Q4 2019 Earnings Call

After today's presentation, there will be an opportunity to ask questions to ask a question. You may press * then one on your telephone keypad to withdraw your question, please press * then two months. Please note. This event is being recorded. I would now like to turn the conference over to Albert chief executive officer and chairman of the board, please go ahead.

Morning, this is Al nahda chairman and CEO in with me is Ahmed president Paul Johnson Executive Vice President and Berry Logan Executive Vice President as well. Now before we start our cautionary statement as usual, the conference call was have forward-looking statements as defined by a sec laws and regulations that are more pursuant to the safe harbor provisions of these various laws ultimate results, May differ materially from the forward-looking statements.

I'll do the report.

Wat School produced another record year with sales and they didn't come in and earnings-per-share reaching record levels.

We also produce record cash flow of 336 million dollars representing 114% of net income.

Reflecting our confidence in our business and they're supported by our strong cash flow and conservative balance sheet. We announced this morning and 11% dividend raised to $7.10 per share starting with our next regular quarterly payment in April of 2020.

We continue to invest it we continued to invest last year and industry-leading Technology platforms.

Interest late today, we have nearly 20,000 customers that have embraced our Technologies far most active users annual sales growth rates are higher with considerably less attrition over the year.

we have intensified are off efforts to drive greater use in which pet adoption and the develop new features and functionality that our customers are asking for

Technologies to improve operational excellence and to drive efficiency are now implemented across all of our Legacy locations.

These internal facing platforms were built to increase the speed and efficiency of fulfilling over seven million customer orders per year and to optimize our inventory and Supply chains.

Do the idea and we improved operating efficiency during 2019 as evidenced by same-store sg&a performance.

Our long-term goal Remains the Same to develop the industry's most attractive and customer obsessed technology platforms, which revolutionised and transform a business is done.

We again invite each of you to come to Miami spend the day with us and learn more from our team.

2019 was also an active year.

With increased m&a activity that is summarized in our press release that we published also today.

We added three new operating companies to our family. School supply in New Jersey Peirce Phelps in Philadelphia and n and s in New York. These are wonderful companies and we are honored they choose to become part of wat Schoo. It is Watts Coast culture to empower each of these companies to operate under their historical leadership same team and name with a deep respect for their entrepreneurial culture from us.

What we ask for in return is growth.

We provide the resources they request including Capital technology Equity incentives and access to our vendor relationships. These companies contributed wage 2019 performance, and we're a creative to our bottom line.

Were you remain very active in the market are in contact with other owners of great companies and we do expect to accomplish for this year.

With the modern technology will believe it is an opportunity or I should say an opportune time for independent Distributors to join the Wasco family since our resources can watch them develop scaled much faster. We also met large investments in areas and what's goes culture and they that are important to us in the long-term. We increased our 401K match and equity-based compensation to expect ownership to expand our ownership culture promote continuity retained talent and said as long term thinking

As important if not more important. We also enriched our employee wellness program to encourage good health and preventive care.

These investments will help attract and retain the industry's best talent.

Our press release provides important details of our financial performance. I will not recite these details in my prepared remarks, but we'll be happy to provide more color during Q&A with that AJ. Paul. Berry are happy to answer your questions.

We will now begin the question-and-answer session to ask a question. You may press * then 1 on your touchtone phone. If you are using a speaker phone, please pick up your handset before pressing the keys to withdraw your question, please press * then two at this time. We will pause momentarily to assemble our roster.

Our first question comes from Jeff Hammond with keybanc capital markets, please. Go ahead and Jeff. Hey morning guys. Just just on the line it seem like I'm kind of a number of one-time items. So I was a little surprised that you know that bump that I know there's some, you know some m&a impact in there. Can you just speak to Jose kind of moving pieces that you know that elevated that number?

