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Watsco, Inc. (NYSE:WSO)

February 20, 2013 12:30 pm ET

Executives

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

Analysts

Scott R. Davis - Barclays Capital, Research Division

John F. Kasprzak - BB&T Capital Markets, Research Division

Scott R. Davis - Barclays Capital, Research Division

.

Okay, folks. Thank you for being patient. I wanted to give everybody a chance to come back from lunch. We're going to start off the afternoon with Watsco and Barry Logan, Executive Vice President and long, long time, how long have you been with Watsco, Barry?

Barry S. Logan

20 years.

Scott R. Davis - Barclays Capital, Research Division

I was going to guess 20. A 20-year Watsco veteran. He's seen the company grown from -- Oh gosh, what was the revenues when you started?

Barry S. Logan

About $150 million.

Scott R. Davis - Barclays Capital, Research Division

I was going to guess $200 million. So $150 million of revenues to its rather large size today. So I've seen a lot of history and have had a lot of successes. When we get calls on Watsco, in general, the debate around the stock more relates to the debate about -- around HVAC recovery. Some of it around housing -- the housing cycle and the pace and sustainability of an upturning housing, but most of it really around the sustainability, and while the potential recovery, I should say, in the aftermarket, which still comprises the vast majority of air conditioning sales, and the trade down that we've had -- the mix shift trade down that we've had amid a regulatory environment that's been rather strange the last few years. But really, when you take a look at Watsco, absent the -- some of the cycle headwinds you have , it is a company that's done, I think, a fantastic job of rolling up in industry that still remains highly fragmented, becoming essentially that 800-pound gorilla in an industry where I'm not sure any of us could name a 100-pound gorilla that they compete against in any real component or scale. And so I think, the company has done an excellent job. I think, Barry, we've done a lot of conferences together, and I think, the message has been pretty consistent over the years. You guys have a very long-term view. But maybe one of the things we can do today, and of course, we'll do our usual audience response with some questions, but one of the things we can do today is, dig in a little bit on what's new at Watsco, what you guys are doing that's different in the context of taking margins up, the mix and with the Carrier assets you purchased and such and getting the total company margin up, and then how you're positioned to benefit from that eventual recovery, and then will be -- our view, as many of you know, is that the recovery will get pushed out until 2014 or potentially, even 2015. But I think right now, it's looking more like 2014. But we could be wrong, and so I think it's important to talk to -- get Barry's perspective on when he sees the lion's share of the recovery and where we may see some normalization in some of the trends that we've seen over the last couple of years. So with that, Barry, I think that's a fairly open-ended way of saying that whatever you think is important to tell us, you can lead off with, and then we can go into questions from there.

Barry S. Logan

Sure, thank you, Scott. I appreciate it. I like to come into a conference, for once, where I can roll out of bed and drive 11 miles, so I appreciate that. Anyone who ever wants to dig in a little more about Watsco and you like Miami, come see us, we're here. It's also nice to have probably, an 80-degree outside -- degree day outside today, with 85% humidity, and it's February. So it will be a good business day today and...

Scott R. Davis - Barclays Capital, Research Division

You want to kick me on the head again, Barry? I haven't seen the light of day in 5 months?

Barry S. Logan

And we like the fact that the earth will actually heat more between now and the summertime, so this is a good market for air conditioning. Again, welcome, here. Again, I've been with the company for 20 years. We've been building the company and, just in a very, I think, measured way, really, first, that was based on acquisitions. So acquisitions because most of the brands in North America were established by family businesses over the last 110 years since Willis Carrier invented this stuff. And over that time, generations of families have owned businesses and reached crossroads, and that's been a big source of growth for us, and will continue to be because that's still how much of the market operates.

So what's new at Watsco is -- what's been old at Watsco is that we do believe and like the fact that these families are probably doing better now in their business than they were a few years ago. That helps the probability that they've been wanting to do something at a value that we can digest and accept, and where we also like the risk factor of investing in a business where the earnings are growing and not at risk. That was not the case 4 or 5 years ago. So I think we put a lot of effort and energy into making contacts with some of the long-term discussions that we've had. I'm not here to announce one or tease about announcing one, but we're putting a lot of energy behind that, from an investment point of view. And we need a balance sheet to do that. And if you look at our balance sheet and ask me any questions, most of the time, you'll hear a very conservative posture on leverage and investment grade pricing, and frugal about our valuation multiples, because as Scott said, we think we're the only one that can afford many of these properties, and one of the few where the OEMs will allow their distribution rights to transfer to someone else. That's always been a unique aspect of buying business as Watsco is -- and OEM has to agree to it. And that's kept a lot of the capital and wealth out of this industry from, let's say, the private equity of the world or people with money that want to invest in HVAC. It has not been simple or easy to enter the market because the OEMs do actually control who does, so we like that.

