you know, to sit here and make predictions on. In our case, we are deep in the Sun Belt. Weather shows up. It's gonna be a hot summer in our big markets. You know, to get into a short-term kind of, you know, ping-pong match on what's the weather like in April, just really has never been a very relevant conversation. Well said. Yeah, I totally agree with that. Second, we've heard that the Payne and Bryant brands have been showing up in more large quotes recently and winning them. Are you gaining more traction in the construction market, do you feel today, than maybe the past couple of years? I understand that only represents 10%-15% of your sales, but, and secondarily, is that also part of the reason why the other HVAC products has been growing faster the past 2 quarters? I don't know. We don't wanna describe. No. Absolutely. particular brands that we're marketing, what they're doing or not doing. Again, it's competitive information. Paul, can you shed some color one way or the other? Yeah. Obviously, we've got, what, 16 brands that we sell at Watsco. We're multi-branded. We've got different strategies for each one. As we change them, I really would not like to get into specifics as far as what our strategies are with 2 particular brands. Got you. All right, guys. Thank you. The next question comes from Jeffrey Hammond of KeyBanc Capital Markets. Please go ahead. Morning, Jeff. Hey, this is actually Brad, filling in for Jeff. Hi, Brad. Hey, just on, you know, going back to non-equipment, nice growth in the quarter. Is that a reflection of just kind of improved productivity with some of the headcount additions last year? Is that, you know, more fundamental strength, or can you pinpoint that? Wow. Who wants that one? Paul? Barry? Yeah, I'll take it. It's really a reflection of just the one, we've got a focus on parts and supply business among all of our people, which we're yielding fruit from. Second thing, a lot of it, I think, ties into our technology, where we've got with our apps, with the bill of materials that are reflected on our apps. I think it's easier and more successful for the contractor to source his product from us than other competitors of ours. I just think it's a lot of good things coming together for us. Just on that tech, you know, now that you've had those tools in place for a longer period of time, you know, when you kind of look at the year-over-year trends, can you provide any update in terms of, you know, adoption or, you know, line item or make or to buy, you know, what you're seeing in terms of adoption from the Russell JV? From the Russell what? I'm sorry. Stickler JV. Stickler JV? No, we don't have that information. We're only a minority owner there. Okay. I just didn't know if you saw any if, you know, they're more open to the, you know, bringing the tech on board or not? Yeah. Can't answer that. Okay. Fair enough. Thanks. The next question comes from Robert McCarthy of Stifel. Please go ahead. Morning, Robert. Hey. Do you prefer this call or the dentist, Al? I don't know. I prefer the call. Yeah. It's great news. The company's once again, reaching record levels. Well, I mean, wouldn't I mean, obviously, a cynic would say, if April was good results, you'd probably disclose them, right? No, I don't know. We don't think that way. You can say all you want. We mean what we say. We're not. All right. Trying to distract anybody. All right. Well, this is Robert McCarthy. We don't believe, we don't believe, we've said it in the past, that we should comment on second quarter because we've learned in the past that second quarter does not necessarily reflect first quarter. It's a much bigger quarter, and we don't wanna mislead people. So give us credit for being conscious that we don't wanna mislead people. Understood. Maybe you feel this pull the need, but we're just being frank. No. Well, listen, I'm stepping up to the call unlike Mr. Hammond, who decided to send his second in this time so he can get his head cut off. In any event. Well, sometimes you guys deserve to be told that you're not, you're not listening carefully, and that was what I do with Hammond. I see. Well, don't worry. I think Mr. Tews is on cleanup. In any event. What does all that mean? Well, I think isn't he the next one on the queue? I don't know. Okay. All right. 1 more question, if you'll indulge me. What do you expect in terms of kind of the key messages to come out of your kind of branded Baird event next May, in terms of the tech spend and what leverage we could get there, not only from growth, but perhaps working capital improvement? Is there anything you can kind of preview in terms of the key messages? AJ? Oh, we're gonna showcase and highlight what we're up to and the impact it's having. We're gonna have some customers there to give you firsthand look at how it's impacting their businesses, which is the whole point. Yeah, you have to come join us. Well, or webcast it, as the case may be. All right. Thanks, guys. Again, if you have a question, please press star then one. The next question comes from Christopher Dankert of Longbow Research. Please go ahead. Morning, Chris. Yeah. Morning, Al. Thanks for taking my question. I guess this one's more directed at AJ here. I guess, you know, you did highlight that e-commerce now about 30% of sales here. Obviously, the app is seeing some nice adoption. Is there anything else tied into that number besides the app at this point? As far as e-commerce adoption? Yeah, yeah. Yeah, the e-commerce is not just on the app. It is on any device. You know, web domains included. It is getting close to 30%, and customers which means that customers are not only using it, but enjoy using it and find value in it. We're seeing that in the numbers as well. It helps our productivity. Customers that are using the tool and using it effectively, they are very sticky with us. The attrition rate is lower and the growth rate is higher for customers that are using the technologies. Gotcha. Are you able to remind us kinda what e-commerce as a % looked like, you know, this time last year? Much less. It's grown. For sure less, yeah. Yeah, 40%-50% higher this year. Oh, wow. Okay, okay. Now I guess just, you know, any comment on M&A here? You know, obviously, we've said, you know, the market looks good, but we've got, you know, kind of tax reform in the rear view now. Just any update