Watsco Inc (WSO) Q2 2020 Results - Earnings Call
Watsco Inc (NYSE:WSO) Q2 2020 Earnings Conference Call July 23, 2020 10:00 AM ET
Company Participants
Albert Nahmad - CEO
A.J. Nahmad - President
Paul Johnston - EVP
Barry Logan - EVP
Conference Call Participants
Josh Pokrzywinski - Morgan Stanley
Stephen Volkmann - Jefferies
David Manthey - Baird
Jeff Hammond - KeyBanc Capital Markets
Brett Linzey - Vertical Research
Chris Dankert - Longbow Research
Steve Tusa - JP Morgan
Operator
Good day, and welcome to the Watsco Incorporated Second Quarter 2020 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note that this event is being recorded.
I would now like to turn the conference over to Albert Nahmad. Please go ahead, sir.
Albert Nahmad
Good morning, everyone. Welcome to Watsco’s second quarter earnings call. This is Al Nahmad, Chairman and CEO; and with me is A.J. Nahmad, President; Paul Johnston, Executive Vice President; and Barry Logan, Executive Vice President.
Before we start, our cautionary statement. This conference call has forward-looking statements as defined by the SEC laws and regulations and are made pursuant to the Safe Harbor provisions of these various laws. Ultimate results may differ materially from the forward-looking statements.
First and foremost, I hope all of you and your families are healthy, safe and managing well. I’m pleased to say Watsco is experiencing a very busy summer selling season. There are many heroic people in our company making an exceptional effort to serve and protect customers while protecting themselves. Our most sincere thanks to them. We also want to express our appreciation to our OEM and vendor partners who have done extraordinary things to react to the accelerated ramp up in demand.
Since our last call in April, a steady recovery began in May, an acceleration to double-digit growth occurred in June and it continues into July. The growth occurred across our footprint and was driven by our U.S. residential HVAC equipment business which experienced 20% plus growth rates in June with similar trends in July. Homeowners are clearly investing in their homes as sales of replacements systems at higher efficiencies are accelerating. Sales of commercial HVAC refrigeration products which were soft early on in the quarter are now recovering.
I’m also glad to report that our industry leading technologies are contributing to our results in driving market share gains. Adoption and use of our mobile apps and e-commerce platforms have increased significantly as more customers use our technology. Our best measurement of impact is that customers that use our technology generally are growing faster than non-users of our technology.
Examples of our progress, mobile app weekly average users has grown 34% over the last year to more than 22,000 with 100,000 total downloads, new processes were introduced to provide rapid on-boarding of e-commerce sales. So far this year the number of e-commerce users has grown 14% and the number of transaction is up by 12%. Our e-commerce sales run rate in June was 33% versus 29% in December 2019. And in certain markets our e-commerce run rate is now over 50% which kind of shows potential of this e-commerce platform. We also justified promotion of two other innovative platforms. They are called OnCall Air and CreditForComfort. These two platforms provide digital support for contractors and homeowners and connect proposals for buying products and for financing replacement systems.
Our contractors’ fulfillment activities, which we refer to as curbside or dockside pickup expanded to more locations and soon will include contactless payment functionality. It is early -- it's in the early days that adopting and growth has been terrific to this point. As always, feel free to schedule a Zoom call with us and we can further explain our technology in progress. We believe these capabilities provide a differentiated customer experience by engaging with us digitally in every way. We also believe a new standard for contractor service has been established, which will serve us well in the long-term.
Also during the quarter, we improved operating efficiency by reducing costs. Same-store SG&A declined 7% with few store closings and loss of business across our network. Our financial position is evidenced by our balance sheet strengthened during the quarter. We generated operating cash flow of $216 million, the highest of any quarter in our history. Over the last 12 months, we've generated $529 million in cash flow versus net income of $285 million. Dividends have been increased and we have no debt at this time. Further financial analysis of our second quarter is provided in our press release.
And now with that, A.J., Paul, Barry and I are happy to answer your questions.
Question-and-Answer Session
Operator
Thank you. We will now begin the question and answer session. [Operator instructions]. And our first question will come from Josh Pokrzywinski with Morgan Stanley. Please go ahead.
