Welcome to the Watsco Second Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, today's event is being recorded. I would now like to turn the conference over to Albert Nahmad, CEO and Chairman of the Board. Please, go ahead sir.

Thank you, Marco. This is Al Nahmad, Chairman and CEO and with me is A.J. Nahmad, President; and Paul Johnston, Executive Vice President; and Barry Logan, our Senior Vice President. As always, before we start our cautionary statement. This conference call has forward-looking statements as defined by SEC laws and 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. Let's get onto the quarter. Watsco produced another record quarter. Today, we also announced our agreement to purchase Peirce-Phelps, a longstanding HVAC distributor, based in Philadelphia. That company was founded in 1926 and has been Carrier's sole distributor in Pennsylvania, New Jersey and Delaware for 75 years. This acquisition will expand our network into these markets. Peirce-Phelps' current annual sales are approximately $206 million, serving more than 9,000 customers from 19 locations and a wide product offerings of equipment, parts and supplies. As important -- or more important, this business is led by four Peirce brothers, who are third-generation owners. We look forward to working with them as they continue to operate the business and we apply our "buy and build" approach. Here's what that means. We start with buying or joint venturing a great business. We keep the name, the team. We honor the culture and empower the leadership. We ask the leadership for an aggressive growth plan and we help them achieve it. We motivate the team with long-term equity and build an ownership culture. And we collaborate with big ideas, technology, capital, M&A opportunities and provide support in any way needed. In addition to the Peirce transaction, we also completed a number of transactions during the quarter, as summarized in the press…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Brett Linzey of Vertical Research Partners. Please go ahead.

Good morning, Brett.

Hey. Good morning. Hey, just wanted to come back to some of the key Sunbelt states, obviously, a barometer for the growth of the total business. How did some of the key states perform, particularly Florida in the quarter? And then, any big outliers within that mix?

Well, we don't want to alert the competition too much but, Barry, go ahead and give it a shot.

Sure. Well, first, as we said in the press release, there was cooler wetter weather in certain markets. And what that really means is between the Mississippi and Rockies, we have a big presence in Texas North and just call it that region of the country is where we saw the particular weakness. If I go to our largest market, we mentioned in the first quarter we had growth. That growth accelerated in the second quarter and we're seeing stronger growth since. So, just to have some fun, the fling -- the flamingo is still very much alive and well and growing. So that really is the story in the quarter is that that geography between the Mississippi and Rockies. And it is what it is, and again, it has an impact on short-term performance, certainly not long-term performance.

Okay. And then maybe just shifting gears to the Peirce deal. Just really about the strategic rationale. I mean, is this an asset that Watsco believes has a similar margin profile some of the Carrier JVs did? And then maybe just separately, how has the Peirce locations been growing organically for the past three years to five years? Thanks.

Barry, you want to take that?

Sure. Well, first, I would say a better-than-average margin versus what we had experienced 10 years ago when we acquired Carrier Enterprise. And that's part of it being an independent distributor and simply thinking that way as entrepreneurs. So, better than average than in the past. Certainly opportunity to improve margin to the Watsco levels that we have achieved since then. So somewhere in between let's put it that way. From a growth point of view, boy, we have -- we were given a 20-year chart of organic growth and very strong growth rates over the years, and again, highly entrepreneur group of four brothers. And so it's only as we say buy a great company. The evidence is in the long-term growth rates that they have had.

Okay. Great. Thank you.

And our next question today comes from Ryan Merkel of William Blair. Please go ahead.

Good morning, Ryan.

Hey, good morning everyone. So, first, let's dig into the other HVAC products and the commercial refrigeration down again, it's been weak I think for a couple of quarters. Just what's going on there? And more importantly, any signs that that could start to improve and grow again in the second half?

Let's go to Paul Johnston.

Yeah, yeah. Okay. Hey, Ryan. Yeah, it was -- when you look at the individual components of the non-HVAC equipment categories that we sell in, lot of softness in some of the commodities, more related to demand as some of the slowdown that Barry indicated that were happening between west of the Mississippi and the Rockies impacted some of the installed products that we would normally sell. And then there is a softness that we experienced in the first quarter continued in the second quarter, but it's leveled out on, some of the refrigerant lot of different reasons why that -- the price is soft right now, but at least it's stabilized at this point. So longer-term, I don't see this as being a continuous trend when you look at beyond the commodities, but when you look at the part sales, parts sales were strong in the second quarter and we were heartened by that.

