Q3 2019 Earnings Call
Good day and welcome to the Watsco third quarter 2019 earnings Conference call.
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I would now like to turn the conference over to all Burton.
CEO . Please go ahead.
Good morning, welcome to Watsco third quarter earnings call.
This is Alan <unk>, Chairman and CEO and with me is AJ Nahmad President.
Paul Johnson Executive Vice President and Barry Logan Executive Vice President.
Before we start our call our cautionary statement. This conference call is forward looking statements as defined by U.S.C.C. laws and regulations that are made pursuant to the safe Harbor provisions of these various laws.
Okay, Great results may differ materially from the forward looking statements.
[noise] watsco produce another record quarter with sales net income in earnings per share all reaching record levels.
In addition, cash flow for the nine month was also a record and we expect cash flow to exceed that income for the full year.
Our 2019 acquisition Vasco supply kept appears belt, both contributed to the quarter and produce sales and profit growth over last year.
We remain very active in the industry seeking great companies.
We believe in investing.
Great companies in providing their leaders with resources to go their business.
These resources include capital.
Technology.
Equity incentive and most important encouraging to preservation of their old entrepreneurship culture.
With the advent of modern technology, we believe it is an opportune time.
For independent distributors to joined a watsco family since our resources can help them develop scale faster.
[laughter].
[laughter] in terms of results for the quarter sales growth was driven by strength in residential H.B. I see equipment.
With more consistent demand trends across the sunbelt markets.
2018 third quarter gross margin comparison prove difficult as last year's Oh, yes pricing access did not reoccur in 2019.
However, as gene a efficiencies were achieved during the quarter and that offset a good portion of the gross margin impact.
We continue to drive adoption, a variety of customer focus technologies to better serve our contractor customers.
That adoption has led to higher growth rates and lower attrition rates with customers are regularly use our technology.
Over the long run we are confident watts goes innovations will transform the way business is done in our industry and will also influence it could be <unk>.
That's great companies to become a part of the Watsco family.
Moving onto our balance sheet, our financial position remains conservative and strong where the 9% debt to total capitalization ratio.
This financial strength allows us to take advantage of almost any size investment opportunity.
Our press release provides important details about our performance I will not reach side. These details in my prepared remarks, but we'll be happy to provide more color.
During Q1 day.
Finally, we renew our standing habitation vis Oh said, Miami and learn more about our technology journey.
You will gain insight into our culture and many of the bases that are underway.
I hope you won't come visit us and learn more with that AJ, Paul Barry and I are happy to answer your question.
Thank you.
We'll now begin the question answer session to ask a question you May Press Star then one on your Touchtone phone.
If you're using a speakerphone please pick up your hands that before pressing the keys to withdraw your question. Please press Star then Q.
First question comes from Jeff Hammond of Keybanc capital markets. Please go ahead Arnie, Jeff Hi, Good morning, guys. How are you. Thank you. So yes, 6% residential <unk> at a you know was was pretty impressive and I know that you know some other folks were kinda complain about the weather can you maybe just talk about you know where yourself.
Particular strengths and where they are still maybe pockets of weakness regionally.
I don't know that we get into that sort of.
Competitive detail, but all that I'll, let Barry dealt with the question.
Good morning, Jeff, Yeah, well, well, giving you know data by state or did it by market I could say it this way that really across our or sunbelt markets in particular very consistent a narrow band width of growth so consistent with what you see overall.
So in our minds it was nice to see Oh, yeah.
That's consistency.
Up north or we have some strength in the residential markets and and Latin America also grew during the quarter. So.
Nice and my son, and plain and simple in terms of overall growth.
Okay, Great and then it looks like the Canary carry a minority interest line was a little light versus my expectations I know like Pearson home Inns, where we're coming into the mix. Just you know maybe speak to that the gross margin pressure and how that might have gone through the the carrier side and then maybe on this.
Gross margin dynamic you talked about just you know do you expect that the carry into Fourq you.
But bear.
Well, John I think most of the change in the quarter four though the minority interest line. It is hellmanns, we purchased 20% of Hellmanns at the end of last quarter.
And that that's where the benefit of that that 20% purchase flows as a reduction in.
Minority interest expense a year over year.
As far as gross profit looking in the fourth quarter. There is a there were some price actions as well in the fourth quarter year ago, there will be a measure of irritation.
And then that should play out so you know in the fourth quarter.
Okay.
Our next question comes from Ryan Merkel of William Blair. Please go ahead Barney right.
Good morning, everyone.