So also what's new is our international business. We highlighted some of the prospects in the results on our fourth quarter call, probably the first time we've done that. International to us is Canada, Mexico, the Caribbean and parts of Latin America. The flagpole for most of that is here in Miami, and then we also have a business unit in Canada. We acquired Carriers Canada distribution about 10 months ago, and it's the newest part of our international business. If we cut through that, it's basically a western hemisphere business, covering Canada to the northern tier of Latin America. And that international business now is about 15% of what we do. It was 0 3 years ago, but we like that it's growing. We have a big -- big markets to invest in. It is a Sunbelt market, south of here. The economies have been growing. The products have been going from a luxury to being more of a necessity like the U.S., and the people, especially in the infrastructure world of the commercial products had been investing. So we like the markets. We have the products that last. And it's been growing, and we've been investing in it. So that's something that can get us beyond growth rates that are simply a US-based business. So whether that's going to recover or grow or not, that's some big markets where there was no 100-pound gorilla either, and although we're not at 800 pounds by far, but we're somewhere in between, I think, in these markets, and it's brand new for us. And it's -- and everyone is having fun.

Also, what's new is some reemergence of new construction for us. If you picture a new house, there's maybe $1,500 worth of equipment that an OEM makes for that house, we sell that. More importantly, there's a few thousand dollars of other stuff that fulfills the rest of the system. It could be ductwork or thermostats, copper tubing and so on, and we are a dominant player in all those product segments. And that business has been obviously suffering as new construction went from 2 million units to 0.5 million units.

And if 25% of your business is in Florida, which ours is, the consequence of decline has been that much greater in a market like Florida. So today, my byline is that new construction is 10% of our business. Five years ago, it was around 1/3 of our business. So any spectrum of growth in between or recovery or rebuilding or what have you, is a nice business outcome. We saw some benefits creeping in to the fourth quarter, and there's no reason to -- no reason not to imagine that the housing data that talks about starts and permits manifests itself in growth rates for us over the next, sort of, over the next few years.

Also something that is new for us is commercial. Commercial air conditioning for us was almost not a business, in terms of being material to us, until a few years ago. Trane, York and Carrier are the 3 dominant players in commercial in North America and as I mentioned, we sold 0 of their products until a few years ago. So our partner in that market is Carrier. We have not all of the products but most of the products they make for the commercial market and the territories, exclusively where we sell them. We've been investing in people and more product breadth. They have been contributing more products in terms of the availability to us and it grew double-digits last year, the market did not. And something that again, we're investing in now that we have a chance to. But I think, we are that player in many of the residential markets in terms of brands and depth and locations and density and product scale and product depth. And the commercial market, we're just a few years into becoming a more important local distributor of that stuff. And when we talk about replacement -- emergency replacement, having density of locations for commercial is also important. And that will be interesting to see how that plays out because so far, so good, and we're very young in the commercial market.

So those -- if I go back to the consumer, there's nothing new about the consumer to report. We're about 60% of what we do, ends up in someone's backyard or a closet or basement. The pricing of those products has been, I think, relatively stable. It's the mix of those products that has been unstable. For about 18 in my 20-year career, the average energy efficiency mix increased every year. That's what drives price in our market. Inflation can matter, but product mix probably matters more. And that's what's been declining for the last couple of years, as the contractor really not having the courage to ask for the last or the next dollar and an upgrade over the consumer. So we're training, we're teaching, we're telling, we're incentivizing, we're putting a lot of energy behind that, and luckily, in 2015, a government mandate will require it in many of our markets in terms of energy upgrade, but that's 2 years from now. In the meantime, we think, as the consumer strengthens, common sense is they'll spend a little bit more money on average, and that will be good for the industry. So there would be some broad brushes of different products and segments and so on of what we have going on.

Scott R. Davis - Barclays Capital, Research Division

That's a good background, Barry. And maybe before I start asking questions, let's go to the audience response system and go to our first question to all get a sense of -- I think, we have had critical mass in here now. So do you currently own a stock? One, yes but overweight; Two, yes, in equal weight; 3, yes, underweight or no? Please vote.

