Good morning and welcome to the Watsco First Quarter 2016 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Albert Nahmad. Please go ahead.

Good morning, everyone. Welcome to our first quarter conference call. This is Albert Nahmad, CEO and with me are A.J. Nahmad, President; Paul Johnston; and Barry Logan. And as usual, first, the cautionary statement. This conference call has forward-looking statements as defined by SEC laws and regulations that are made pursuant to the Safe Harbor provisions of these various laws. Ultimate results may differ materially from the forward-looking statements. Now, let’s get on to our results. We achieved another solid first quarter and are off to an excellent start for the year. We are operating at record levels. And at the same time, we are continuing to make significant investments in technology to transform our business into the digital age. Our annual run-rate for tech spending is now approximately $22 million. The incremental tech spending during the first quarter had a $0.03 impact on our results. It is very early, but we are already seeing benefits that include: customers are beginning to use our mobile apps. They are also adopting e-commerce to gain speed and efficiency. Our supply chain initiatives are gradually improving inventory turns. Our 565 locations are implementing technology that fulfills orders more efficiently and saves our customers time. Our employees have better insight into their operations from using our business intelligence platform. All said we are excited about what is happening in this period of – let me say that again, we are excited about what is happening in this period of creativity and innovation at Watsco is at an all-time high. We are also delighted with our results in comparison to the strength of last year’s first quarter when operating profits was up 32%, operating margins were up 110 basis points and EPS increased 35%. Now, although it is early in the year and not yet…

Thank you, sir. [Operator Instructions] First question comes from Steve Tusa with JPMorgan. Please go ahead.

Good morning, Steve.

Hey, guys. Good morning. How are you?

Good.

What are you seeing on the mix front? How do you kind of see the 13 SEER stuff playing out? I know it’s early in the selling season, but maybe what’s kind of the feedback from the channel on how long that inventory will be around for the 13 SEER?

That’s not too early, Steve, because there is a mandate about when you have to sell it, so I will let Paul answer that.

Yes. We are seeing the runoff in a very orderly fashion right now and we saw our 13 SEER sales dropped significantly, which we expected and we are seeing that being reflected in our 14 SEER sales increasing.

And I guess on the 14 SEER pricing for the new 14 SEER products, I think we were at least hearing kind of around double-digits, maybe perhaps a little bit less than that. What do you guys feel is kind of the appropriate price for the new entry level 14 SEERs and all that settles out?

The question is about price of the 14 SEER?

Yes, over the – yes, the price premium of that entry level 14 SEER or the 13.

I think every manufacturer has different spreads. But what we are suggesting to you is that there is price integrity, no one is yet hurting market price.

Right. And you are seeing a pretty smooth transition from all the OEMs when it comes down to supplying you guys with a product you need?

Yes, very much so.

Okay. And then how is April trending so far?

April, well, it’s growing. I would say the mid single-digit right now and which is what we did in the first quarter.

Got it. Okay. And then, Al, one more question, you don’t really seem to ever worry about much. What, other than the weather – other than the weather, what are you from a market perspective, did this cycle seems to be playing out pretty smooth and actually maybe even smoother than it was when housing was red hot? It seems like a much more rational steady state, good, solid tone on demand type of cycle. And anything you are seeing out there that worries you at all on the consumer side or – I don’t know. And anything that worries you structurally about how the industry is shaping up here kind of as we move through this new cycle?

Well, first of all, we are not a major player in residential construction as we mentioned several times. So, we are primarily in the aftermarket and that’s a very consistent demand year after year. And of course, we are being the largest in that, we enjoy that. Paul, do you want to add any color there?

Steve, everything right now, I will be rosy with Al as right now everything is transitioning pretty much as if it was supposed to be this way. And I am very happy to say that.

Okay.

I have one thought, too. One thought on that to build on that, one of the big assets we manage is accounts receivable and it has 88,000 customers that pay us money everyday and it really is the healthiest we have seen that portfolio from an exposure point of view, from a payment point of view, especially entering a season. So, that’s always a great kind of indicator of what’s going on in the end market and it’s been a very healthy asset these days.

That’s good, okay.

