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Watsco Inc (NYSE:WSO)
Q3 2019 Earnings Call
Oct 17, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Watsco Third Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]

I would now like to turn the conference over to Albert Nahmad, CEO. Please go ahead.

Albert H. Nahmad -- Chief Executive Officer

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, 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 net 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 opportunistic[Phonetic] 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 actions 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-to-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 reside 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 under way. We hope you will come, visit us and learn more.

With that A.J., Paul, Barry and I are happy to answer your questions.

Questions and Answers:

Operator

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.

Albert H. Nahmad -- Chief Executive Officer

Good morning, Jeff.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Hey, good morning guys. How are you?

Albert H. Nahmad -- Chief Executive Officer

Thank you.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

So yes, the 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?

Albert H. Nahmad -- Chief Executive Officer

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

Barry S. Logan -- Executive Vice President-Planning & Strategy and Secretary

Good morning, Jeff. 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, consistent with what you see overall. So in our minds, it was nice to see that consistency. Up North, 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.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

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.

Albert H. Nahmad -- Chief Executive Officer

Go ahead, Barry.

Barry S. Logan -- Executive Vice President-Planning & Strategy and Secretary

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's where the benefit of that, 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 is a -- 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.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Okay.

Operator

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

Albert H. Nahmad -- Chief Executive Officer

Good morning, Ryan.

Ryan Merkel -- William Blair -- Analyst

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

Albert H. Nahmad -- Chief Executive Officer

Well, who wants that one?

Paul W. Johnston -- Executive Vice President

I can take the first half of question.

Albert H. Nahmad -- Chief Executive Officer

Paul, A.J. or Barry?

Paul W. Johnston -- Executive Vice President

What?

Albert H. Nahmad -- Chief Executive Officer

Go ahead, Paul.

Paul W. Johnston -- Executive Vice President

I can take the first half, that 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, 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.

Aaron Nahmad -- President

Yes, this is A.J. As for technology, we -- it's 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.

Ryan Merkel -- William Blair -- Analyst

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 a priority for the Company and what is it that you need to achieve that to just better sales growth?

Barry S. Logan -- Executive Vice President-Planning & Strategy and Secretary

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's good for the long-term. We have a big lead on technology, we want to increase it, and I think that's kind of a 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.

Albert H. Nahmad -- Chief Executive Officer

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-year to 20-year period probably. That's -- why we can do that is because we are doing it from a position of strength, which is a nice place to invest from.

Paul W. Johnston -- Executive Vice President

I wish to add to 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's a very deep part of what we are doing. So that's a good feeling, and I think there will be more to come.

Ryan Merkel -- William Blair -- Analyst

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

Operator

Our next question comes from Stephen Volkmann of Jefferies. Please go ahead.

Albert H. Nahmad -- Chief Executive Officer

Good morning, Stephen.

Stephen Volkmann -- Jefferies -- Analyst

Good morning, guys. Maybe I will just follow-up on that if I may, because your revenue line was a little stronger than what 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?

Albert H. Nahmad -- Chief Executive Officer

You mean in terms of technology spending?

Stephen Volkmann -- Jefferies -- Analyst

Yes.

Albert H. Nahmad -- Chief Executive Officer

Well, let's have the President answer that.

Aaron Nahmad -- President

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

Stephen Volkmann -- Jefferies -- Analyst

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

Aaron Nahmad -- President

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

Barry S. Logan -- Executive Vice President-Planning & Strategy and Secretary

Yes, for technology, year-over-year, it is up to[Phonetic] $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 with our IoT strategy, also our longer-term investment. And that anniversaries this quarter. So that influence will not be as great going forward. So that's not a spike, that's an explanation for why it went up this quarter.

And longer-term, again, it's opportunistic. It's not a -- the plan is to keep driving adoption of what we've invested in for the last four or five years. And that 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.

Aaron Nahmad -- President

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

Stephen Volkmann -- Jefferies -- Analyst

Okay. Great, thank you. And then if I can just pivot a little bit. We've heard through some channel checks for Carrier -- I don't know that they would want to say it this way. But maybe it's 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?

Aaron Nahmad -- President

Well, first, let me say I hope what you have heard is true. [Indecipherable] 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, then this is a good thing for Carrier and therefore a good thing for Watsco.

Stephen Volkmann -- Jefferies -- Analyst

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

Operator

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

Albert H. Nahmad -- Chief Executive Officer

Good morning, Robert.

Robert Barry -- Buckingham Research -- Analyst

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 $4 million of IT spend?

Albert H. Nahmad -- Chief Executive Officer

Of course, it does.

Robert Barry -- Buckingham Research -- Analyst

Okay.

Albert H. Nahmad -- Chief Executive Officer

IT technology spending is in our SG&A.

Robert Barry -- Buckingham Research -- Analyst

Okay. Yes. Just wanted to...

Albert H. Nahmad -- Chief Executive Officer

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

Robert Barry -- Buckingham Research -- Analyst

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[Phonetic], we haven't delivered much margin expansion in recent years. That's 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 op margin suggests that maybe the goal of op margin expansion is less of a priority now? Just...