Very sure morning Jeff. Well, you have to look at things on a same-store basis. And and we do we we show that in in the performance data is on the same-store basis sg&a was up 1% And so if you look at that in terms of the overall picture, you know still a very moderate growth rate despite some growth going on some Investments going on and so forth. So I think overall we we ended the year with the exact same percentage up 1% on a same-store basis including technology including the Investments that we've flight including some transaction expenses for em and activities. So if we account for those and exclude them, I would say the base business itself actually had pretty flat sg&a in the year and for the quarter.

Okay, and then you know, I think a number of guys have talked about kind of you know, whether headwinds into for you and you know, maybe early in age 20. Can you just maybe speak on on early twin Trends in to end of the year?

Paul Pitts

It is really early to talk about early 2020, you know, the years starting out like it finished in the fourth quarter, but you a January and early February really don't give us a a strong indication of which way the markets going to blow for the entire year.

Okay, and then just last one it looks like you guys raised the dividend your kind of bumping up against you know, you know kind of a hundred percent pay out of your free cash and just maybe speak to the rationale wage of moving that up and your comfort level, you know, kind of given the the payout ratios berries are expert on that. Sure will Jeff again the source of our David is our cash flow and it was record cash flow this past year. And if you look at free cash flow, there's still obviously room between the dividend. We're going to pay this year and the free cash flow that we just produced home. So we really look at at at the past cash flow the forward-looking cash flow where I think we have opportunities to have another very strong year for free cash flow and and that's the objective or that's how we look at it.

Okay. Thanks guys.

The next question is from Ryan Merkel with William Blair, please go ahead. Hey morning everyone. So first off what explains the big every year decline in gross margin in a point where I think Nick's is probably part of that answer but maybe just walk us through that what else born in that we have

They should going out with pricing from two large oems and we're engaged with them to see if we can have some action on pricing that my resolve that as well as what you stated. Maybe you could dig into that a little bit more out. What's the issue with the larger black pricing exactly?

Bear you want to deal with that? Sure Ryan. Well again, if you think about the last few years we've had probably more pricing volatility in the market wage. They never Seventeen and eighteen eighteen and nineteen and and now we look back and look at margins and look at the really the forward-looking margin profile that we seek to operate a business. So given all the volatility and and the realities of of the last few years. We take the data We examined the data we present the data. We we act on the database or weekends and that's what we're doing.

Okay, so I guess should we be extrapolating this weakness in to 2020 or is flat gross margin the goal in 2028, excellent question, but like I said, it's a work in process, but we're very optimistic that our margins will be recovering our gross margins.

Got it. Okay, maybe just lastly just want to ask on Florida. What were Industries shipments in 2019. What was the growth? And then what are you forecasting for? 2020? That's helpful. Thanks. Are you forecast or Paul know I don't try to forecast in history. It's a Fool's bad man. But you know, we do know what suckered in the prior-year to the industry in total, you know for the us and it was it was a very flat year for the industry as far as what the the industry shipments were both on gas furnaces as well as presidential splits.

Okay. Thanks. Just just add to it Ryan not to leave you hanging completely on that. You know, we said earlier in the year that really are Eastern markets and I'm not being the largest had performed and behaved well of a sales and growth point of view. Well measure market share when we have the data ourselves for our individual markets, but Florida North Palm, you know all the way to the seat up to the Eastern Seaboard had had better than overall growth rates. And like we said, I think last quarter it really the middle part of the country was was off irritated Market, but this idea of of consistent irritation or whatever. We said last year about Florida and 2019. We said we'd react to Thursday. We set our you know, we push our Williams to come to the table and growth rates. Where as I said better than average in Florida this year.

All right. Perfect. Thanks for that. Pass it on. The next question is Robert Barry with Buckingham research, please. Go ahead.

Hey guys, good morning, honey. Just curious a little more color on why growth in the quarter was only one was that the middle part of the country pulling it down or the Northeast just a little more color there would be

Very sure it is Robert. It's you know, again Eastern Eastern part of the country stable and and stronger and middle part of the country not as not as you know, typically weaker in terms of the algebra. Yep, and the middle part is that just the weather factor or what's causing it to be weak.

