Good day and welcome to the Watsco Third Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Albert Nahmad, CEO. Please go ahead.

Good morning and welcome to Watsco's third 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, our Executive Vice President. Before we start our call, our 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. Watsco produced another record quarter with sales, net income and earnings per share all reaching record levels. In addition, cash flow for the nine months is also a record and we expect cash flow to exceed that income for the full year. Our 2019 acquisitions DASCO Supply and Peirce-Phelps both contributed to the quarter and produced sales and profit growth over last year. We remain very active in the industry seeking great companies. We believe in investing in great companies and providing their leaders with resources to grow their business. These resources include capital, technology, equity incentives and most important encouraging the preservation of their own entrepreneurship culture. With the event of modern technology, we believe it is an opportune - time for independent distributors to join the Watsco family since our resources can help them develop scale faster. In terms of results for the quarter sales growth was driven by strength and residential HVAC equipment with more consistent demand trends across the Sunbelt markets. 2018’s third quarter gross margin comparison prove difficult, as last year's OEMs pricing actually did not reoccur in 2019. However, SG&A efficiencies were achieved during the quarter, and that offset a good portion of the gross margin impact. We continue to drive adoption of a variety of customer focused technologies to better serve our contractor customers. That adoption has led to higher growth rates and lower attrition rates with customers who regularly use our technology. Over the long run, we are confident Watsco's innovations will transform the way business is done in our industry, and will also influence and convince great companies to become a part of the Watsco family. Moving on to our balance sheet, our financial position remains conservative and strong with a 9% debt the total capitalization ratio. This financial strength allows us to take advantage of almost any size investment opportunity. Our press release provides important details about our performance. I will not resize these details in my prepared remarks, but we will be happy to provide more color during Q&A. Finally, we renew our standing invitation to visit us in Miami and learn more about our technology journey. You will gain insight into our culture and many innovations that are underway. We hope you will come visit us and learn more. With that A.J., Paul, Barry and I are happy to answer your question.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jeff Hammond of KeyBanc Capital Markets. Please go ahead.

Good morning Jeff.

Hey good morning guys, how are you? So yes, 6% residential was pretty impressive and I know that some other folks were kind of complaining about the weather. Can you maybe just talk about, where you saw particular strengths and where there still may be pockets of weakness regionally?

I don't know that, we get into that sort of competitive detail, but I will let Barry to deal with the question.

Good morning Jeff. Well, we are not giving data by state or data by market. I could say it this way that really across our Sunbelt markets in particular, very consistent, narrow bandwidth of growth, so consistent with what you see overall. So in our minds it is nice to see that consistency up North there, we have some strength in the residential markets and Latin America also grew during the quarter. So nice and plain and simple in terms of overall growth.

Okay great. And then it looks like the carrier minority interest line was a little light versus my expectations. I know like Pearson, Homans were coming into the mix. Just maybe speak to the gross margin pressure and how that men had gone through the carrier side. And maybe on this gross margin dynamic. You talked about just - do you expect that to carry into 4Q? Thanks.

Go ahead Barry.

Well, Jeff, I think most of the change in the quarter for the minority interest line is Homans, we purchased 20% of Homans at the end of last quarter and that is where the benefit of that 20% purchase flow is a reduction in minority interest expense year-over-year. As far as gross profit, looking in the fourth quarter there were some price actions as well in the fourth quarter a year ago, there will be a measure of irritation and then that should play out in the fourth quarter.

Okay.

Our next question comes from Ryan Merkel of William Blair. Please go ahead.

Good morning Ryan.

Hey, good morning everyone. So first off back to the 4% equipment gross number, which is pretty solid. Do you think you are taking market share and then is the tax spending the big driver?

Who wants that one?

The first half that you know as far as the numbers aren't out in the third quarter yet from HRI. So, looking at the first two months of what came in, in the quarter, which would be the larger months. You know I think we definitely did grow some market share during the quarter on the residential side. We were up, I think the markets going to be flat to down slightly when all the numbers are tabulated.