Great. One more quick question, how is the acquisition environment out there? You guys have taken debt down now. You guys haven’t done a biggie in a while, maybe what’s the pipeline like on the acquisition front, any change there?

Well, we are very much in tune with you. We like the biggie. Can you help us get one of them, because that’s what we are trying to do. We think we have got a lot to offer.

I will get our bankers on that, but no real change in the tone out there.

I can use that help Steve. No.

Okay, alright guys. Thanks a lot. Good quarter. Thank you.

Thanks.

Our next question is from Matt Duncan with Stephens. Please go ahead.

Good morning Matt.

Good morning Al. First question I guess just on the SG&A side, I mean it’s pretty impressive drop in SG&A as a percent of sales year-over-year despite the technology investments, can you talk a little bit about sort of specifically what kind of costs you guys are managing there or is this just really sort of across the board efficiency?

Barry?

Hi Matt. Good morning. Well first, we have leaders across the company that are paid to grow EBIT each year and they are going to always manage their business to grow margin and EBIT in a way that produces opportunity for them, so really as a granular local management process throughout the company. Culturally, dealt with through how we incentivize people. So I think it’s a good quarter, for us a good start to the year. But there would be a thousand answers to the question, not a single answer in the way in terms of how it’s managed across the company.

Sure, okay. That makes sense. Then on the gross margin, the 20 basis point drop there, is that really just noise, mix, is there any one thing you would attribute that to and sort of where do you think gross margin ought to come in for the year, is it going to be up or down versus last year?

I don’t that we even could tell you that, we don’t know. But in terms of what’s already occurred, perhaps Paul or Barry could add to that.

Yes. I mean, Matt I think what you saw in the first quarter, we had a very strong equipment mix in our sales and that really constituted the great majority of that 20 basis point change. So that trend continues, I don’t know where that would bring us, but I think we are in good shape.

Okay, that makes sense.

I mean I would just add, just from a trend, I mean sequentially, margin was up. If we look at probably a couple of year period, margin was up nicely. So single data point this quarter is something you want to read into. And equipment growth, simply is the basis of that change quarter-over-quarter.

Okay. Yes. Obviously, it’s been trending up, that’s what I was getting, I was just making sure there was nothing that’s sort of changing in the business and it sounds like the answer is no, so that’s been....

No.

Okay. And the last thing what kind of price increase are you seeing year-over-year so far on the equipment side?

Those were announced much some time ago. Paul?

Yes. Those were announced – what we are seeing is 2% to 4%.

Okay. I am just making sure the price…

Yes.

So the same as the announcements basically?

Right.

Okay, alright guys. Thanks. I will hop back in queue.

The next question is from Robert McCarthy with Stifel. Please go ahead.

Hi Robert.

Good morning. Good morning everyone. I guess not to be pedantic, but could you talk a little bit, did the Easter shift caused a little bit of perhaps lower than expected revenues kind of go into March and then do you think you got some kind of benefit going into April or would you just say that’s fairly minor in terms of the impact?

Well, I don’t know how to answer that. Paul, have you got an idea?

I’m not that smart to know if the Easter shift caused anything. That’s pretty tough to answer, I think.

Well, I think some of your comments was just obviously the tough compare of 1Q and...

I think the share last year for the quarter up 35%, so you are up 9%, we think we are doing pretty good.

Right. And then I guess what else I would say is in looking at the trends of what you are seeing right now kind of the mid single-digit growth, any areas where you are doing better regionally or any geographic kind of dispersion in terms of that?

Yes. We have gotten that question in the past and we don’t answer that for competitive reasons.

Yes, for obvious reasons.

I will say this, domestic is stronger than international.

Domestic is stronger than international, okay. And then back on the acquisition front, I think there has been a suggestion, I mean do you think there is a possibility for you to go into and partner with perhaps captives or not captives, but OEMs that perhaps you haven’t partnered in the past, how do you think about the opportunities that…?

Yes, I would love to, I would love to. And Robert if they will agree, we can develop their business much as we have Carrier.

And it’s nice that my sell side brethren are critiquing me as I ask these questions, so it’s nice. So, thank you all. In any event, I think I will leave it there and perhaps I will circle back for a follow-up.

Sure.

Thanks a lot.