Okay. And just a quick follow-up on the commercial refrigeration. So, are you saying that refrigeration prices that are primarily the issue? The equipment and the parts that you sell in that business, is that actually growing?

The equipment pricing is stable and has grown. The commodity side of it is the weakness, yes.

Okay. And then just a follow-up on gross margins down year-over-year. I'm guessing that's a function of lower equipment selling margins and possibly mix, but maybe provide some color there if you would?

Barry, you covered that in your writings to me. Go ahead.

Sure. Well, selling margin, which is simply our markup on all products is flat year-over-year and equipment up slightly. And so that speaks to the pricing and margins on equipment still ticking up, so that's a good sign. Some of the weakness is in the non-equipment, which Paul described and you can hear the little bit of the angst in the voice short-term about pricing of refrigerants and things like that. And overall, if equipment is growing at a faster rate than non-equipment, there is a little bit of mix just simply and how that algebra works out. When you said mix of equipment again mix of equipment has been up all year long fractionally not materially and that trend continued in the second quarter, but it's really the mix of equipment versus non-equipment that's in the algebra.

Got it. All right. Thanks. I’ll pass it on.

And our next question today comes from Stephen Volkmann of Jefferies LLC. Please go ahead.

Good morning Stephen.

Good morning guys. Thanks for taking my question. Maybe just back to the M&A. I'm curious about -- you've obviously stepped it up a little bit. I'm curious if the pipeline is more full if there's some reason you think more deals can get done in this type of environment?

We have expressed such an attitude in the prepared remarks. We do have more interest from sellers -- potential sellers some great companies.

And that's driven by sort of a desire for getting on board with the technology or is there something else in their businesses that's feeling more challenging to them?

Hard to answer the last part of that question, but I can tell you that from our perspective; there are two things that should attract a great company. That is first our culture. We don't disrupt great companies quite the opposite. We're not cost cutters. We're not going to flip anything in five years. None of that exists in our culture. And we're very respectful of people that sell us or have joint venture with us. That's also unusual in the M&A world. Now, with respect to technology well that is not a secret in the industry anymore. We lead it the innovation. The adoption we've expressed over and over again will take a long time, but we're in it for the long-term. But if a distributor -- successful distributor wants to take advantage of what we have we certainly afford it to them. And I think that will be a continuing attraction. Culture and technology should be a continuing attraction and stepping up.

And I'll just add to that Al. I think with Peirce, we can have Brian on the phone with us this morning Brian Peirce being the leader of the company, but a 94-year-old company decided to sell to us and I think a big motivator was technology and is technology moving forward. And again at a point in time where we can open things up, I think it would be good to get some perspective of someone like Brian Peirce who by the way is the current Chairman of HARDI. So, from a leadership point of view, we have an industry leader making that decision. So, it's something that is certainly part of the ingredients, family still have to decide it's the good time for the family, but--

And I'm going to hold you to that Barry since you run our M&A. You better get more done.

This is A.J. I'll just add that we've been talking about technology for a long time. You guys asked good questions about that, but I really encourage you to come see us in Miami, spend time with us, let us take you through the fundamentals. Because when you do that, when you meet the team you understand how big of a deal this is and how impactful it has been and how much an it ensures our viability going forward. And those are the conversations that we're having with some of these targets like the Peirce brothers who understand that technology is a real thing that it's something that they need for their business that they are going to have to be very challenged to do on their own, but a nice landing place to do it with Watsco and not only because of the technology, but because of the culture. So, again, I encourage you to come down and see it firsthand to anybody on the call.

You can come in August still.

No, that's not a good time to go. August we have humidity.

Thanks guys. With that, I guess, I'll pass it on. Thanks.

And our next question today comes from David Manthey of Baird. Please go ahead.

Hi David.

Good morning guys. First off you provided the same-store sales figure of plus 1% versus a 3% reported revenue number. I was wondering if you can give us that same-store figure by each of the three product segments.

Barry do you want to do that?

Yes. Dave, I think it's a very similar relationship in terms of the overall to each of the pieces.

Okay. All right.

The same math.

Okay. And second, should we assume that price mix is a low single-digit type contributor to the overall growth?

Barry?

Yes, there is price in the market still. And if you look at the residential pricing, which is the primary driver, it was up 3%. A moderate amount of price and a moderate amount of unit growth.

Got it. Okay. And then when you say the momentum rebounded in July, I'm wondering if you can be a little more specific on what things looked like in the month of June for you and then sort of month-to-date July growth rate?