So first off backed up 4% equipment growth number which is pretty solid do you think you're taking market share and then is the tech spending the big driver.
Uh huh.
Well once that way.
I'll take the Hey, Barry.
Well, that's all I can take the first half of it you know as far as you know that the numbers aren't out in the third quarter, yet you know from age arise so.
You know looking at the first two months of abort came in the quarter, which would be the larger.
Months.
No I think the I think we definitely did grow some market share.
During the quarter.
On the residential side.
Yeah, we were up I think the market's going to be flat to down slightly when when all the numbers are tabulated.
Yeah, as I say, Jay Yeah, yeah, as they Jasper technology as well we.
It's hard to a measure causation, but as far as correlation what I can tell you is that the customers that are using technology and using it more regularly are growing out at a faster pace with us and the customers that are not and their attrition is much lower than customers that are not using technology. So.
Generally speaking the customers that use it more often are.
Stronger customers with us.
Got it okay.
Okay and then.
On operating margins just stepping back it's been flat for few years now I'm. Just wondering is expanding operating margins that priority for the company and and what is it that you need to achieve that is it just better sales growth.
Well don't forget we're very long term focus and.
We believe that for the long term we have to.
And that's significantly and and our technology.
And.
Even though they may have heard short term resolved Smith, because we are spending more on technology.
It's good for the long term, we have a big laid on technology, we want to increase it.
And I think that's a part of the yesterday.
Although overall, we sustain same.
Percentage level that we did last year. So I'm pleased about that but don't be surprised if we find opportunities and in terms of technology and take advantage of it because we're not really focus on a short term.
Yeah, I'll say, that's too I mean that technology spending has been.
It's been a a big part of our business for the last three or four years, but this is not a short term.
Exercise right. This is a journey [noise] remember, we're a big company, a big industry with a mature market and well then stepped up the.
Investments, we're making today will play out over a 10 to 20 year period, probably where it that's why we can do that is because we're doing it from position of strength.
Which is nice wasted.
Invest from.
Yeah, I'll, just add that part of that Ryan in in terms of the long term is.
Well, what well Oems think about doing with distribution over periods of time as things are evolving this way.
We're already an immense partner to many or most of them and we all we think that will only improve and deep and overtime.
And then there are 1300 independent distributors that also we're gonna face some sort of music about technology.
And as part of this investment we're already seeing some benefits and attracting.
Some age old businesses that had never sold her business to anybody.
And in terms of of completing transactions and conversations going on it's it's a very deep though.
Part of what we're doing so that's a good feeling and and I think they'll be more to come.
Okay. Appreciate the color I'll pass it on thanks.
Our next question comes from Stephen Volkmann of Jefferies. Please go ahead, our next Steven.
Good morning, guys, maybe I'll just follow up on that if I may cause your revenue line was a little stronger than we were looking for but but so it was yesterday spending I think and I'm wondering you know relative to your plan. Obviously, we didn't know that but did you find some additional things that you decided would be good investments during the quarter and.
And sort of spent a little more than you thought or was this in line with kind of your longer term plans.
You mean in terms of technology spending.
Yeah.
Well, let's have the president so yeah, there's nothing that.
That stands out as I'm, a big Spike and technology spending this quarter. So.
Okay I'm just trying to think about how are you trying to play in that out I think year to date.
We have a number of that have over last year.
And Barry do you have that number.
Yeah protect all year over year, it's up 4 million about 10 cents a share and most of that a good portion of that at least is the acquisition of alert labs.
Which is an Io t. company that we acquired to help with our ROE to strategy also a long term investment.
And that anniversaries this quarter, so that influence will not be as great going forward.
So there that's not a spike that's that's explanation for why it went up this quarter.
And longer term again its operates its opportunistic it's not a there's not up the plan is to keep driving adoption of what we've invested in for the last four or five years, how do we get more customers every day.
Making our technology, they're way of life.
And obviously, there is spending going on to develop more and more customers and more and more usage across our network.
But the big spending big tickets is not something that.
You know comes along and if it does we evaluated it makes sense of it and decide if we want to do it or not but the specific transaction you just mentioned Barry.
It said, it's a tech development company, we knew going into it would be losing money and that will continue to lose money, but we think that the outcome of that technology improvement.
And in the long term will have a major impact.
Okay, great. Thank you [laughter] and then if I can just pivot a little bit we've heard through some channel checks the carrier.
I don't know that they would want to say it this way, but maybe as a little more focused and on their end markets and you know little more willing to to get involved in marketing and and so forth. The are you seeing any kind of changes from them in terms of their partnership with you well first let me say I hope that you've heard us true [laughter].