Our next question is from Ryan Merkel with William Blair.

Good morning Ryan.

Hi, good morning, it’s Ryan Merkel, William Blair. So I guess first question on the equipment growth rate, was there a big difference between residential and commercial?

No. They are about the same.

They are about the same, okay. And did the equipment mix of SEER 14 above rise meaningfully year-over-year just as a percent of the mix?

Paul?

Yes, it did.

It did. You guys probably won’t disclose any specific numbers, but I will ask anyway.

We really can’t split again on the mix.

As the market leader, we don’t want to invite our competition to go where we are doing well the vice-versa.

Understood Al, okay. Well, can I ask this, of the 7% growth rate for the equipment score, how much was price mix versus volume?

Barry?

Again, in the U.S. market, which is kind of what is dialed in on is about two-thirds of it is unit growth the rest is price and mix.

Okay. So that’s tracking about the same, right, Barry?

That’s correct.

And then lastly for me, back on the OpEx, is it fair to think that you could grow OpEx kind of in that 3% range all year or maybe said differently, keep a 2-point spread between sales growth and OpEx growth?

Well certainly, we like to achieve that. I think we are on the same page as you are. But we will just have to wait and see.

Okay, alright. Fair enough. Thanks.

The next question is from Brett Linzey with Vertical Research.

Good morning Brett.

Good morning everyone. Just want to circle back, just looking at the other category, so other HVAC products up 4%, this is actually the best it’s been in a couple of years, is there something in particular that’s giving it a lift there, I guess any color on the quarter and how do you think about that category for the balance of the year?

Paul, you want that one?

Barry, why don’t you handle that?

Okay. Well, it is good news that the growth rate is higher. There is 125 product lines in that line item, by the way. And I would say as a composite, we have seen some improvement in price and some of the big categories that has helped it.

Okay. And then just on Canada, what was your sales performance like in the quarter. And I guess just a general update on the spending environment in that region heading into the selling season and some of the progress at the...?

We don’t break out regional stuff in the international business for the same reason, the competition.

Okay. And just a final one here, so just want to ask about the FASB change on stock comp, this is something that can be adopted this year, is it being considered. And I guess is this change something that could be meaningful to your tax rate this year or next?

Barry?

We are certainly looking at it. The tax rate generally benefits when thing is best. And in our vesting structure, if you read our filings, takes a very long time to vest, most of the time between 10 years and 15 years from today. So it’s something that will help eventually. We look at this end a little bit further, but just always remember that the vesting of what we have is long into the future and those benefits won’t be derived really until then.

A little more color on that. We started several years ago of vesting period or retirement age of 62 or older. That’s a very long-term view in our minds and we like to reward people for long-term performance. So we do vesting over the longest period of anybody that we know that’s public, generally vesting in public companies of between 3 years to 5 years, we are much longer than that, age 62 or older.

Okay, great. I appreciate all the color.

Thank you, Brett.

Our next question is from David Manthey with Robert W. Baird. Please go ahead.

Hi, David.

Hi, good morning. I can get qualitative here, too. As you look at 2016 Al, what would you define success this year?

Well, as we stated earlier, a record performance in growth in all the major categories. And further adoption as important as that is the performance in numbers is the adoption of our technology, which is just beginning. I mean David we are in a transformation plan and that’s why I am so excited. We are getting to be a better and better service to our contractors and internally with the information that we are generating with our business intelligence platform. It’s very exciting stuff and it’s going to have a huge long-term impact, I can’t quantify it for you, I am just telling how I feel.

Okay. While we are talking about that, I know there is at least, there is one OEM out there in particular that’s struggling with technology and reliability. And I am wondering based on that plus your technology if you could talk about the success you are having with share gains via getting new contractors in existing markets today?

Well, that’s a good question, but one we can’t answer because we don’t know that yet. We are just beginning to adopt. And whether we gain share or not, the value we bring to our contractors we think will be immense and no one can do it better. I mean, if we are going to disrupt, we would rather do the disruption in the industry that let somebody like Amazon do it. So, we have an enormous piles of data on I think I said it once before, 300,000 SKUs and that’s growing, the number is growing. It will be very difficult for anybody to disrupt what we do because of our knowledge of all the products that go into the $35 billion distribution industry, which in turn retails for $80 billion.