We're not going to disclose that. We're just giving you a sense of things. We're not going to put any numbers on it rates or anything. We're just giving you a sense.

Right. I had to ask though.

I like that.

Finally, it seems like -- I've been getting more questions from investors on SG&A leverage. Can you just broadly talk about the major actions you've taken on OpEx? And then, as you look at the $196 million of SG&A, is there any way you can talk to us about how much of that is kind of same-store versus the contribution from acquisitions, greenfields et cetera just to give us an idea where that number is shaking out year-over-year?

Well we've reported previously that we've got -- we're getting more efficient with the employees that continues the cost of employment. But don't get too stuck on growth of SG&A, especially the investment in technology. Because we are who we are the industry leader not only in size and technology, a lot of people are coming knocking on our door with fascinating innovations. And as the guy who runs technology A.J. Nahmad had said, we have no desire to limit our investment in technology. Things are going to change and they could change dramatically in terms of spending for technology. But I also believe that we're getting more efficient with the non-technology cost. And I hope we reflected that in the numbers or if you need more color on that Barry can add to that.

Yes, I would say looking at the year-to-date Dave, so we're looking at a longer period just to evaluate your question and up 1% on a same-store basis for year-to-date technology spending accounts for much of that. You can certainly imagine there is still inflationary risk going on with facilities and rent and some of the other line items offset largely by the productivity stuff that we've talked about. So that's how I would talk about three variables with a 1% year-to-date increase in SG&A. And it is a sea change over the last three or four years, if we put it in context. So there is definite progress all at once are doing something silly we're not going to do, but we want to make progress and we obviously have. So if you do the -- again the math between same -- the SG&A growth rate without new stores versus new stores you can impute the cost of the new stores and DASCO being part of that equation too.

Yeah. It makes sense. Thanks very much guys.

[Operator Instructions] Today's next question comes from Jeffrey Hammond of KeyBanc Capital Markets. Please go ahead.

Good morning, Jeff.

Good morning, gentlemen. So just on the new store openings, did I -- I didn't see a mention like last quarter. Are those kind of all new kind of running through this quarter and it seems like a step up and so how should we think about that prospectively? And where are you adding stores?

We won't answer the last part of the question because of competition, but we will tell you that for the last 12 months, the eight stores that we have greenfielded, but we've added quite a few through acquisition of DASCO and now with Peirce-Phelps.

And Jeff, we did certainly talk about same-store SG&A in the last -- in the first quarter there was a discussion of that in the quarter.

Okay. So just to be clear the 17 new stores, nine are acquired and eight are greenfield?

That's correct.

Okay. And then just I noticed at least in my model that the minority interest number was materially lower than how I was thinking about it. And I just didn't know if there is anything going on within the Carrier Enterprise business that they might have been seeing a little more margin pressure dropping through?

Yeah, Jeff the answer is no. If you look – in the quarter the actual reported results minority interest is down about $600,000. And that is where the benefit of owning Homans 100% shows up. So as we purchased the 20% in Homans that we didn't own that was early in June and there is a benefit to – that's where the benefit of that transaction shows up.

Okay. And when did Homans close?

Beginning in June.

Okay. Great. And then just last question. Certainly you've done DASCO and now Peirce and a couple of these other maybe smaller ones. Is there a way to think about the accretion opportunity as you look over the next 12 months and enroll these in clearly you're bringing good businesses in at – and your financing costs are low that would be helpful? Thanks.

Barry, you want to look at the future?

Sure. Well, we certainly – they certainly are accretive on their face in terms of just historical EBIT and you mentioned the word smaller. Brian Peirce would take offense to that, because they're number 15 out of 1,300 in the industry, so just to put in perspective for that transaction. The real accretion, if you will is not just the math at the day of transaction, it's what we've talked about and the Watsco way, how can we help the Peirce brothers double the size of the business and help the DASCO team double the size of the business. And that's where we've seen the benefit of really the acquisition itself. Yes, the math works today, but it's really the next step. And over the next few years that's very critical to what's going on.

Okay. I was actually referencing the Sigler and not the Homans as the smaller ones but –

Appreciate it.

I appreciate it, guys. Thanks.

Thanks, Jeff.

And our next question today comes from Robert Barry of Buckingham Research. Please go ahead.

Good morning.

Hey guys, good morning. I guess, I wanted to just circle back to an earlier question about SG&A and really just broaden that to ask you about op margin. I mean, I think you've acknowledged in the last few quarters that given some growth investment there hasn't really been much op margin expansion in the last few years, but it seemed like there is going to be a more concerted effort to get some this year? I mean, what's the latest thought there? I know, you want to still grow the business or invest to grow the business, but do you think that you can expand the operating margin this year?