[Voting]

Wow, holy cow. And this room's relatively full. There's a lot of people here. Okay. Well, let's go to the next question then. What's your general bias towards the stock right now? Remember, it's bias for the stock, not the company. Positive, negative or neutral. Please vote.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Neutral. We may have to upgrade our rating, Barry. We're right in the consensus here. Okay. Well, let's go to the next question and try to figure this out. Your opinion, through cycle EPS growth for Watsco will be above peers, in line with peers or below peers? Remember its through the cycle. Hit the paper. Chop, chop.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Well, that's more bullish. Okay. Let's take a break from that and move back to the questions. And please, just raise your hand if you have any questions in the audience. I wanted to dig in a little bit to the 2 issues. One, the resi recovery, and get a sense for you on if there's been anything that's changed. And the reason why I asked that question is that, our homebuilders more apt now to -- we've seen in the appliance industry where they're more apt to either in very high-end or very low-end and not much in the middle. Is that similar to what you've seen in this -- in the last 12 months of the new builds? Or is it just too early to really draw a conclusion on that?

Barry S. Logan

Yes. What we're seeing is, energy efficiency in our world is 13, 14, 16 SEER. That's good, better, best. There's probably a 10%, 15% price difference in the 3 tiers and different layers of government incentives that incentivize each. So energy star, we've all heard of that. Energy Star gives the builder rebates from the U.S. government for installing 14 SEER, okay? And that's where we've seen movements towards is the 14 SEER products for new construction. It's not -- and also, Florida Power & Light for example, here in Florida, would also give an incentive rebate to installing that system to help with the gap and cost that's there. So we are seeing movement towards that. And I think, generally speaking, there's a better warranty that will come with that product that the OEM offers.

Scott R. Davis - Barclays Capital, Research Division

Is that the 10-year warranty?

Barry S. Logan

Correct. And so it's generally, a better value for the homebuilder to do kind of a brochure to you when you're buying the house. That wasn't always that way. I think that's been a migration in the cycle as we get started with it.

Scott R. Davis - Barclays Capital, Research Division

And the same question in the aftermarket where, as you mentioned, the installer is still shell-shocked from this housing cycle that is not willing to come in. I had my own, this is anecdotal of course, but I had an air conditioner break in my house, and the guy came in and his first offer was the lowest-end unit that he provided. I mean, he didn't even try for -- I ended up convincing him to sell me something better, but it took a little pushing. And his basic response when I queried in on it was that, he just wanted to get any unit in the house so he could have the service business. Has that changed? Was it always -- I mean, is it changed? Or is there -- just not willing to go after that extra $400 or extra $500 just because they don't want to risk losing the...

Barry S. Logan

Yes, again, I think, that's the consumer sensitivity. That would be true with all -- almost any big ticket purchase. I -- if you sold automobiles, if you sold almost anything more than $1,000, I think, there's some measure of price paranoia that somebody selling that would have, and our product would be the same. So I think there's been some of that the last few years. What we're seeing is people are replacing more often than fixing. That was this something that we saw a couple of years ago. And then whether they're replacing, too, becomes the important part of the discussion. So what do we do about it? Or for example, we spend about $40 million advertising the brands we sell. Part of that is co-op and shared with the OEMs who make the brands, and some of that shared with the contractor who's in your kitchen table. So we're trying to change the way that money is being spent and allocated. So there's a greater incentive to upgrade at your kitchen table. Does that mean pay you a cash back? If we would've offered you $300 cash back at point-of-sale, would you have taken it, be more active with the utilities in terms of providing rebates to you as a home owner? We have those relationships in this equation. So it's really just reacting to that. And as I said, in 2015, the government will mandate it. So we'll look smarter when that occurs. But in a 5- and 10-year picture, it really has to be a consumer that feels the confidence, not different than many other large consumer purchase.

Scott R. Davis - Barclays Capital, Research Division

So just the last kind of couple of questions that I have is -- relates to M&A. And you've done some great deals in the past and in fact, we had a -- we put a buy on your stock the day you announced the Carrier deal. X number -- the first Carrier deal, x number of years ago. It's just a fantastic deal for everybody, it seems. But we were surprised that you didn't have 3 or 4 things teed up for the end of 2012, just given the concern that some of these moms and pops might have on tax policy, and the window being open to generally sell things. And, yes, I think, I might have been asked on your conference call by a couple of folks and I don't recall exactly, but what did you see? Is it -- I think Al may have, at some point, said the prices were just too high or -- but I don't get it, I mean, if somebody wanted to sell for tax reasons, then presumably, they know the bid.