Well for that [laughter] no. They we met their their senior leadership, Oh, yeah, they couldn't be more positive about.
Their future in terms of being independent publicly traded and of course that the word that applies to them now as it does to us is growth.
And to get growth you have to do the things are talking about investment products investing.
And then distribution.
All the signs are positive.
That this is a good thing for carrier and therefore, a good thing for watsco.
Okay, Great I'll leave it there thank you guys.
Our next question comes from Robert Barry Buckingham Research. Please go ahead Barney <unk> good morning.
Just wanted to follow up on a few things when you report the SGN a same store as flat does that include that 4 million of <unk> spend.
Of course it that.
Okay, I T a technology spending isn't an IRS DNA.
Okay. Just wanted to add it also the losses are included in the DNL too.
Yeah, I mean, it's not a profitable business and we know that going in but yes. That's all part of the main.
Financial statement.
Right I mean, I guess, just still need to be the head of dead horse, but you know it seemed like the tone at the beginning of the year was less than we haven't delivered much margin expansion in recent years, it's going to be more of a focus. This year. There was some cost actions at the end of last year to kind of gets you there and that's gionee has been flat same store it it seems like the.
Responses to the earlier questions on op margins suggests that maybe the goal of op margin expansion is less of a priority now I just.
We tried to make sure that Eric.
Yeah. This is opportunistic we don't.
We don't look at things the way you outlined that we look at what's what the is the opportunity long term.
To keep growing the company and an increase our competitive advantage right not numbers driven you know why don't we do this because it's a budget or this and that the other.
So this year. It was it was the one we just mentioned alert labs headquartered in Canada, great products.
I didn't know marketed or they're coming to the market and we believe strongly and that now we're supporting them and we will continue to do things like that.
With whether I see day goes up or goes down you know that's a consequence of what we do but we're not so focused on numbers as we are the opportunities that we see.
Got it got it I also want to just get a little more color on what drove the gross margin down I mean, you mentioned the tough comp with the price.
Yes, yeah, let's let's do that Paul the deals or yeah. Yeah. We had we had as you know last year was unprecedented as far as the number of price increases we had and obviously that drove up our gross profit percentage.
And that was a big part of it.
You mentioned that gross profit Yeah drive is always it always in front of us as far as what we're trying to drive to increase the gross profit on or products.
There is a market out there, though and we are competitive in that market and and we maintain our competitive nature in that market.
And sales, we try to balance sales gross and gross profit at the same time, we want both to grow.
Got it just lastly, just follow up on another comment sounds like most of the markets were tracking in that 3% same store growth rate does that.
Include Florida, and just any update on what's happening there and what the outlook is for Florida.
No we're not going to answer geographic questions, we don't want at the Psystar.
Our competitors.
As you've heard earlier today, it's like it's a mature market very competitive and we don't want to give anybody an idea where they can.
Uh huh.
Do better against Us.
All right I'll pass it on thank you.
Our next question comes from Josh Pokrzywinski.
Organ Stanley. Please go ahead I'd Uh huh.
Hi, This is Brian down for Josh right [laughter]. So just wanted to look out inventory swine. It looks like inventory is elevated relative to the amount of sales that were items from the deals are just general and growth can't talk about core watsco inventory and if it's running higher than usual this season.
Any observations you had <unk> industry. That's a great question I think any of these could answer that but I think Paul do you want take a shot that.
So to do all the money [laughter] does good yes, it's all my fault [laughter] inventory is up a you know month over month from September there from August through September and and what we've seen as inventory has been has been increasing one we had price increases.
Compared to prior year comparisons.
In the equipment that we do carrying into parts and supplies that we carry a secondly, there was a small build up.
That.
Probably you'll see a reflected across the industry with a gas furnaces, where we had a cut off in July .
For a furnace energy ratings changes and so we built a little bit of inventory for that but nothing nothing that exciting that won't be sold out in the second half of the year.
Okay. That's helpful. And then just wanted to follow up on a deals is there any use any potential for synergies that can extract add on fashionable yeah. <unk> Oh, we have already answered that gives me give this a lot of thought the reason we buy these great.
Independent distributors is because they they're very successful and we don't want to pick a risk.
And we will avoid taking a risk.
Trying to do anything to change their culture and there.
There are a record of success.
We don't look for synergies, we that's up to them. These businesses that have done so out, but we think we can grow them faster.