Mr. Logan?

Again, every distribution model of every kind forevermore is going to be dependent on a measure of sales growth to produce long-term margin expansion. Otherwise, they're probably cutting their business up short-term for short-term reasons. So the sales growth year-to-date obviously same-store sales growth of 1% didn't achieve that result of higher EBIT margin. But again, for the rest of the year, we certainly see improved growth. We see improved – we only have visibility to really the month of July, but we have some confidence about the rest of the year in terms of expanding margin. Longer term, it will still take reasonable sales growth to drive the longer-term margin expansion that everyone looks for. And the rate of investment in technology is still going to increase, but not at the same rate that it did the last three or four years. And so that opportunity is still there. And short-term, we can wring our hands over it. Longer term, we're not.

Got it. This growth in adding stores just organically outside of acquisitions is that something that you'd see picking up or moderating?

It gives me an opportunity to discuss how we deal with that. Watsco is a very decentralized model and meaning that opening locations is not considered or even decided at headquarters. People in the field decide what they need and they implement it. So, wherever they see a need, they just do it. Can we forecast what they might be doing? We can't, because we're not making those decisions for them. They're just doing it on their own, and they're very optimistic orientated. And we do like a methodology being very decentralized, because that gives them an opportunity in the field that we at headquarters could not see.

Got it, got it. I just had one last one kind of a minor item on the SG&A front. I think last year in the third quarter you actually had a spike in SG&A growth, because there was a variable comp true-up. I think that was worth about $6 million. Is it fair to assume that would not reoccur this year and maybe we could even see same-store SG&A down in 3Q?

I wouldn't forecast the future, but Barry go ahead and answer the past.

Sure. Yeah there were some second half hits and that are in the SG&A that were disclosed. And again time will tell in terms of performance. Performance driven comp we wanted to go up in the third quarter, because it will be driven by performance. In fact I wouldn't get too surgical about whether SG&A is up or down. I think it's an opportunity to have a better third quarter, but I think predicting some type of decline is probably not the right thing.

Got it, fair enough. All right. Thank you.

You bet.

And our next question today comes from Chris Dankert of Longbow Research. Please go ahead.

Good morning, Chris.

Morning, guys and thanks for taking my question. I guess back to start off the year, Paul had kind of somewhat previewed that you were working with suppliers on some growth initiatives internally. I guess -- and you'd kind of mentioned once you got into the selling season you're already on the beaches you could talk about that a bit more. Is that part of the DMI you announced? Or just any other color there would be really appreciated.

Mr. Johnston?

Yeah, I guess -- rephrase your question for me again if you would, so I can clearly understand what you're asking.

Sure, sure. Just at the start of the year you guys were talking about doing more with suppliers to try and help take share, but just any kind of color on those initiatives would be great?

Oh, yes. That's just our DNA, working with our suppliers to try to increase share. We had a number of programs in the first quarter. We continued it in the second quarter. Unfortunately the weather in the -- didn't cooperate with us quite the way we wanted to and hopefully in the third quarter we'll start seeing some fruits of those efforts.

Are we talking about more like advertising, marketing things along of that nature? Or we -- is it more again on the tax side of things just any…

It's on all of the above. It's on whatever the customer -- it's getting very customer focused looking at market segments, looking at specific customers, national accounts, builders, looking at the advertising it's pretty much across the board, depending on what the product category is.

Got it, got it. And then just secondly here any update on Latin America? I know that was a bit of a struggle in the first quarter. Just any update there would be helpful.

Yeah, Dave we can do that. Barry, tell them about the second quarter performance.

Sure. Again we got into mid single digit growth in Latin America for the second quarter…

Say it again mid single digit growth.

Mid single digit growth in the second quarter. And again progress as the year has gone on for sure. And second half of the year we're -- is an opportunity probably for some profit growth where last year was rather severe in terms of results.

Got it. Glad to hear we've turned the corner there guys. Thanks so much again.

You bet.

And the next question comes from Blake Hirschman of Stephens Inc. Please go ahead.

Hi, good morning guys. Just a quick one for me. There’s been more and more distributors pointing to incremental price cost issues looking forward. It doesn't seem like it's been much of a factor for you guys, but just wanted to get a quick update there? Thanks.

Barry, can you fill that?