Albert H. Nahmad -- Chief Executive Officer

Well, we tried to expand...

Robert Barry -- Buckingham Research -- Analyst

[Speech Overlap]

Albert H. Nahmad -- Chief Executive Officer

Yes, 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 [Indecipherable] 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 SG&A goes up or goes down, that's a consequence of what we do, but we are not so focused on numbers as we are the opportunities that we see.

Robert Barry -- Buckingham Research -- Analyst

Got it. I did 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 [Speech Overlap]

Albert H. Nahmad -- Chief Executive Officer

Yes, let's do that. Paul?

Paul W. Johnston -- Executive Vice President

Yes, we had a -- 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. In sales, we try to balance sales growth and gross profit at the same time. We want both to grow.

Robert Barry -- Buckingham Research -- Analyst

Got it. Just lastly, just to follow up on that 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's happening there and what the outlook is for Florida?

Albert H. Nahmad -- Chief Executive Officer

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.

Robert Barry -- Buckingham Research -- Analyst

Alright. I will pass it on. Thank you.

Operator

Our next question comes from Josh Pokrzywinski of Morgan Stanley. Please go ahead.

Albert H. Nahmad -- Chief Executive Officer

Hi, Josh.

Brandy Debroux -- Morgan Stanley -- Analyst

Hi, this is Brandy 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?

Albert H. Nahmad -- Chief Executive Officer

Yes. That's a very good question.

Brandy Debroux -- Morgan Stanley -- Analyst

And any observations you have in the industry?

Albert H. Nahmad -- Chief Executive Officer

Yes. That's a great question. I think any of these could answer that, but I think Paul do you want to take a shot at that, since you do all the buy. Just kidding.

Paul W. Johnston -- Executive Vice President

Yes. [Speech Overlap] Yes, this is all my fault. Inventory is up month-over-month from September, from August through September and what we've 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.

Brandy Debroux -- Morgan Stanley -- Analyst

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

Paul W. Johnston -- Executive Vice President

Yes. We have already answered 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's 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 I don't -- 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's 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.

Brandy Debroux -- Morgan Stanley -- Analyst

Okay, I understand. Thank you.

Operator

Our next question comes from David Manthey of Baird. Please go ahead.

Albert H. Nahmad -- Chief Executive Officer

Hi, David.

David Manthey -- Baird -- Analyst

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 4% and 6%?

Albert H. Nahmad -- Chief Executive Officer

Barry?

Barry S. Logan -- Executive Vice President-Planning & Strategy and Secretary

Good morning, Dave. 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's not really a price cost conversation to have. Just slightly less growth in the US 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.

David Manthey -- Baird -- Analyst

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

Paul W. Johnston -- Executive Vice President

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

David Manthey -- Baird -- Analyst

Oh, OK. Maybe I misunderstood that. Okay then on overall organic equipment unit volumes. If we 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?

Albert H. Nahmad -- Chief Executive Officer

Paul?

Paul W. Johnston -- Executive Vice President

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's been increased by probably an extra 1 million, 1.5 million 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 million[Phonetic]. 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.

David Manthey -- Baird -- Analyst

Right, OK. And one more if I could on -- 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 data that we have seen that implies. It's up sort of 3-plus percent right now?

Paul W. Johnston -- Executive Vice President

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

David Manthey -- Baird -- Analyst

Okay. All right, thank you very much.

Albert H. Nahmad -- Chief Executive Officer

Sure.

Operator

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

Albert H. Nahmad -- Chief Executive Officer

Hey, Blake. Good morning, Blake.

Blake Hirschman -- Stephens Inc -- Analyst

Oh, yes, good 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?

Albert H. Nahmad -- Chief Executive Officer

Paul?

Paul W. Johnston -- Executive Vice President

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

Blake Hirschman -- Stephens Inc -- Analyst

All right. 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?

Albert H. Nahmad -- Chief Executive Officer

Again, Paul?

Paul W. Johnston -- Executive Vice President

Barry?

Barry S. Logan -- Executive Vice President-Planning & Strategy and Secretary

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 mid-year, which almost never occurs. And so year later that's the comp we are talking about and again as things have played through and we worked 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.

Blake Hirschman -- Stephens Inc -- Analyst

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

Operator

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

Albert H. Nahmad -- Chief Executive Officer

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's 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.

Operator

[Operator Closing Remarks]

Duration: 27 minutes

Call participants:

Albert H. Nahmad -- Chief Executive Officer

Barry S. Logan -- Executive Vice President-Planning & Strategy and Secretary

Paul W. Johnston -- Executive Vice President

Aaron Nahmad -- President

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Ryan Merkel -- William Blair -- Analyst

Stephen Volkmann -- Jefferies -- Analyst

Robert Barry -- Buckingham Research -- Analyst

Brandy Debroux -- Morgan Stanley -- Analyst

David Manthey -- Baird -- Analyst

Blake Hirschman -- Stephens Inc -- Analyst

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