What we said in the press release, we can capitalize them better we can I ask him to take more risk if they wish to.
But basically our our culture and acquisitions that support the entrepreneurship there was there before we got there.
Yeah, we're not gonna mess around with trying to take some cost out because that's not what we do we're in for growth. What we wanted to discontinue the build the network and I don't want we don't want the risk of.
Trying to tell them how to.
How to operate as a isn't isn't pad business so they're independent.
In terms of what they do but then part of watsco utilizing the resources of Watsco, that's a heck of a good that combination which has helped us to become the largest in the world than what we do.
Yeah. So synergy is not a word reuse growth as the word views.
Okay I understand thank you.
Our next question comes from David Manthey Baird. Please go ahead I David. Thank you. Good morning out [laughter] first off if you could talk about the breakdown of price mix versus volume in both equipment and the resi equipment numbers, you gave us that four and six.
Barry.
When it did well and the residential market I'm more more unit growth in price and in terms, if I'd dissect the 6%.
And for the commercial business, which makes up the rest to get to the 4% overall, that's that's not really a price cost conversation to have a this slightly less growth in the U.S.
On the commercial side and not all the price mix really had any consequence, so on the residential side, though it was it was a.
Probably better than expected unit growth.
Okay. So couple couple points there.
And then Paul implied that there was also some price benefits in parts and supplies noted I would guess that's fairly nominal.
If I did I did not mean to do that that I did not see that no.
Oh, Okay, maybe I misunderstood that okay, then on.
Overall or Yannick equipment unit volumes would be take price out of the equation you sort of think about the the selling season in the second and third quarter. It looks somewhat flat this year with the second quarter down in the third quarter.
And I know you talked about.
The cycle and you didn't really want to talk about it have you given any thought to just broadly nationally.
The H. back cycle, and then the impact that might be having on the overall industry.
[noise] Paul Yeah, Yeah, we've been we've been looking at this years <unk>, yes.
We've got it we've got a couple of things at play into it. Obviously you know we still have the 80 to 90 million installed base on the residential side, which you know it's going to be replaced overtime.
That hasn't changed you know, it's been increase by problem and extra million millionaire and a half units this year.
Secondly, as far as you know looking at <unk> in total it's kind of hard to come up with an exact number but.
You're talking roughly 45% to 50% of those units that are out there are still R. 22, and obviously, we'll have replacement coming up but you know sooner than later so.
The general replacement cycle nationwide. You know is is still a still a good market to be in a good place to be position for watsco.
Right, Okay, [laughter], one more if I could and when you mentioned industry unit shipments you thought they'd be down for the full quarter I'm I'm. Just wondering why you think that given that quarter to date.
Shipment in.
Data that we've seen that implies it's up sort of three plus percent right now.
I think I said flat.
Huh.
Okay, and Oh, <unk> I, just I, just don't see where there was is gonna be a robust cycle of shipments in the month of September that's all that's what it's an estimate.
Okay, Alright, thank you very much.
One thing I did you have a question. Please press Star then one.
Next question comes from Blake Hirschman Stephens, Inc. Please go ahead.
Yeah. Good what do you guys first off did hurricanes during the quarter did they impact activity in the near term at all indoor create any incremental repair work on the back and looking forward.
Paul.
Yeah, I don't think it had a material impact on the quarter for us now.
Right and then back to the gross margins did.
Acquisitions that you guys have done year to date did they.
Create a drag at all or was it really just due to tough comp and.
Price increases from last year.
And Paul.
[noise] a very.
No. The you know the acquisition gross margin is at par with Watsco. So there was no influence on gross profit from that perspective.
Okay, EBIT margin is where there's opportunity to improve but.
Long long term.
The change in gross profit if you look at it a year ago. It was up 50 basis points last year's third quarter gross profit margin was up 50 basis points.
Strictly due to passing on relatively material OEM price increases mid year, which almost never occurs.
And so a year later, that's the comp were talking about and and again as things I've I've played through.
And we work through it becomes a more normal and stable circumstance going forward.
So this is really just a quarter for that type of.
Have a.
Occurrence last year in terms of standing out.
All right that makes sense, thanks, I'll leave it there.
This concludes our question and answer session I would like to turn the conference back over to Albert Nahmad for any closing remarks.
Well once again, thanks for your interest in our company I'm I'm glad you're involved.
I really wish you would come down here and get a better.
Handle on but what we're doing with our.
Major technology effort.
Think about the winter that's a good time to come down in Miami.
So thanks, again and it will speak due at the end of the.
Current quarter by now.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.