Josh Pokrzywinski
So, I guess clearly some stimulus payments there helped put up a very good quarter relative to maybe the broader macro. But any regional commentary from Paul that you can share either at the Watsco level or maybe industry observations that can help square up that performance?
Albert Nahmad
But we don't like to share regional for competitive reasons. But Paul, the second part of the question?
Paul Johnston
Have we seen any other trends in the industry? Well, obviously demand is high and we're constantly focused on trying to make sure that we can maintain the inventory to satisfy our customer needs. That's been a battle for the last 60 days, obviously. Pretty much demand has been has strong on the replacement side and picking up again on the supply side right now, and we hope it continues through the quarter.
Josh Pokrzywinski
And then just on the technology initiatives, Al or A.J. I think most contractors, at least, kind of the bigger, more stable ones tend to use a couple of different brands, but are fairly sticky in that and not rotating around a lot. I guess, does that mean with the share gains or outgrowth or however you want to track the technology, is it just doing more business with customers that are already doing something with Watsco and just can do more or is it really causing folks to bring on a new distributor relationship?
Albert Nahmad
A.J. you want to answer that?
A.J. Nahmad
Yes, sure. It's both. I mean, we touch a lot of contractors in North America. Some of them buy lots of products from us every day, some of them buy just a little bit of products from us every once in a while, but those are all targets to get a visibility and see the technology in action and what it can mean for their businesses and that outreach to customers, whether they're small customers of ours or not customers at all, getting them exposure to the tech, helping them understand how different it is doing business with our companies versus our competition is moving the needle.
So I guess to say it more succinctly, there are small customer of ours doing more business with us, and there are customers coming on board for the first time. And the technology is driving a lot of those conversations.
Albert Nahmad
Another way to look at it might be, Paul can you discuss here?
Paul Johnston
Yes. I mean for the second quarter we definitely had market share increases. As you guys recognize the industry shipments were probably down in the 10% range for the second quarter and our residential sales were flat. So that's a pretty monumental move towards an increase in market share. And in the front half of the year the same numbers apply, the market was down, mid single-digits and Watsco basically was slightly up given what we did in the first quarter. So we are gaining share there. Proud to say we're gaining share in Canada. Those numbers come out faster than the U.S. numbers. So we're becoming a force in Canada again. So I'm very happy to see everything that's happening from a share perspective.
Operator
Our next question will come from Stephen Volkmann with Jefferies. Please go ahead.
Stephen Volkmann
Hey guys. Thanks for taking the question. I'm curious if you could comment a little bit around gross margin. I think that was a little better than some of us were expecting, especially given -- I think your mix is shifting a little bit more towards equipment, which I would have thought would be a margin headwind. So, just what's going on in gross margin? How should we think about that sort of going forward as business remains strong?
Albert Nahmad
Barry or Paul, somebody jump in with that one.
Barry Logan
Yes. Stephen, good morning. You're right. As equipment grows at a much faster rate, algebraically our gross profit margin is impacted by that in terms of what you see optically on the face of the income statement. Also as we get through a selling season and a busy time and making the efforts to sell products, price and margin and cost and every day market-by-market, local competitive landscape, there's not one answer, there's 50 answers. There's 50 variables that are playing out every day. So this year is showing some improvement over the last year in terms of trend, but still there's a lot of work to do on margin, a lot of work to do as we get through the selling season and looking into next year and beyond.
Stephen Volkmann
Okay, thanks, Barry. Is there any reason to think the second quarter was unusually a little bit better than it would be or how do we think about the trajectory going forward?
Barry Logan
Now, there's nothing remarkable or unremarkable about the second quarter Stephen, that would be a lead commentary.
Operator
Our next question will come from David Manthey with Baird. Please go ahead.
David Manthey
Al, I believe that you said June and July month to-date were -- the June all in and July month to-date were up 20% year-on-year. First, did I hear that, right? And second, could you put that in the context of same-store daily sales for us?
Albert Nahmad
That was good. I enjoyed that. Barry?