Yeah, we'll examine the data when we have it state-by-state. The industry hasn't sent that to us yet. So I can't comment on it. But you know all summer long. I think it was pretty temperate and in Texas, which is our biggest Market in that part of the country and it is it is it is what it is at this point.

Got it, just to follow up on the gross. Margin question. When you talked about the issue with pricing is that have to do with anything to do with rebates you're getting or would you like those zillions to be more aggressive pricing and they're not being as aggressive or just trying to see what you mean by that issue with I think it's best not to comment on that since these are ongoing discussions and negotiations off. It is just lastly from a question on the sg&a theme store only 1% So really good performance. They're just curious as you think about going forward, or you think that is sustainable and if that's the goal

well

We asked the president of the company because we're he has been told he has a an opportunity to develop technology as fast as he can and as complete as you can and so my to the genie expenditure could come from him AJ. Sure I think very said it well earlier there and you said well, there's a good performance on the sg&a line and 2019. We do think that's a result of efforts we've taken in in leveraging some of the tools and technologies that we put in our leaders hands. But with that said, there's more investment to come as there's good opportunity for investment. We are long-term company. We are investments today don't necessarily have 12 month Roi we're investing for the years ahead. And that's true with all this all this technology spending, you know, this is not all just an offensive program. This is a you can say defense of program as well where we are really Shoring up at the Quality job.

the company we are with

the latest and greatest and tools and Technologies and people and processes and while these may not have

To invest more we will got it got it. So just to make sure I'm hearing you correctly. It sounds like you know, maybe seems to our sg&a of only one is a little you know, maybe too low given all the opportunities you see to invest on the technology front. Well, it's hard to say because as as these technology Investments proliferate through the organization and have impacts on our on our efficiencies, we should see results as far as lower sg&a spend, but it may be offset by Future Investments. Got it. All right. Thank you took it on.

The next question is from David. Mann. Say was bared please go ahead morning David. Hey, good morning. Good morning everyone. So first off relative question on free cash flow and dividends and Acquisitions. Could you just refresh us on the company's philosophical view on Leverage? And is there an upper limit it to net debt-to-ebitda that you'd be willing to run with I can't give you numbers, but we don't like that.

we

Moderate debt and we intend to continue that way if if our m&a program requires large investment will solve it will take appropriate debt and Equity at that time, but we consistently can keep a conservative balance sheet in order to be able to deal with anything that comes along of some size. If there is nothing of some size that more of the size of you've been doing you should see any change in our debt to equity and you know the leverage part. Okay. Thanks and second looking at the other HVAC products category has been inconsistent and maybe a little bit weaker more recently. I'm just trying to understand the the makeup of that business. I know there's construction related products as well as repair parts and supplies in their wage.

with the the housing market doing

In a lot of units in this mid-teens age cohort shouldn't that that category be doing better overall? And you just discuss what what's happening there with Paul?

Yeah, it's that's probably the most the category that fluctuates the most for us as far as you know commodity prices as well as demand wage seasonal demand. So I don't think there's anything strange going on there. I just think that you know, as we unbundle some of the the China tariffs and such, you know, we're going to see some fluctuations back and forth on that. Let me what I would add is it it's roughly 880 product lines if I thought about it six hundred vendors and a lot of moving pieces as Paul said it's a it's a it's a grab bag of both new construction stuff, but it's also parts parts would be the largest of the product lines in there and to the extent equipment is growing at a faster rate that's going to drive home equipment growth versus the parts growth. But as I said, that's one of only, you know, only one product line within the bucket so a lot of moving pieces there.

Okay. Thanks. And and then last question if I can sneak Within?

Here on the we were talking about the the price cost Dynamic and thinking about the coming year. Should we be thinking that if nothing changes price would be 0 and if your negotiations are successful you could have a positive price outcome and I assume the manufacturers are pushing through moderate prices. They typically do is that the situation or might not seem clearly.

