Albert H. Nahmad - Chairman, Chief Executive Officer, President and Chairman of Nominating & Strategy Committee Paul W.

Johnston - Vice President Barry S. Logan - Senior Vice President, Secretary and Director

Matt Duncan - Stephens Inc., Research Division Ryan Merkel - William Blair & Company L.L.C., Research Division Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division Joshua C.

Pokrzywinski - MKM Partners LLC, Research Division Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division David J.

Manthey - Robert W. Baird & Co.

Incorporated, Research Division Jason Feldman - UBS Investment Bank, Research Division Mark Douglass - Longbow Research LLC Walter S. Liptak - Global Hunter Securities, LLC, Research Division

Sorry about that delay, we were waiting for the queue to get online. But in any event, good morning, everyone, and welcome to our second quarter conference call.

This is Albert Nahmad, President and CEO. With me is Barry Logan, Senior Vice President; and Paul Johnston, our Vice President.

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. Watsco had a terrific record-breaking quarter.

We established new records for sales, operating income, operating margins, net income and earnings per share. Growth rates were strong, with sales increasing 11%, operating profit increasing 22% and EPS increasing 29%.

Residential equipment sales grew at 14%. It was the key to our performances.

This reflects a continued trend towards system replacements and better sales mix of higher efficiency systems. We also believe we gained market share again in our markets.

We achieved higher selling margins during the quarter and -- for both equipment and non-equipment sales, and SG&A was again well-managed. Our culture thrives on serving the needs of local customers with branch density and product density in the 2 most important competitive weakness -- competitive weapons, I should say.

Let me do that again. Our culture thrives on serving the needs of local customers with branch density and product depth, being the 2 most important competitive weapons.

We also firmly believe our strategy of incentivizing performance through a combination of cash and long-term Watsco equity creates a high and unique culture for our leadership to perform and build value with customers at a scale and commitment to grow unlike any other company in our industry. All in all, a great quarter for our company.

Now onto the specific numbers for the quarter. Revenues grew 11% to a record $1.12 billion, up 8% on a same-store basis.

Residential equipment sales were up 14%. Commercial HVAC equipment sales were down 6% following a plus 20% comp versus a year ago.

Sales of other HVAC products were up 4%. And sales of commercial refrigeration products grew 6%.

Gross profit increased 12%. Gross margins improved 20 basis points to 23.8%.

And SG&A increased 2%. Let me say that again, SG&A increased 2%, excluding new locations.

Operating profit improved 22% to a record $105 million, with operating margins increasing 90 basis points. On a same-store basis, operating profit increased 21%, with operating margins improving 100 basis points to 9.5%.

EPS increased 29% to $1.48 per share. Now for the 6 months.

Revenue grew 11% to a record $1.8 billion, up 6% on a same-store basis. Gross profit increased 14%.

Gross margin improved 50 basis points, and SG&A increased just 1%, excluding new locations. Operating profit improved 28% to a record $136 million, with operating margins expanding 100 basis points to 7.4%.

On a same-store basis, operating profit increased 25%, with operating margins improving 110 basis points to a record 7.6%. EPS for the 6 months increased 33% to a record $1.87 per share.

Now for cash flow in our balance sheet. We used $59 million of cash in the quarter versus $69 million last year.

Cash this time of the year is used to fund the working capital requirements of our business during the primary selling season. Cash flow will become positive as the year goes on, and our cash flow target for 2013 remains the same as always, to generate operating cash flow in excess of net income.

That was $388 million at the end of the quarter, which is less than 2x trailing EBITDA. We ended the quarter with a debt-to-cap ratio of 27%.

Now regarding dividends, I mentioned during the recent calls that we'll continue to review dividend policy during the year and consider an increase depending on our debt position and on other prospective needs for capital. Now as for our 2013 outlook, we have increased our range to $3.65 to $3.80.

We are still in the middle of our selling season. There is much execution left to do, but business is good, and we're feeling confident that this will be a great year for Watsco.

Now one last item before we take your questions, Watsco will be hosting an Investor Analyst Meeting on November 8 in Miami. We will send out a formal invitation and announcement soon.

Please send Barry, our Investment -- our Investor Relations fellow, Barry Logan, a note if you would like to attend. It will be a great event at a great venue.