As for technology it is hard to measure causation. But as far as correlation, what I can tell you is that the customers that are using technology and using it more regularly are growing at a faster pace with us than customers that are not. And their attrition is much lower than customers that are not using technology. So generally speaking, the customers that use it more often are stronger customers of this.

Got it. Okay and then on operating margins just stepping back its been flat for few years now. I'm just wondering, is expanding operating margins priority for the Company and what is it that you need to achieve that to just better sales growth?

Well, don't forget, we are very long-term focused and we believe that for the long-term, we have to invest significantly in our technology and even though it may hurt short-term results, because we are spending more on technology. It is good for the long-term, we have a big lead on technology, we want to increase it and I think that is part of the SG&A. Although overall, we sustain at the same percentage levels, as we did last year. So I'm pleased about that. But don't be surprised, if we find opportunities in terms of technology and take advantage of it, because we are not really focused on the short-term.

Yes. I will say this too, I mean the technology spending has been a big part of our business for last three or four years. But this is not a short-term exercise, right. This is a journey we are a big Company and a big industry with a mature market and the investments we are making today will play out over 10 to 20 year period probably. Why we can do that is because we are doing it from a position of strength, which is a nice place to invest from.

I wish to add that part of that Ryan in terms of the long-term is, what will OEMs think about doing with distribution over the periods of time as things are evolving this way. And we are already an immense partner to many or most of them, and we think that will only improve and deepen overtime. And then there are 1,300 independent distributors that also are going to face some sort of music about technology. And part of this investment, we are already seeing some benefits and attracting some age old businesses that had never sold our business anybody. And in terms of completing transactions and conversations going on, it is a very deep part of what we are doing. So that is a good feeling and I think there will be more to come.

Okay. I appreciate the color. I will pass it on. Thanks.

Our next question comes from Stephen Volkmann of Jefferies.

Good morning Stephen.

Good morning guys. Maybe I will just follow-up on that if I may, because your revenue line was a little stronger than where we were looking for. But so as your SG&A spending I think, and I'm wondering, relative to your plan, obviously, we didn't know that. But did you find some additional things that you decided would be good investments during the quarter and sort of spent a little more than you thought, or was this in line with kind of your longer term plan?

You mean in terms of technology spending?

Yes.

Well, let's have the President answer that.

There is nothing that stands out as a big spike in technology spending this quarter.

Okay. I'm just trying to think about how are you sort of playing that out.

I think year-to-date, we have a number of that over last year. And Barry do you have that number?

Yes, for technology, year-over-year, it is up to $4 million about $0.10 a share. And most of that or a good portion of that at least is the acquisition of Alert Labs, which is an IoT company that we acquired to help it our IoT strategy, also our long-term investment. And that anniversaries this quarter, so that influence will not be as great going forward. So that is not a spike, that is an explanation for why it went up this quarter. And longer term, again, it is opportunistic. The plan is to keep driving adoption of what we have invested in for the last four or five years. How do we get more customers every day, making our technology their way of life. And obviously, there is spending going on to develop more and more customers and more and more usage across our network. But big spending, big tickets is not something that comes along and if it does we evaluate it and make sense of it and decide if we want to do it or not.

With the specific transaction you just mentioned Barry, it is an development company. We knew going in that it would be losing money, and will continue to lose money, but we think that the outcome of that technology improvement and in the long-term will have a major impact.

Okay, great, thank you. And then if I can just pivot a little bit. We have heard through some channel checks that carrier - I don't know that they would want to say it this way. But maybe it is a little more focused on their end markets and a little more willing to get involved in marketing and so forth. Are you seeing any kind of changes from them in terms of their partnership with you?

Well, first, let me say I hope what you have heard is true. Now we have met their senior leadership and they couldn't be more positive about their future in terms of being independently publicly traded. And of course, the word that applies to them now as it does to us is growth. And to get growth, you have to do the things you are talking about investing in products, investing in distribution, if all the signs are positive, that this is a good thing for carrier and therefore a good thing for Watsco.