Oh, you're with you mostly what do you were here? Yeah, everybody everybody's pushing moderate price increases through right now, you know all all basically the six big players out there Lennon retrain your cream. Goodman have all pushed through, you know, single-digit, you know, low single-digit price increases effective January February. So we're just going into the season after all those up and and see what sort of impact they're going to have on the market.

All right. Thanks very much guys. Sure. The next question is from Chris Dankert with Longbow research, please go ahead. Hey guys, this is Brian. For Chris morning. How's it going? I think we were looking at is just the tech spend in 2020 now will that increase and is it safe to kind of assumed that normal growth of increased you guys have seen the past couple of years?

I'm sorry, I didn't.

Where did you get the question? Yeah and increase yeah, go ahead and answer it. Yeah Brian, this is AJ. I think I've been consistent and and and that answer which is we certainly ramped up our technology spend over the last few years and overall. It's I would say that a Thursday State however where and when there's opportunity to invest more than Roi opportunity, we're going to invest more because this is a long-term company got it that's helpful and then touching gears to the inventory entering into twenty-twenty. I know you guys previously mentioned you'd be willing to stack above seasonal average as long as the balance sheet remained healthy. Is that still the case and you know, I am looking heading into twenty-twenty.

Adrian yeah, as far as inventory again, that's a major initiative as far as the tools and Technology go. We now have modern platforms to ensure that we're having the right product in the right place at the right time to meet expected customer demands and that's a slotting location by Branch by business unit math equation. So now we have the right tools. We've got great teams that are using these tools and our fill rates are customer fill rates have have jumped significantly. So that's the first step make sure we have the right product in the right place right time and the right quad to fill customer demand secondly as take product out of our Network that has not sold or is is under performing to free up cash flow to make investments return share dividend wage et cetera. So overall that that remains the focus in in parallel with that or in tandem with that is that the supply chain in general from from oems and birth

Vendors especially with what's going on in Asia right now. There's always or I should say it's not a hundred percent reliable all the time. So

if and when we think it's necessary to to bring in some extra inventory to make sure that our customers have the product they need you know, those are investments we can make

all right. The focus is on our customer needs got it. And then just click one final one. Here. Is are you able to provide the price mix first volume and the equipment and

Age I think it got a question and I think that's probably very small and very maybe yeah, I again you can see the growth rates for for our equipment business days and and obviously far more units than price in 2019 for both the quarter in the year.

All right. Thanks. That's all I have. The next question is from Patrick Baumann with JPMorgan, please go ahead.

Hi Patrick. Hi, good morning. I stick my question. Most of the good ones have been asked but I'll try to do a couple on competition. There's no one choice distributor talking about trying to win back market share loss over the past year or so, and I'm just wondering whether you're seeing any more aggressive behavior from any of your competitors and in the market.

It's a good question. I think they come and they go Cycles in and out that Paul. Yeah, it's I would say I I don't think anybody relaxes on their competitive juices as far as as being in the marketplace. Everybody's trying to grow market share. Everybody's working hard to try to develop sales and and sales rep. So I I I can't see where it fluctuates up or down, you know, based on what the you know, what somebody said on their earnings call. It's it's strong competition in this Marketplace and it always has been and I'm sure to always will be

Okay makes sense. I know no change to that that's not maybe on the acquisition Revenue. So it looks like it's contributed. I don't know. I don't have the exact numbers. But at least half of your Revenue took over the past couple of quarters. So I'm just curious if there's any margin implications related to that Revenue coming in. I don't I don't know what kind of margins these deals, you know come in at and if it's a drag on gross margin or operating margins just curious if if if there's anything they're very yes. Well, I'm from a gross margin point of you know, they're they're neutral and and in terms of gross margin, so that's not really a conversation from an ebit margin point of view the businesses do come in with a lower ebit margin historically and our Challenge and and birth. You know, where we where we want to invest in growth in these businesses is to change that we don't touch cost. We don't touch the organization. We asked them to grow.