Barry S. Logan

No. What we're finding in reality is, is that the family business today is making probably 30% or 40% less EBIT than they were 5 years ago just because of what's going on with the cycle. And if your business is making 40% less, it's worth 40% less. And we're not going to invent multiples for the sake of doing something. And a higher tax rate is not going to fill that 40% gap of value that's there. So what we're finding is people are curious and interested in doing better, but the valuation is still less than what their dream was maybe 4 or 5 years ago. They've delevered so they -- they have cash. I've had owners tell me, if you would give me this amount of money and I put it in a money market account, I have basically no income. Right now, I'm taking money out of the business and I'm sleeping at night. So it's really more complicated than getting something done at the right multiple where there's emotion -- there's family emotion. Mostly there's been, I think, an valuation gap that can only be closed with some improvement in underlying performance of the targets.

Scott R. Davis - Barclays Capital, Research Division

So in some ways, just a devil's advocate, it doesn't sound like you're willing to make a cycle bet then because presumably, if that EBIT or EBITDA number is up 25% in the next 2 years as we get to 2015, then you might actually, even if you paid an extra multiple point, get a pretty good deal, all in.

Barry S. Logan

We'll pick our places and our moments to do that when we find one. It's been, I think, again, in a family business, it's always -- it's almost always also a non-financial threshold, they've reached in some way. And it's being there when those -- either a family event or death or people are arguing or people are at it again, that threshold for some reason other than financial reasons. So, yes, that's being there when something happens and that's unpredictable.

Scott R. Davis - Barclays Capital, Research Division

Right. Can I ask you about credit? Four or 5 years ago, we had concerns about -- with the GE Capitals of the world are kind of pulling away from financing air conditioning units and folks not being able to really use their home equity loans and their credit cards were tapped out. What have you seen -- how do you see that back filled? Is it the local banks? Is it other banks? Is it people finding other ways to pay for things? What's your sense? Do you have any data at all on what percentage of the units are being financed?

Barry S. Logan

Sure, we do. We first have our relationships with some of our consumer banks that want access to our customer to finance products. So if you're a contractor, you're getting our tool that we're getting from GE Capital or Wells Fargo, someone like that, Citicorp, and getting that tool to the contractor to close you at your kitchen table for $4,000. That has never amounted to more than about 5% or 10% on what gets closed. And one of the reasons why that might be, has never been a big consequence of where the consumer credit is ebbing and flowing and impacting positive or negative at that kitchen table discussion. It's really been, I think, mostly funded by credit cards and the cash that somebody has. Home equity, I think, has been more of an application of someone as redecorating, refurbishing, adding on, and that's been less of a consequence, too. But I think, in a day, credit cards is what drives the capability of payment, and it kind of goes back to the consumer's confidence and so on. What -- a different tact that's interesting in your question is, we provide 50,000 contractors, basically $300 million of credit, $6,000 a piece. The health of our end customer, we can see every day when we collect from them. The health of their replacement business, we see every 30 days when we send a statement out, that's either past due or not. It's one of those things that makes us feel good going to this year, as we have the lowest bad debt write-offs, the lowest bad debt expense, the healthiest credit that we've have seen in our careers. I mean, under 5 basis points, I think, with bad debt expense in 2012. And these are -- picture in your mind, our customer type paying us $3.5 billion after selling them $3.5 billion. So it's extraordinarily good, credit environment for their customer, which we like. And maybe that tells us some -- that a lot of the test stuff or economy or bad customers or bad credits work itself out. Or it tells us that the end market is pretty healthy right now.

Scott R. Davis - Barclays Capital, Research Division

Well, we go out to the audience now. A slow day of questions today. Right, John?

John F. Kasprzak - BB&T Capital Markets, Research Division

On the quarterly call, you guys talked a little bit about looking at raising the dividend later in the year. I was just wondering, is there any trigger and how that -- the thought process for potentially bringing the dividend back up later this year, deleveraging targets, obviously, subject to M&A, but how that process is going to go?