Okay, great. I will leave it there. Thank you guys.

Our next question comes from Robert Barry of Buckingham Research. Please go ahead.

Good morning Robert.

Hey guys, good morning. Just wanted to follow-up on a few things. When you report the SG&A same store as flat. Does that include that four million of IT spend?

Of course, it is.

Okay.

IT - technology spending is in our SG&A.

Okay good, just wanted to get…

And also the losses are included in the P&L too. I mean, it is not a profitable business and we know that going in. But yes, that is all part of the main financial statement.

Right. I mean, I guess, just don’t mean to be the head of dead horse. But it seems like the tone at the beginning of the year was listen, we haven't delivered much margin expansion in recent years. That is going to be more of a focus this year. There was some cost actions at the end of last year to kind of get you there and SG&A has been flat same store. Yet it seems like the responses to the earlier questions on margin suggests that maybe the goal of margin expansion is less of a priority now. I just…

This is opportunistic. We don't look at things the way you outlined. We look at what is the opportunities long-term to keep growing the Company and increase our competitive advantage. We are not numbers driven, why don't we do this, because it is a budget or this net the other. So this year, it was the one we just mentioned Alert Labs at [indiscernible] Canada, great products, not in the market yet or they are coming to the market. And we believe strongly in that. Now we are supporting them and we will continue to do things like that. Whether our SG&A goes up or goes down that is a consequence of what we do, but we are not focused on numbers as we are the opportunities that we see.

Got it. I also want to just get a little more color on what drove the gross margin down. I mean, you mentioned the tough comp with the pricing, how about the deals are -.

Yes, let us do that Paul?

Yes, as you know, the last year was unprecedented as far as the number of price increases we had and obviously that drove up our gross profit percentage. And that was a big part of it. You mentioned that the gross profit drive is always in front of us as far as what we are trying to drive to increase the gross profit on our products. There is a market out there though, and we are competitive in that market and we maintain our competitive nature in that market, and sales, we try to balance sales growth and gross profit at the same time. We want both to grow.

Got it. Just one lastly a follow-up on a comment. It sounds like most of the markets were tracking in that 3% same store growth rate. Does that include Florida and just any update on what is happening there and what the outlook is for Florida?

No, we are not going to answer geographic questions. We don't want to assist our competitors. As you have heard earlier today, it is a mature market, very competitive. And we don't want to give anybody an idea where they can do better against us.

Alright. I will pass it on. Thank you.

Our next question comes from Josh Pokrzywinski of Morgan Stanley.

Josh.

Hi, this is [Brandy] (Ph) on for Josh. Good morning. So just wanted to look at inventory, it looks like inventory is elevated relative to the amount of sales that were added from the deals or just general in growth. Can you talk about core Watsco inventory and if it is running higher than usual this season? And any observations you have in the industry?

That is a great question. I think any of these could answer that, but I think Paul do you want to a shot at that. Since you do all the buy.

It is all my fault. Inventory is up month over month from September or from August through September and what we have seen is inventory has been increasing. One, we had price increases compared to prior year comparisons in the equipment that we do carry and in the parts and supplies that we carry. Secondly, there was a small build up that probably you will see it reflected across the industry with gas furnaces, where we had to cut off in July for furnace energy ratings changes. And so we built a little bit of inventory for that, but nothing that exciting that won't be sold out in the second half of the year.

Okay. That is helpful. And then just wanted follow-up on the deals. Do you see any potential for synergies that can be extracted on the SG&A any level?

Yes. We have already answered for that, because we give this a lot of thought. The reason we buy these great independent distributors is because they are very successful, and we don't want to take a risk, and we will avoid taking a risk, trying to do anything to change their culture and their record of success. We don't look for synergies. That is up to them. These businesses that have done so well, but we think we can grow them faster by what we said in the press release, we can capitalize them better, we can ask them to take more risk if they wish to. But basically, our culture and acquisitions support the entrepreneurship that was there before we got there. And we are not going to mess around, we are trying to take some costs out, because that is not what we do, we are in for growth. What we want to do is continue to build a network and we don't want the risk of trying to tell them how to operate as an independent business. So they are independent in terms of what they do, but they are part of Watsco utilizing the resources of Watsco that is a heck of a good accommodation, which has helped us become the largest in the world in what we do. And so synergy is not a word we use, growth is the word we use.