Okay. I guess we would be remised if we didn’t bring A.J. in on this thing and maybe, A.J, if you talk about the apps, the supply chain and business intelligence, those three things. Where are they in their various stages of implementation? I think apps are fully implemented, but if you talk about where you are, early returns you had and just – it’s probably too early to start asking about where the IT spending starts to plateau just yet, but if you have any thoughts on that as well?

Well, first of all, thank you for bringing me into the next day and I am excited to participate. I mean, you are right, it is early days and a lot of these things, some of the programs that we started earlier like apps and e-commerce, they are live and they are in the market and they are getting traction, but it is still first or second inning of these things, but all the trends are positive. We obviously want adoption of these tools. We want them to make an impact for our customers and for our businesses and they are. And as we get more mature with these things, we will start talking more specifically about impacts we see in dollars and whatnot. The supply chain technology has got a later, well, I should say, we did those after apps and e-commerce. So, they are even earlier days. And while they are starting to take route in some of our areas, they are not yet fully implemented, but where it is, it’s again very positive trends in terms of the impacts that we are seeing for our businesses. And again, those touch our customers as well. So, it’s all very positive, just early.

Right. Alright, fair enough. Thank you very much.

The next question is from Keith Hughes with SunTrust.

Good morning, Keith.

How are you all? To build on the questions for A.J. again, to build on your last answer, the supply chain initiatives, is that the transmission back and forth of order data or billing data or what kind of things are you working?

Yes. I think we spoke about this on our Investor Day. There are several buckets or pockets of opportunity in huge numbers, right. I mean last year at peak season, we inventoried $900 million worth of products, where there is a huge opportunity there, right, 600 – or about 600 warehouses, about 13 million square feet of facilities. Those numbers, we think are prime and ripe for doing a lot better. So, it’s about getting the product in and out of our warehouses, better or faster, it’s about having the right products at the right time at the right place to serve our customers and have higher fill rates, but not have too much inventory of things that optimize that whole flow and getting customers in and out of our stores faster, so they can go back into the field, sell more jobs and then buy more product from us. That’s kind of the big themes.

And I mean, it sounds like there is more to do, you said its early days on this. Should we be expecting this roughly $0.03 a quarter spend on tech, is that going to continue for the rest of the year, I mean, just more or less what it was last year?

Yes, I think that’s fair. If we see opportunities to do more that we think will have a high return, we might do more. If we need to pull back on some things, we will pull back on some things. Nothing is written in stone here, we are very flexible and very opportunistic.

Okay, thank you.

Next question is from Josh Pokrzywinski with Buckingham Research. Please go ahead.

Good morning, Josh.

Good morning, guys. How are you?

Good.

Just a couple questions for me, you have done over a lot. I think just first for A.J. on the technology rollouts. Al, I think you mentioned in your prepared remarks that user rates or adoption on the mobile apps are up anything that you could put on that quantitatively in terms of numbers out there or where that is trended over the last couple of years?

A.J., do you have such a number?

We have numbers. Again, I am going to be purposely vague to probably frustrate – to your frustration, I am sorry, but again the numbers are – they are small still, but they are trending very positive...

Maybe I can help this. Is it in the hundreds or the thousands?

The thousands, certainly in the thousands.

And how many – I think Barry said you have 80,000 some customers that you have billing relationships with, so is that kind of the saturation rate, some large percentage of that number?

No, no, not even close. No.

And Josh, when I say we have 88,000 customers, those guys might employ 5 to 10 people, so it is an immense user base potential beyond just the number of customers.

Okay, got it. And then just maybe parse out some of the technology spending, how should we think about this breaking out between bringing in folks and a spend number that is ongoing as you pay these guys regularly versus kind of one-time or small time hardware investments where you get up and running and there is not as much ongoing spending?

A.J., you want to deal with that?

Sure. Yes, I would say, generally speaking, most of the big one-time spends have happened and now it’s about continuous improvement of what we have and what’s in the field and that requires probably more people over time as well as we drive adoption, do things that have bigger and bigger scales, but the big time of huge purchases of software and hardware, I mean we don’t really buy hardware, but software I would say most of those have already occurred.