Sure, again selling margin as I mentioned earlier is the purest determination of that question and are we marking out products in an efficient way year-over-year with a lot of price actions, a lot of moving pieces that have gone on. And again in the quarter and year-to-date we've seen a slight pickup in selling margin. So that's a good feeling given all the price actions that have gone on.

Thanks for that. I’ll turn it over.

And our next question comes from Patrick Baumann of JPMorgan. Please go ahead.

Good morning, Pat.

Hi, good morning guys. Thanks for taking my call. Just had a few questions and I apologize if some of these have been asked I dialed in, but just got a little bit late. Did you comment on your regional sales trends if certain regions were stronger than others?

Well, we commented what we've thought the wet and cool markets. Barry you want to advise him about that.

Yeah, we did comment earlier. And the commentary was that again this is kind of stripe between the Mississippi and Rockies is where we had the big weather impact in June. If I look Florida and east coast again positive growth, unencumbered by any kind of wet weather. It's really that central part of the country that was impacted. And then -- and with Texas for example is a big market for us. That's where the short-term impact probably affected us the largest.

Understood. That makes a lot of sense. And then, did you comment on price mix contributions as part of that 3% HVAC equipment growth?

Yes we said earlier there's a little bit of both.

Okay. That's helpful. And then on Peirce-Phelps, it sounds like it hasn't closed yet, is that right? And then also, did you disclose how much you paid and anything on margins? Just trying to nail down expected accretion to net earnings and the related timing of that?

Well there are consents and approvals that are required in order to close. We expect that to happen in the third quarter. We commented that the margin profile is better than let's say the historical joint venture margins that we started with 10 years ago with Carrier, but still less than Watsco's, somewhere in between, so opportunity to grow.

And just remind me, what were those historical JV margins? I don't recall those formats, I'm sorry.

You'll find an 8-K in 2009 that says 3% margin was what we acquired when we acquired Carrier Enterprise.

That was good.

Okay.

I like that.

And then the -- on the inventories in the balance sheet, looks like up in the second quarter. Anything unusual with regard -- I mean, I guess they're always up in the second quarter, but seemed like they were up a little bit more, anything unusual there?

We just want to be ready. There were some freight -- there were some delivery issues and we've got the strength with our balance sheet to take it in earlier in order to be ready for the season.

So there are delivery issues this year? Or are you talking about last year?

They were earlier this year.

Understood, understood. And then, last one for me, sorry I'd a bunch of questions, I apologize.

It’s all right. Take your time. We are in no hurry, take your time.

So the SG&A growth for the year, do you still expect it to be slower than the rate of sales growth. I guess maybe in the second half maybe or for the year, how ever you want to comment on. I believe, last quarter you talked about it growing at maybe half the rate of sales, but obviously this quarter was -- you had some issues in June with the topline which were not your fault, but just curious if you have an update on that.

Mr. Logan?

I'm sorry I really lost -- I lost you at some point. So go ahead and repeat it.

You don't have to be in a hurry. Just relax and we'll give you all the time you want.

Thanks so much. Thanks. The main question is SG&A growth for this year. Do you expect the growth rate in SG&A to be slower than the rate of growth in sales still? And about how much would you kind of target?

Again, one, we're in control of. One is, is how much money are we spending. In the first half of the year SG&A on a same-store basis is up 1%. Any level of sales growth in the second half beyond that will derive that equation that you're asking about, but sales growth has to occur for that to happen. So, I think there is some confidence there, but still dependent on the sales growth as I said earlier.

Okay. And I'm sorry, I do have one last one. Just in terms of the competitive situation from other distributors, Lennox had some issues with their plant in Marshalltown earlier -- or last year. I'm just curious, if you're seeing any change in like competitive behavior with regard to them trying to recapture market share that maybe they loss because of production being down?

I'll see if I can give you my thoughts on that. Lennox is a great company and the leadership has done outstanding since they joined the business. Are they taking share back, I couldn't tell you, but I can tell you fundamentally, they are a great company.

Okay, makes sense. Thanks a lot. Congratulations on the acquisition guys. Good luck.

Say hello to Steve

Will do.

And ladies and gentlemen, this concludes the question-and-answer session. I would turn the conference back over to Albert Nahmad, CEO and Chairman of the Board for any closing remarks.

Marco, thanks for monitoring this. Are you going to be back the next quarter too?

Let's hope so.

All right. Thanks everybody for listening and look forward to talking to you in the next quarter. Bye-bye now.

Thank you. Today's conference has now concluded. And we thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.