Members of our senior management will have fun telling you more about our company. Now with that said, Barry, Paul and I will be happy to answer questions.

Andrew?

First question I've got now. You touched on this a little bit on your prepared remarks, just kind of looking at the replace versus repair cycle.

I know in previous calls you guys have talked about equipment sales growing faster and then compressor sales, which is a good way to track that. What is, I guess equipment resi, equipment was up 14%, what about compressor sales?

What does that look like right now?

Paul, do you want to take that?

Sure. Compressor sales, as they were in the first quarter and the second quarter, they were down.

So that trend that you saw in the first quarter continues as the year has gone on.

So kind of maybe if you can help us understand what you guys think is behind the 14% growth in the resi market. How much of that is new construction versus the replacement market maybe recovering with existing home sales on the rise?

And there's obviously a lot of other things going on, but how do you sort of break that out between the various market factors and then maybe market share you guys are taking?

That's the last part is the most important part. Market share gains, but specifics on the breakdown, Paul, do you have a feel for that?

Yes. It's a -- residential new construction is growing at a very rapid clip, and we feel we're gaining -- definitely gaining share in residential new construction, as well as gaining market share in the replacement market.

Even though the new construction market is up materially, it's still a pretty small percent of our overall revenue, our overall sales. So I think, anyway, in total, it's still -- it's double-digit, but it's barely double-digit as far as what our equipment sales are.

It's really a move from the consumer and the aftermarket to replace versus repair. And which I think reflects consumer confidence.

Okay, and then last thing and I'll hop back in queue. What type of revenue growth is attached to the $3.65 to $3.80 earnings guidance?

You guys were up about 8% organic this quarter and do you think you can keep that up during the rest of the year?

We haven't prepared for that and we haven't put that forward.

So I think you commented on the residential equipment was up 14%. What was the commercial equipment growth rate?

Go ahead, Paul.

It was down 6%.

It was down 6%, okay. Right.

That's on top of the -- compared to last year it was up 20%, over 20%. So the comp was very difficult.

Okay. And then can you provide the volume versus price mix in terms of the equipment growth rate of 12% I think it was?

Barry, do we do that? Barry?

Is he not on the line, Paul?

Ryan, if we benchmark it against the 11% total equipment growth, we did see a positive pricing in the quarter versus unit growth, rather just keep it at that in terms of how much, but we did see a little bit of positive price in the quarter.

Okay. Great.

Then in terms of the parts increase, I guess we talked about compressor sales being down. So what was really up?

Was it supplies for new housing applications? Or what was the driver in the other direction there?

Go ahead, Paul.

Yes. We saw -- and we benched this among our suppliers to make sure that we're on target with our supply business.

As in particular, with a small rebound in the new construction market. And we're seeing upper single digit, low double-digit growth in things like flex duct grills, registers, duct tape, that sort of thing.

So the supply business remains strong, the parts business is not as strong.

Okay. And then just last one, do you expect the same-store SG&A growth to be in the low-single-digit for the rest of the year?

Barry?

Yes. Ryan, as we've said many times, the infrastructure cost has been coming down over the last several years.

This quarter is no exception. The only thing driving SG&A growth is variable selling expenses and performance-based compensation, which we're happy that it's increasing because that dictates performance.

So yes, I think the low-single-digit is certainly achievable in terms of the rest of the year.

Just, Barry, you said you saw a favorable price. Can you just maybe give us a little more color on mix and just touch on what trend you're seeing in R-22?

Sure. R-22 equipment sales declined, so consistent with the compressor decline, that tells us 2 things.

Again, we said before, the replacement market, the system upgrade that's going on in the market is very strong, again by seeing lower compressors and also the lower R-22 unit sales. On the mix side, what we said in Al's comments is we did see a better mix of high-efficiency systems, I'd call it very slight, a very slight increase in mix.

We'll see how the rest of the season plays out, but it's a positive trend.

Okay. And then where do you feel you're picking up shares?

Is it regionally? Are you -- is it within the brands that you're selling?

Just maybe a little more color on where you're picking up share and how you're getting comfortable that you are indeed seeing share gains?

Of course, Jeff, we don't have the data from the industry yet. This is our own sense of it.

So caution you that this is what we think. And go ahead, Paul.