Barry Logan
Sure. Well, Dave. Yes, you heard right. And we did comment on trends. We are adjusting for sales days. Those are average selling day trends that you're hearing in the remarks.
David Manthey
And that was based on residential air conditioning sales. That wasn’t based on total, no?
Barry Logan
Yes, in the press release, you read double-digit growth in June. And Al’s remarks you hear, residential up 20%, that's what you're hearing.
David Manthey
Got it. And that's same store daily sales. Okay. Second, looking at the operating expenses from the first to the second quarter, the reduction was impressive. Probably the most impressive we've seen in Watsco’s history sequentially like that. You basically did $350 million more in revenues on $9 million lower OpEx sequentially. I know the company is very decentralized. But are there any major cost buckets you can talk about that drove that decline. And that's really unusual and a big drop?
Albert Nahmad
Barry?
Barry Logan
Hey, David. Well, again, I can't invite you to our Friday Zoom call with 35 core managers across Watsco. If I could, what you hear is what you said, decentralized challenges to constantly react to what's going on in the market. So, it was a Watsco pen and paper session, it's 35 managers going out and prosecuting what they believe is important to take care of customers, employees, they have markets where revenues were untouched that needed to deal with a cost structure in that respect. We had other markets that were more heavily impacted. They cut costs and [indiscernible 14:59] costs very aggressively in the short-term. And so the good news is this is all a local lead and reaction to what's going on in the marketplace that drove the cost. As a parent company, we certainly have the conversation, but it's all driven in the field.
A.J. Nahmad
This is A.J. I just have to add, those 35 leaders or so have just been tremendously impressive during this whole period and the 5,000, 6,000 people that work for them, it's just unbelievable effort and spirit, and they deserve all the credit.
David Manthey
Yes, it's really impressive, guys. Thank you.
Albert Nahmad
And this is Al. I mean the corporate cost of Watsco, corporate expenses is under 5% of SG&A. So for any level of reductions going on in the field, any reductions that you're seeing optically in terms of performance is all driven by them. So again, once again the credit belongs there.
Operator
And our next question will come from Jeff Hammond with Keybanc Capital Markets Incorporated. Please go ahead.
Jeff Hammond
So Paul mentioned, inventory being a challenge. Just talk about -- we picked up on our check, some of the OEMs, kind of struggling to get product out the door. And certainly it may be that expectation was demand was going to be weaker than it is. So can you just speak about your ability to get product, how quickly that kind of normalizes and how you're able to kind of keep up with these strong demand trends?
Paul Johnston
Well, we can't speak for the OEMs, but I can tell you they're doing their best. It’s complicated to get their supply lines to accelerate. But they've done it and they're doing a pretty good job. And I don't think they're going to lay off, they're going to continue to support the demand and God bless them. They're just great suppliers and not just the OEMs, but also the regular vendors. We've kept up our continuous cadence of orders, even in the down times of April and May. We continued replenishing the inventory. We didn't cancel any orders. We followed through with it. We have daily discussions with our primary OEMs. We have weekly discussions with our vendors. We're talking to them constantly about what their problems are and giving them lead time and a look at what we're doing and what our needs are going to be.
Also Barry and A.J. are mentioning the -- a more cohesive opportunity that we've had with senior managers talking every Friday and going through what their issues are. We're seeing more and more intra-company movement of inventory as one part of the country gets hot and the other one cools down on sales, we're able to move inventory intra-company, but also a new feature that we've been able to do with our new technology on inventory is intra-Watsco inventory where we're actually moving orders or inventory amongst the Watsco companies. So it's tough. It's still tough. We've had to do some substituting the product from time-to-time. But once again, I'm very, very proud of what our OEMs and our vendors have been able to provide us to-date. And we just hope they can continue all the way through the season.
Albert Nahmad
Every one of our OEMs has come to the party. They're functioning as best they can. And we're very grateful to them.
Jeff Hammond
Hopefully those aren’t pool parties in Florida that they're coming to. Just on the -- you talked about the residential trends. Can you just talk about the commercial piece of the business, and any signs as markets kind of open back up, you're seeing some stabilization there.