Okay. I understand. Thank you.

Our next question comes from David Manthey of Baird.

Hi David.

Thank you, good morning all. First off, if you could talk about the breakdown of price mix versus volume in both equipment and resi equipment numbers you gave us that four and six?

Barry.

In the residential market, more unit growth in price, in terms if I dissect to 6%. And for the commercial business which makes up the rest to get to the 4% overall, it is not really a price cost conversation to have. Just slightly less growth in the U.S. on the commercial side and I don't think price mix really had any consequence. So on the residential side though it was probably better than expected unit growth.

Okay. So a couple points there. Paul implied that there was also some price benefits in parts and supplies I would guess that is fairly nominal?

And if I did, I did not mean to do that. I did not say that. No.

Okay. Maybe I misunderstood that. Okay then on overall organic equipment unit volume. So if you take price out of the equation, you sort of think about the selling season in the second and third quarter. It looks somewhat flat this year with the second quarter down and the third quarter up. And I know you talked about the cycle and you didn’t really want to talk about it. Have you given any thought to just broadly nationally the HVAC cycle and any impact it might be having on the overall industry?

Yes. We have been looking at this. We have got a couple of things that play into it. Obviously, we still have the 80 million to 90 million installed base on the residential side, which is going to be replaced overtime. That hasn't changed, it is been increased by probably an extra million, million and a half units this year. Secondly, as far as looking at it in total, it is kind of hard to come up with an exact number, but you are talking roughly 45% to 50% of those units that are out that are still are 22. And obviously we will have replacement coming up sooner than later. So the general replacement cycle nationwide is still a good market to be in and a good place to be positioned for Watsco.

Right, okay. And one more if I could. When you mentioned industry unit shipments, you thought they would be down for the full quarter. I'm just wondering why you think that given the quarter-to-date shipment in data that we have seen that implies, it is up sort of three plus percent right now?

I think, I said flat to that. And I just don't see where there is just going to be a robust cycle of shipments in the month of September, that is all and it is an estimate.

Okay. Alright, thank you very much.

[Operator Instructions]. Our next question comes from Blake Hirschman of Stephens Inc. Please go ahead.

Good morning Blake.

God morning guys. First off, did the Hurricanes during the quarter did they impact activity in the near-term at all and/or create any incremental repair work on the back end looking forward?

Paul.

Yes, I don't think it had a material impact on the quarter for us no.

Alright. And then back to the gross margins. Did the acquisitions that you guys have done year-to-date, did they create a drag at all or was it really just due to the tough comp and price increases from last year?

Again Paul.

Barry.

No, the acquisition gross margin is at par with Watsco, so there is no influence on gross profit from that perspective. The EBIT margin is where there is opportunity to improve, but long-term. The change in gross profit, if you look at it a year ago was up 50 basis points. Last year's third quarter gross profit margin was up 50 basis points. Strictly due to passing on relatively material OEM price increases midyear which is almost never occurs. And so year later that is the comp we are talking about and again as things have played through and we work through it, it becomes a more normal and stable circumstance going forward. So this is really just a quarter for that type of occurrence last year in terms of standing out.

Alright. That makes sense. Thanks, I will leave it there.

This concludes our question-and-answer session. I would like to turn the conference back over to Albert Nahmad for any closing remarks.

Well once again, thanks for your interest in our Company. I'm glad you are involved. I really wish you would come down here and get a better handle on what we are doing with our major technology efforts. Think about the winner that is a good time to come down to Miami. So thanks again and we will speak to you at the end of this current quarter. Bye-bye now.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.