Okay. Yes, we feel like we're definitely gaining share in residential new construction because our growth rate there is in excess of what new home starts were for the quarter.

When you get into replacement, it's our sense, obviously, that we're growing share in most every one of our markets because we're seeing sales gains pretty much across the board. And without exception, every brand had sales gains in the quarter.

Okay. Great.

And then just final question. Can you touch on what you're seeing from an M&A front?

You've obviously cycled through a lot of the Carrier JV opportunities. And so, as you maybe shift back to looking back at the independent distribution opportunities, what do you see in the pipeline?

Well, we're always eager to invest more in M&A. And I think that the needle -- to move the needle, we have to do fairly substantial transactions at $3.5 billion run rate.

So with that caution that the smaller ones are going to move the needle, we still remain interested in doing the larger ones, but I'm afraid I don't have anything specific to report to you. If I did, I'd report it in a separate press release.

One thing I would remind everyone of is that next July we do have a step-up in ownership of our Sunbelt joint venture with Carrier, a 10% bump in ownership, and a fairly material benefit in transaction for us that is in the pipeline.

But Jeff, longer-term, we think with what we have, we have a very good prospects in the sense that we're going to focus on our export business and grow that we hope hundreds of millions of dollars. We're good at it.

We're probably the best there is in the Americas in that area. We also like the technology that's coming through the VRF regarding commercial buildings.

We want to be very sizable in that market niche. We also see the recovery going on of systems replacements versus systems repairs, and that's a long-term prospect for us.

So there are a lot of things besides M&A that's -- we have confidence we are going to continue to contribute to our long-term growth rate. And I just highlighted some of the ones that come to mind.

Just a quick question here. First on cadence through the quarter, it seems like, obviously not to focus too much on weather, but weather might have been a little bit of an irritant April, May.

Any color on how those ended up and I guess then just the trend in the June and July as weather has turned more favorable?

We don't really pay attention to weather. I mean, we are a seasonal business, but I think you pretty accurately described it.

In some markets the weather was negative, in some markets the weather was positive. I think we just had a great quarter.

And I think it's mostly our own performance within the industry regardless of the weather.

Do you get the sense that the consumer though is looking more, outside of any kind of weather, that this propensity to replace is driving the performance [indiscernible] .

Yes, well said. And I think that's going to continue for quite a while.

Don't forget, we've been in -- from that perspective, in a negative market for several years. So as that turns and, I think it is turning, we have several years of positive impact from that behavior by the consumer.

Any sense of the start to July? Any...

It's strong.

Okay. And then going back to the commercial market color.

I understand down in the quarter against the tough comp. But any sense that there's been a downward inflection point there or softening or is that a pure comparative comment?

Let's ask Paul that.

That's a -- I don't think there's been any downturn in that market. I think the market was pretty flat for the quarter compared to -- we were down 6% in the first quarter, down 6% in the second quarter.

And a lot of that was some new products that we added in 2012 that really spiked the -- spiked our comps. So I think maybe a little bit of it was timing as far as a lot of those are longer-term jobs, they take a while to be -- from the time we actually quote them, inspect them, until we deliver.

So it's not a lot of dollars difference quarter-over-quarter.

But longer-term, as I mentioned earlier, in the commercial side, we're very excited about -- this is going to take many years, it's not going to come right at now, the technology of VRV to help us gain substantial market position in the U.S. and the Americas.

VRV technology. And we're gearing up for it, we're investing in it, and it will be a while before we see a material impact.

But over the years, it's going to be huge for us.

Great. That's helpful.

And then just one last one on the pricing comment, and I understand you don't want to get too deep into it. But obviously, the OEMs put in price increases to start the year.

Any sense of how those have stuck at various [indiscernible] levels.

Yes, they did. Yes, that was positive.

Were they stickier at higher efficiency and maybe not as much at 13 SEER? Were there competitive differences there?

Do you know the answer to that, Paul?

No, I don't. I can look into that, Josh.

I don't have that on top of my head.

A question on gross margin. Given what was fantastic revenue growth here and some pricing, I thought it would have been up a little more.

Were there some offsets that hurt you in the quarter on gross margin?

Barry, do you...

Keith, we're not disappointed in gross profit, quite frankly. You have to consider the fact that equipment, by its nature, has a lower gross profit.