Albert Nahmad
Well, I commented on that but I’ll let Paul go ahead.
Paul Johnston
Yes. Second quarter obviously was absolutely brutal on the commercial side. However, as states began to open up, we started to see some upticks, but we're not back to zero yet, obviously on the commercial rooftop side of our business. Applied has remained strong. And even commercial refrigeration we've seen good life in that in the month of July….
Jeff Hammond
Okay, and then just last one. Can you give us the tech spend in the quarter either in total or year-on-year, how much you expect that to be up for the year?
Albert Nahmad
It is running the same. And it will change from time to time as we see opportunities. So, don't think that's the end of it. I know that's a persistent question of yours. We're going to add as much as needed. Anything that we see we're going to invest, some of it will work and some of it will not but that's the business we're in, innovation. That's what Watsco is, an innovative business and we're going to -- we have the financial means to invest in it. But there hasn't been any dramatic change from recent spending.
Operator
And our next question will come from Brett Linzey with Vertical Research Partners. Please go ahead.
Brett Linzey
Could you just update us on the efficiency mix trends in the quarter, any noticeable change whether it be mixed up or mixed down by homeowners, just a little bit of color there would be great?
Albert Nahmad
By homeowners. Paul, have you seen any data on that?
Paul Johnston
Yes, we've seen some data on that. We've seen a mix up, where we've seen a bit more on the 16 SEER, 18 SEER front. It's not a remarkable change. I guess the thing it’s been the most amazing to me this second quarter was I didn't see any material change in system change outs that people were replacing the entire system. They weren't just replacing the outdoor unit. So, the consumer would never have guessed is was acting fairly normal as far as what we've seen historically.
Albert Nahmad
Just an interesting data point on our technology, we mentioned OnCall Air in the prepared remarks. That tool is about helping contractors sell into homes, into building owners. And it provides a very modern, very feature rich platform to provide a beautiful modern experience in the sales process and without going into too specific, it is early days with a tool. High efficiency sales are much higher on that tool, and without the tool, in other words it’s helping sell bigger tickets, higher margin products, and higher efficiency systems.
Brett Linzey
And then maybe just shifting to price, what are you seeing from a pricing standpoint? Any intra, inter-quarter July price increases given the strength of the market here?
Albert Nahmad
Paul, have you seen any?
Paul Johnston
No, I really haven't seen any price increases on the equipment side, there's been some commodity moves, which are normal this time of the season but nothing on the equipment side and nothing on the finished goods, supply and part side.
Operator
And our next question will come from Chris Dankert with Longbow Research. Please go ahead.
Chris Dankert
Kind of circling back to SG&A for just a moment. Again, really impressive, as David pointed out. I guess just out of curiosity, how quick does some of that spending had to turn back on, I know the mantra is, we're investing for the next 10 years. So again, I was also very surprised to see SG&A come down to the magnitude it did. Just any comments on hiring, on what it takes to kind of maintain this level of growth you've seen in June and July here?
Albert Nahmad
Well, so Barry, you’re the futurist, given the gust of what you see is best you see it. Oh, gosh.
Barry Logan
Well, I mean the big picture obviously is that we're a labor-driven company. If you visited our stores, you'd find five to 20 people helping customers. And to the extent that business is roaring, we will have more resources, more costs dealing with that issue. So that's a good problem to have where much of our labor can be variable or discretionary in a way that can be tied to the sales trends. So that will occur and we will see SG&A spend creeping up as business volume drives it. That's part of being a distribution company and inherent in the distribution model. But we've also challenged the 35 leaders to look at under every rock over the last two or three months and determine what they can really change in terms of mindset or sacredness, or how do they react to the technology flow that's going on, really challenging their status quo. That's where as a parent company and our culture we can have an impact. It’s challenging that status quo in all of these markets. So that is going on as well.
I would expect there to be efficiencies that we can sustain well beyond just this temporary state that we're in. How much and how material? We'll find out as we get through this year. And that's sort of being a futurist, I know that we're a better company today. 60, 90 days into this and the cost structure is a portion of that improvement that we've made and we'll see how much of it once we get into next year. I wouldn't want to try to have you to guess right now.