on, you know, what's out there right now? We can't tell you what's up there because these acquisitions, as you know, it's, you know, you can't disclose them till they're done, or at least till you're pretty sure you're gonna get them done, so we're not going to do that. Oh, no, I meant more on a relative basis of number of targets, anything along those lines. No, no. It's the same thing. We are always on the search. We do grow by acquisitions. I think we've done over 60 of them, and I think we're gonna continue. The nice thing about our balance sheet is that when we think we can do almost any size that comes along. That's the benefit of scaling. We've scaled so that we can do that. That's a positive. Sounds good. Thanks again, guys. The next question comes from Walter Liptak of Seaport Global. Please go ahead. Morning, Walter. Hi, this is Steven Freiberg on for Walt. Morning, Steve. Hi. You know, I think you guys talked a little bit about the app, you know, kind of its, you know, the percentage of, you know, individuals who are on it. Did I catch that right about the entire network's gonna be online with all the stores by the end of 2018? Sure. That probably can be better explained. AJ, you wanna explain that? Yeah, that was in reference to proprietary software that we're deploying, in the warehouses, for the pick, pack, and ship process. Our warehouse guys can pick more accurately, quicker and get contractors in and out of our branches or stores faster and get back on the job site faster. That's in about 300 plus stores today and should be in all of them by the end of the year. stores. Perfect. Yeah, the, I mean, the concept there, just to develop that, is that, you know, the idea of having a front-end, great customer obsessed, you know, order process, information information source, and so on is great. How we fulfill that, those orders 7 million times a year becomes the next treatment and customer, you know, enhancement. That's that second stage AJ's talking about, is not only just the order processing on the front end, but how do we deploy those orders once they're received. That's the world-class process, is to see that all the way through to the customer, when they drive away with our products. Okay, perfect. Thanks for the color. Going back to the headcount addition question asked earlier. I think on the last call, you guys, you know, alluded to, you know, new branches and new territories. You know, is there any, you know, update or any color on that? Barry? I'm not sure what we alluded to. Perhaps what we said is that we, you know, opening up new branches is typically something we've done within our current footprint, within territories to bring density and simply greater, you know, greater local service. We've done some of that this quarter. There's more of that planned this year. Outside of our territories tends to be where we focus our acquisition efforts and focused on companies that have built businesses that dominate markets outside of our territory. That's always been our principal focus is not greenfielding everywhere, but focusing on some of the large targets and being patient about it. All right. Thank you. The next question comes from Stephen Tusa of J.P. Morgan. Please go ahead. Morning, Steve. Hey, guys. Good morning. I guess, you know, Rob got ahead of me here, but just a question on price increase. You know, you talked about, I think, or we've at least we've seen Carrier go through with, you know, this kind of mid-year. Have you seen anything from Goodman yet? There's, you know, we haven't picked up anything on that front. Yeah, it's a good point. I don't think we have. Paul, have you? No. Excuse me. No, we have not excuse me, seen anything from Goodman yet. Is that typical for them? Do they kind of wait and see and then, you know, strike where they can? Or, what historically I know, you know, 10, 15 years ago, they were, you know, they had a very, you know, a cost approach, a value approach, which served them well. You know, is this kind of normal behavior for them, or what do you think? Well, Stephen Tusa, you know that they've had a new owner now in recent years. They're owned by a very large Japanese company called Daikin. Right. There's no reference to years back there because these are different people, and they have different goals, and we happen to be one of their largest customers. Right. I don't think there's a pattern, Paul, but maybe you could answer that. No. I don't think there's a pattern. You know, like I said earlier, Steve, it just we're in unfamiliar grounds right now, you know, due to all the tariff talk and buzz as far as, you know, OEMs actually addressing and some of them coming to the plate on mid-season price increases. Generally, we would be all through with this in December. I don't know if there's a lot of precedence anywhere on this particular price increase. Any fulfillment issues from any of your suppliers? Yeah, good question. because of supply chain and tariffs or, you know, or the, you know, the new factory they're ramping up. Anything going on fulfillment wise? Paul? Yeah, I just knocked on wood. No. Okay. Right now, I think everybody's in good shape. I don't think the tariffs, at least from the conversation we've had with our various suppliers, the tariff doesn't appear to have an impact on our availability. That the products will be available to us. It's not gonna impede anybody in that regard. It's just the pricing that's gonna be unique. Okay, got it. One last one. Carrier, actually, UTX mentioned on their call that there was a, there may have been a little bit of a pre-buy on these price increases. Did you guys take advantage of, you know, the pricing today to kind of get ahead of what may come mid-year yourselves? Did you take on a little bit more inventory than you would've in a normal year? Paul, do you wanna answer that? Yeah. Yeah. I think we generally, you know, we do pre-buys, you know, in, you know, selectively wherever we have an opportunity, you know. The answer is we did. Yeah. Great, great, direct answer. I'd appreciate it, guys. Thanks a lot, and good luck for the rest of the year and the summer selling season. Thank you, Steve. Thank you. 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. We look forward to communicating results in the next quarter. Bye now. Bye. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.