Got it. And then just flipping over to the quarter, I don’t know if you guys mentioned in your prepared remarks or not, but just the growth on higher efficiency product kind of 16 SEER and above?

I don’t know. Paul?

Yes, it’s just noise right now. As far as – we already had a pretty good penetration, a very high penetration on 16 and above. And it’s just pretty much holding. The big news is between 13 and 14 SEER.

Got it. So, I guess there has been a thesis out there that when you shift the base higher that you get some accelerated growth in the high end that you are just – your entry point is a little higher. Is that something that you are seeing or is a lot of that shift just as the consumer feels healthy already happened?

Well, if we see that shift we will see it this summer once the supply of 13 SEER depletes.

Fair enough. Alright, thanks guys.

Our next question is from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Good morning, Jeff.

Hey, good morning, guys. My questions have been answered. Thanks so much.

We will move on to Charles Redding with BB&T. Please go ahead.

Good morning, Charles.

Good morning, gentlemen. Appreciate it. Maybe if you could just speak a little further to current demand trends in commercial refrigeration. Certainly, we got a nice 6% pickup here. And then as we think about the 2020 transition on R-22, would you expect more of a spike in replacement demand after that happens or does the gradual phase-out really keep that transition more measured?

Alright. Paul?

Repeat the second half of your question, if you would.

Sure. Just thinking about the transition again in 2020 as we get post R-22, would you expect again the gradual phase here in terms of replacement or would this transition keep it more measured?

I think there is – that’s a wonderful question. I think there is going to be a, obviously, a continuous transition away from the 22 to the 410. I don’t see any sudden jerks in the road where it’s all going to stop just because the R-22 isn’t available. There are other replacement products that are available, 407C being one that you can use to replace R-22 within the field. So, I see it’s a continuous gradual down slope.

Great. And then inventory turns obviously have been pretty consistent at or about 4x, you stated the 5x goal, are there one or two kind of more near-term compelling opportunities that will help you push that number or is this again more of a long-term thing that we should expect as your initiatives kind of play out?

I would say it’s all a long-term investment that we are making that will move the needle there.

Fair enough, I appreciate the time.

[Operator Instructions] Our next question is from Walter Liptak with Seaport Global. Please go ahead.

Good morning Walter.

Hi, good morning. Thanks guys. I want to ask about the operating cash inflow versus last year and it looks like most of that’s coming from working capital and wondering if it’s inventory, what would you attribute it to, is it the buildup that you had last year in 13 SEER?

Yes. That’s some of it, that’s a good question. But it’s also just beginning about 15% of our revenues are now just having to install the new technology. So I expect we will move away from seasonality of that build and more into a better management of the inventory as we start to level load technology.

Okay. So, this is level loading of your inventory in the branches?

Well, it’s all of the above. The inventory management system is new technology that we have just installed and 15% of our revenue and there is a lot more to go. It covers everything, inventory in branches and inventories in districts. So it’s the entire cycle.

Okay, got it. And then I wanted to ask about pent-up demand where we all know that there is probably still some pent-up demand, but wanted to hear from you if there is a way of measuring it, if you guys think about that still, is that a factor in some of the residential HVAC growth rate that we are seeing?

Well, Barry Logan will describe the demand business, Barry do you want to deal with that?

Sure. I mean we look at a 30-year average or probably a 40-year average even, it’s a 3% or 4% unit growth environment for replacement. For one reason, the installed base has grown at that kind of rate for those 30 years, 40 years. So we have been seeing really over the last 3 years a better growth rate than that in the units for replacement in the U.S. And that’s simply the consumer having the cash and having the incentive through the energy efficiency and the contractor to close the sale at an increasing rate of replacement. And as I have said, it’s been about almost 3.5 years that we have seen a very consistent trend line along those lines. And so I think as long as the consumer continues its kind of stature and posture, those growth rates are possible. That’s the way to look at it. It took a long time to build the installed base. It will take a long time to replace it again. And with the incentives and kind of the foundation of that and a good consumer, it’s a really good business. I wouldn’t call it pent-up demand. I think it’s more subtle demand.