That to the extent that has a terrific quarter, it's going to put some pressure on the algebra of our margin. But I can assure you that gross profit was up for equipment and it was up for non-equipment.

Are you seeing a difference in growth rates on the higher-priced equipment versus more mid-priced equipment, thinking Carrier specifically?

As we said, Jeff, if mixed increases, what we're saying is that the higher-efficiency systems grew at a faster rate than the base level of efficiency.

Jeff, don't forget that in new construction, there are incentives for builders to put in a higher efficiency equipment over the base of SEER equipment. So that also helps the mix.

You would've thought differently, you would have thought that go for the least expensive base equipment, but there are incentives for them to go the higher efficiency equipment.

But isn't it really -- isn't it true over time as this remodel recovery that you've been discussing, as that comes down, that's going to be a -- that even on equipment, a better sale from what we see from the builder great, correct?

Well, I don't know that it's better because the builders are already going into the higher efficiency, but it certainly will help our mix.

Just a question on the -- I hate to keep hitting the growth equation here, but when we look at that 11% growth obviously it's made up of price mix and units. And sounds like the impact of mix from what I think Paul said is, was very slight.

The price increases though -- I was under the impression those were not insignificant, so I'm trying to gauge that. Is it safe to say that of the 11% growth in HVAC that more than half of that is units at least, can we at least say that?

Paul, if you could answer it, go ahead.

I think that's a Barry question. I think Barry was the one who had that.

Yes. More than half the growth rate is units, yes.

I like your persistency, well seriously.

I was just trying to drill down here. So then beyond that, I think in the past, you've given us data on what percent of your equipment sales were 13 SEER and then 14 and higher.

Is there any chance we can get an update on that this quarter versus maybe what it was a year ago or last quarter?

Yes, that's a little bit proprietary. David, I don't remember giving out that level of data.

Okay. And then the final question is, you touched on the weather already.

I'm just wondering if anecdotally, if you look at the -- obviously most of your markets are in the Sunbelt. But if you look at the few that are in snow belt in Canada, is there any anecdotal data you can give us in terms of differentials in growth rates that would imply that it would've been even better had the weather not been what it was in the Northern part of the U.S.?

I wouldn't reach that far. I would just say that we don't like to think of ourselves as a weather company.

We like to think of ourselves as a market share gainer because of our ability to provide high density of branches to provide convenience to the contractor. And secondly, the product offering, we probably have a larger product offering than our competitors in all markets.

So I just don't want this to become a weather story. I mean, you know that the weather has been bad in certain markets, and you know it's been good in other markets.

And I think that's pretty predictable in future years as well, it's going to continue. Where we make a difference is in the things that I just stated, the high density and the product offering, as well as the incentive system that only we can do by providing equity to some of our leaders and they sure work hard to get that equity.

Inventory levels looked about consistent with prior years adjusted for sales. How would you think or how would you characterize kind of the inventory levels relative to demand today?

Are you kind of about where you would want to be?

Barry?

Yes. With the strength in the quarter, the inventory that -- may be a little bit of an overhang we saw in the first quarter, plowed through in the second quarter and inventories I think are in very good shape.

Okay. On the M&A front, when you're looking at various options over the course of the next year or so, with the Sunbelt, the Carrier Sunbelt JV option coming up, does that limit your flexibility over the course of the next year?

Not at all. There are no limitations to our M&A activity, not at all.

Okay. And then lastly, I mean, you kind of touched on this before, but SG&A as a percentage of sales kind of at a record low, sounds like it's expected to grow substantially slower than sales.

Yes, we do believe that, we do believe that.

So where do you see the EBIT margins kind of being able to get to in the near or medium term?

Well, I think we've stated publicly, we like to get to the 10% EBIT margin. So we have a nice opportunity ahead of us.

I have not stated when we expect that because we really don't know, we just like the progress we're making towards that goal.

With the commercial HVAC, you mentioned that the very difficult comps there. When do the comps abate or do they this year with '12 really strong?

And then I think you mentioned that commercial is the marketing general's relatively flat. Is there rumblings in the market that is going to improve in the second half?

Or what do you think in the second half?

Paul, do you have a sense for that?

We're just going on the idea that it's going to remain flat. We're not really hearing anything that says that there's going to be a commercial recovery in the near term for us.