Chris Dankert
And then again both your labor force and your customer labor force is a little more specialized, skilled. But again, we have seen some issues with guys not being able to show up or being kind of enticed away from certain jobs. Is any difficulty in labor availability either for you or your customers that's having any meaningful impact?
Albert Nahmad
We don't know what our customers are having issues that way or not, but I can tell you that our workforce has been just terrific. And we're keeping up with demand and we're very appreciative and we expect that to continue.
Operator
[Operator Instructions] Our next question will come from Steve Tusa with JP Morgan Securities. please go ahead.
Steve Tusa
Hey guys. Good morning. Congrats on the execution and kind of a volatile quarter here. I'm just trying to put the pieces together. Did you have any significant difference in the performance of your suppliers on the equipment side in resi?
Albert Nahmad
No, they're all just doing the best they can. And they're all -- know the fit, know what's going on. They're very supportive. We're not their only customer, they're supporting the entire work -- their entire customer base. And they're just doing a great job. I'm just -- couldn't say nothing about them, every one of them. Yes. True partnerships.
Steve Tusa
And you guys don't sell a ton of Lennox, right?
Albert Nahmad
I don't know that we sell any. Unless you have some ideas, we will continue to.
Steve Tusa
I don't have any ideas right now, it sounds a little bit confusing. So, I guess if your kind of major brands are gaining share and they're -- I mean is there like an outlier in the industry that's really struggling to kind of deliver product that you guys don't sell? Because Lennox already reported and they're claiming to have gained share. You guys are flat, they were down 6. I am just trying to kind of -- is everybody on the same boat do you see like or are there some that are struggling more than others?
Albert Nahmad
Well, I would say that all major equipment brands that we have are doing well. I mean the issue is, how quickly can they produce and get the product to us, but they're all doing well and they're all very supportive. I couldn't be happier with it.
Steve Tusa
Right. How do you guys look at the inventory situation, where the inventory stand today and then will you -- how you kind of play that out in the back half of the year?
Albert Nahmad
That's a very good question, because the inventory has come down. But part of that is the tools that we've -- our technology group has come up with, very good technology. I don't know how much detail you want to get at that but we're happy to. Well, A.J, go ahead and talk about this.
A.J. Nahmad
Sure, So, some of the or a lot of the inventory reduction is because of supply chain constraint, and the -- it’s non-excessive but extreme demand. But also to the broader point of, we are doing better managing inventory. We have new tools and technologies, better teams, better system, better focus and daily effort on what we call non-performing inventory, and moving low performers, SKUs that don't sell in one place, moving them around. And I would say a significant portion of the inventory reduction we've seen is about getting our inventory position healthier. And that should be sustained and continued over the next ….
Steve Tusa
Right, so you're kind of using these tools to maintain kind of a lean inventory position while you're delivering and when you get to the back half of the year, there's not some need for a big kind of load up heading into next year. Do you feel comfortable with what you have?
A.J. Nahmad
Yes, I wouldn't say lean, I would say healthy, right? To put products at the right place at the right time is the key.
Albert Nahmad
The term we use is inventory effectiveness as opposed to inventory turns, how effective is our inventory. Before we had these tools, can you imagine trying to manage hundreds of thousands of SKUs and try to regulate or try to figure out where they should be in 600 branches? And the math is what you heard. And so the new tools that we have -- we have meetings every day with our senior inventory management teams for every one of the Watsco companies and sharing their information, sharing data among those people has been just invaluable. When I look at the technology gains that we've made, for me, personally, the inventory systems are just magnificent.
A.J. Nahmad
And they're going to get better. Because we haven't implemented the tools throughout the company yet. We’ve just partially through it.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Albert Nahmad for any closing remarks, please go ahead.
Albert Nahmad
Well, let me just close with what’s on everybody’s mind, the pandemic. We truly wish all of you to stay healthy and stay safe. We are staying at home here as much as we can and just want everybody to have the best possible outcome from this terrible virus. Bye now. Thank you for attending.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