And we asked them to take advantage of our of our OEM programs. We asked them to expand their.

Business and that's where the ebit margin development comes from looking for it. So this first year we'll we'll break out things on a same-store basis. They are deluded tumor in the ebit. Margin in the in the in the short-term and the medium and long-term though. We you know, we look to have them grow and and raised their margin to the kind of the Lots go off margin.

Got it. And that's what for me on maybe back on pricing. Just curious like

Do you have a view on you know, whether we're getting closer to a point where you know price pushing price is harder where consumers might consider repair vs Republic more like what's your view on kind of you know, the Tipping Point there for kind of that that's switch in a consumer Behavior. Are we are we close to that or how do you how do you view that page from the day? You showed me the unit sales or higher continuously unit sales continue to grow. I I think that's a really tough question to try to get Dad's around only because it's it's a product that we sell for a given price and then each contractor dealer that we have would represent whatever their installation cost would be sober a lot more. I'm more things that go into an installation and then just the equipment cost. So I don't see any real elasticity issues, you know on the horizon right off.

Please you know, I would say.

In general then the big picture the the consumers strong consumer data is good. Unemployment is low and I think those have always been in our residential business in the most important correlation. So I think this is a consumer product and it is something people have to have and what they spend is is going to be based on really the quality of the consumer. I think at the end of the day

Also at this is AJ. Also, I believe there are more consumer financing options coming online than ever before so I'm making it more affordable for for homeowners to actually buy new age.

Okay, that's it for me. Thank thank you so much. I appreciate it.

Again, if you have a question, please press * then 1 the next question is from Blake horstmann with Stevens, please go ahead morning bright. Good morning, but did you guys say what same-store operating?

Margins looked like for the year. I heard the sg&a and I assume gross margins pretty similar to the overall, but just wanted to check and see Berryman take that. Yeah, I think it's a 2010 basis-point difference organic would be about 10 basis points higher and then on m&a the most recent deal you guys did had some Plumbing. Should we be thinking about that as an area you might look to expand in or is that more of kind of a one-off? That's a great question when we find a dual product distribution and examined the profitability and the growth we will not hesitate because there is a theory that eventually they'll convergence but that's not proven. But if we see a business this well managed with great principles of of business, we will not

the date because they're doing

Well, why would we not continue to do well and just help them grow faster than what they have with providing more capital and and branches and whatever else that they need, but we would not not do one that's not like a double negative. But yes, you very good observation. You know it mean I had to that it's a 74 year old business run by the same family that started it. It's part of their DNA. It's part of what they do in the market. It's how they address their customer and there are more like it. So that's the reason enough is too as we always say keep the continuity of that and from a product or technology or convergence down the line. That's nice. But at the end of the day, we're really trying to keep this great company that's been around for so long simply growing and doing more of what it does. Well,

That may be teaching us how to do things. We don't know how to do with plumbing.

Got it. And as a follow-up there is it is it more often than not that it's the same contractor putting in the plumbing and the HVAC that that you're selling to or does it seem kind of vary based on where you're at in in the country.

Who wants to volunteer for that one? Yeah, it does vary around the country. I don't go north. You're going to find a lot more plumbing and air conditioning contractors. I mean you get down to the South you find it's more wage in air conditioning person and a plumbing person. But the Alice point we are seeing some convergence some overlap, you know, spreading throughout the country but Blake also dead. Sometimes the business opens up a branch in a small market and they can't survive it just air conditioning or Jor SE products. So they add Plumbing.

Because the the revenue needs that in order to survive in the very small Market we see that model to which is pretty interesting, you know do both and be able to sustain the service level by having a very more convenient service to the customer.

Got it makes sense. I'll leave it there. Thanks guys. Thank you. This concludes our question-and-answer session. I would like to turn the conference back over two months. Once again, thanks for your interest in our company. And once again, please come visit. It is cold up there those of you that are in the north and we'd love to see you and have you got a first-hand. Look at what we're doing here in Miami. Goodbye. Now the conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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