So our guys are -- we're trying to add new products like Al said, and we're trying to get new opportunities for our people out there because if the market's going to be slow, obviously, we want to gain share and gain presence in it with new products.

And then when do the comps get easier again?

Probably next year.

Next year. Okay.

That's helpful. And then last question.

There were some issues with getting the regional standards adopted this year, legal battles. Does that look like next year that could potentially come through?

Or is it going to be a challenge to get those moved through the legal system?

Go ahead, Paul.

Yes. The legal battle continues.

It's a suit that was filed by HARDI, which is a group of independent air-conditioning distributors to -- challenging the procedure that the EPA went through in order to establish this regional standard. I think it's a little bit like what we went through when -- with the change from to 13 SEER efficiency.

We're reaching a critical point here where people have to either put their inventory in place, assuming it's going to go through or not and the OEMs have got to do something or not. So I think it becomes a moot point as time goes on if there's no settlement, whether HARDI is successful or unsuccessful with their legal suit.

That's a lot of uncertainty, in other words.

It is.

Just a couple of follow-ups I guess. On the SG&A, keeping it at this low level, can you talk about a couple of things that you're doing to try and restrain or leverage that overhead cost?

And if there's anything coming up in the back half of the year, compensation or any true ups that we should be aware of?

I don't think there are any true ups. But go ahead, Barry, give him a more comprehensive answer.

No, Walter, it's again, it shouldn't be any surprises in SG&A in the second half. About 2/3 of what we spend, what I would simply call facility cost, rent, the people in our branches, the delivery trucks that deliver products and again fairly, fairly fixed in nature.

And the rest of what we spend is a lot of compensation on salespeople, that are fully commissioned, on performance-based comp, which is largely earnings growth rate generates a lot of what ends up in our compensation structures for our leaders in our field. And again, the moving pieces are pretty simple and simple to see and look forward to, so -- and adjustable based on performance.

So, no, it should be, again, a fairly consistent second half based on what you see in the first half.

Okay. And if I can -- just trying to start a new one.

You had a nice quarter and the way that you presented everything, it's all very positive. But I wonder if you talk at all about some of your suppliers?

Anything in short supply with the pickup that's happening or are you getting better service of mix from any of the different OEs?

We've had no supply issues with any supplier unlike some of the other products you're hearing about, I'm sure you're talking about the survey that was done by the National Home Builders on the components that are in short supply for building new homes, and we're not experiencing that. And if you read the survey you found that the one product that wasn't in short of supply out of the 24 that they selected was HVAC, so...

Just a couple of quick follow-ups. One, you mentioned in the release raising the dividend later in the year.

How are you thinking about just raising the quarterly dividend versus considering another special dividend?

Good question, Jeff. I think we're going to consider only raising the dividend rate, not a special dividend.

Okay. Great.

And then Al, you mentioned the VRF technology. Can you just maybe expand on what you're doing today, and how you're going to market and where you see the growth opportunities within that subsegment?

Well, I'd give you my view and then, let Paul, without diverging too much comparative information you can follow this up. Jeff, as one of these technologies that's been around the rest of the world, but it's just barely in recent years entering the United States.

It's a very efficient way to provide climate control to commercial buildings. And I just think that the building market in the United States is ready to start doing even more than they've been doing historically.

And eventually, I think we're going to see some big numbers from it, and I want to be the leader in the U.S. market.

We want our company to be the leader. It doesn't mean we don't have a lot of competition, but I do believe that we have the resources and the focus to get there.

And therefore, I think it will have a big impact on our operating results in the years ahead. So Paul?

Yes. You've looked at it, Jeff, it's great technology, it's a great solution for the small chiller, the large rooftop unit and it's something that, as Al has indicated, we're drilling into, we're looking at what the resources would have to be, to be #1 as we are #1 in the other product lines that we sell, and we're going to be #1 in the VRF and VRV [indiscernible] .

We're sure going to try.

We're going to bust our you know what to make it happen.

But Jeff, I don't think that's a short-term -- you're not going to see short-term results in this. It's more of a longer-term.

But when it comes, it would be very solid and very significant.

Well, thanks for listening. We always appreciate your interest in our company and look forward to having another great quarter and to talk to you about it about 3 months from now.

Thanks again. Bye.