Okay. So maybe more the pent-up demand or the strong consumer going on for a number of years, it sounds like?

That’s the opportunity.

Okay, alright. Great. Thank you.

Next question is from Chris Dankert with Longbow Research.

Good morning Chris.

Good morning guys. Thanks for taking my question. Just kind of want to touch back to an earlier question on for duration, its smaller part of the business, but it really had strong growth in the quarter, I guess was there anything you would call out driving that or was it just good execution by your guys in the ground?

Of course, you would take the latter. Paul, do you have any answer to that?

I will give our people credit for that. I think our guys are doing a better job of going after refrigeration market. We are very big in nice machines and I know they have been doing a great job in that area.

Okay, great. Thanks. And then just quick checking in, I guess any plans you would articulate on store closings or openings in the year?

No. It’s the normal process. We add stores and remove stores. Although the technology that A.J. Nahman is leading, we will be able to do more with existing stores, so therefore eventually reduce the amount of the space that we use in our warehouses.

Okay, great. Thanks so much guys.

The next question is a follow-up from David Manthey with Robert W. Baird.

Yes. Thanks for taking the follow-up. We have been hearing a lot from other distributors about financing as being an important option for consumers as the equipment is becoming increasingly expensive, are you and your manufacturers helping your contractors access financing options so they can sell these products to consumers, sort of on a monthly payment basis rather than a lump sum, is that something that you are involved with?

Sure. Paul?

Yes. Absolutely David, we have been in this business of helping the consumer with financing for, gosh, probably the last 10 years or 12 years, both independently as Watsco setting up programs to finance companies as well as with our various manufacturers. So this is not new, this is something that just continues.

So I would imagine as the largest, there is somewhat of a competitive advantage there given that you probably have a better access to capital than your competitors?

I wouldn’t go that far. No.

Alright. Thanks very much.

The next question is also a follow-up from Robert McCarthy with Stifel.

Let’s try this again. Could you discuss, following up on the kind of the comments about the replacement cycle and pent-up demand, which you think is I guess a dirty word, but just given, we are getting kind of...?

We cannot – there is no way to know pent-up demand, all we can go is the historical data and it’s a huge installed base, 89 million homes. And eventually those machines were out. Now they have a life, they have a life, machines do wear out and then sometimes, the consumer will repair what he has got or sometimes they replace. That’s what Barry was talking about, the ability to pay for it. So I suppose if the consumer is healthy, then he is going to replace what he is going to repair.

Right. And I guess it’s too hard to put too fine a point on it, more teaser kind of for a certain unit size or product probably sold in the kind of 2005 to 2007 timeframe are going to come off warranty, short order, the replacement cycle usually means about 10 years to 12 years just in terms of breakage. So I guess the point is what do you – is there- do you think there is a thesis to perhaps acceleration in kind of 2007 to 2018 on the basis of kind of seeing kind of greater, greater growth than what we have been seeing historically or are you just think it’s too subtle for that and we just – we will see a continuation of the current trends?

I wish I knew the answer. I will let Paul try to get strategy.

I wish I had the answer to that too, but...

It’s a great question.

I think units have varying lives depending on where they are applied in the country also. So it’s hard to just paint a brush against it and say it’s all the same. A unit on the Coast of Florida has a different life span than the unit in Phoenix, Arizona.

But I think if you – I am just doing this on the run here, but if the consumer is healthy, that will affect growth rates of demand for our product.

Always the key driver is the consumer’s financial health. Consumer feels good and is employed. They are going to buy....

But we just experienced it since ‘08 the trend went into replacement and I am sorry into repair. You probably saw our data from then. And now that data is reflecting replacement rather than repair.

Which definitely speaks to the health, yes.

Yes.

And then just as a follow-up, I mean is there anything over the horizon you are doing with potentially with utilities in terms of potentially stimulating demand?

Well, always. As they put up flyers in their bills and things like that, that’s a marketing channel for sure. And they provide incentives too and maybe as much as I used to. If you buy a high efficiency air-conditioner or furnace, they will incentivize the consumer to do that.

Understood. Thanks for your time.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Albert Nahman for any closing remarks.

Well, thanks again for your interest in our company and we look forward to the next conference call. Bye now.