Barry S. Logan

Sure. And so to place as foundation for your questions is to help others that may not know the story of it. We paid a dividend for 40 years. We paid a rising dividend for the last 12 years. And because of the uncertainty of the tax rates, we decided to pay a special dividend in the fourth quarter of 2012 of $5. So we had a about $70 stock that we're already paying $2.48 dividend on and then paid $5 on top of that in 2012. But then we've just decided to do and did it. We borrowed money. We borrowed $173 million to pay a special dividend. Relatively speaking, that's well under 1 turn of our EBITDA, so we're not leveraging the company to pay a dividend. We borrowed money to pay the dividend. We said, and what we did is we recalibrated the dividend to $1 a share and said we'll pay down debt, keep our balance sheet free to consider large transactions and then raise the dividend the way we have in the past. And so that's what we'll do. Our balance sheet still is -- has under 1.5 turns of EBITDA -- debt to EBITDA, and still very frugal in terms of our mindset for debt. And we've said, by the fourth quarter, we -- by the fourth quarter -- before the end of the year, we would expect to raise the dividend, knowing that we paid down some debt and feel good about the prospects of -- Mike said it the same, how much and how fast and how quickly we retrieve it to where it was. I think it will take some time. It won't happen all at once. But dividend still remains our most important method of giving shareholders a reward for earning the stock, and it will be a material and important part of the philosophy going forward. Other kind of anecdote I'll tell is, there's big numbers, for the fun of it, but it makes the point. We've earned about $1 billion in the last 12 years. We generated about $1.2 billion in cash and we've paid about $700 million in dividends. If you let that sink in for a second, one of our great partners, UT, will be here tomorrow to talk about cash flow exceeding net income. Our ratio's been about 120% for 12 years and return more than half of that through dividends. But we'll do that, we'll raise it. How much and how far and how long it will take, we'll see. But it's still our core philosophy of the company.

Scott R. Davis - Barclays Capital, Research Division

Barry, what have you seen -- have you seen any changes with Daikin buying Goodman. Have you seen any changes in their strategy, whether it be price or whether it be warranty or anything that's notable?

Barry S. Logan

No, we haven't. We are Goodman's largest independent distributor, and we're also a large Daikin distributor for the products they make. I think it's -- we're not going, I think, Barry thinks, it will be stabilizing for pricing in the market. A stable Goodman pricing model is important. They are the value category -- dominant value category in the market, and I think that will be good for the marketplace. What Daikin brings is some innovative products with the chance to distribute them in more locations, including our locations where we distribute Goodman. So I think, we're generally bullish on it. The details, I think, are being -- still being strategized within the Daikan-Goodman management team and leadership, and we have our role to play as their biggest customer. But right now, I think it's stabilizing after having 3 or 4 different owners over the last 8 years. And I really know, in the endgame, that was going to be played. Now the endgame is Daikan-Goodman wants to grow the business very profitably in the U.S. marketplace, and we're a big partner to them.

Scott R. Davis - Barclays Capital, Research Division

Can you -- and I think, Dave [indiscernible] was saying at the Emerson meeting last week is that he thought the variable compressors would come into the market more aggressively in the next couple of years. Do you see that as being real? And I guess the other kind of question around here is the role of mini splits. So I mean, from my perspective, variable, speak compressors and motors and drives and such have been around a while. I guess, the price points have always been pretty high. Why do you think you would think all of a sudden that, that product would start having broader acceptance?

Barry S. Logan

I think, first, the contractor have to install them is getting used to it and more capable of it. And on the commercial market, more engineers and the people that are defining the application or specifying the application are getting used to it. So I think it's like probably like any other building control or something it has is new or different. It's the acceptance rate that's probably equal to the number of people that know what it is and know how to install it. So I think that's accelerating and will, I think, the Dock 3 equation is simply another new product that is sold throughout the world, not so much in the United States, but there's a reason for it. It's energy-efficient, it's quiet, it's quicker, maybe simpler, that's a start, as many contractors that know how to do it yet. So as a distributor, we're helping establish that market, establish those brands, growing very well in those markets, but it's still small. But it's something, I think, that will accelerate.

Scott R. Davis - Barclays Capital, Research Division

What are the main brands you're selling in Dock course?

Barry S. Logan

Our brands today would be Mitsubishi, Daikin, Fujitsu, Gree, which is a Chinese manufacturer, LG. So we have a mixture of brands. I'm leaving some out, not on purpose, for those guys that are listening in...

Scott R. Davis - Barclays Capital, Research Division

Understood. Let's do the next audio -- audience response question, please. In your opinion, what should Watsco do with excess cash? Bolt-on M&A, larger M&A, share repo, dividends, pay down debt, internal investment. Go ahead and vote.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Okay. It's interesting. All right.

Barry S. Logan

I would agree, by the way, with the priorities.

Scott R. Davis - Barclays Capital, Research Division

Yes, I think, we're trying to see some trends today on this data. Let's do the next question then. All right. What should Watsco trade at? This is P multiple on 2013 earnings? Why don't we start voting now?

[Voting]

Scott R. Davis - Barclays Capital, Research Division

Not bad. I think it's higher than last year, Barry. And then, did we have one for last year, guys? No. I'm sorry, I made that up. I thought we did. And then let's do the last question. What do you see as the most significant investment issue for Watsco? Core growth, margins, capital deployment, execution slash strategy? Go right ahead.

[Voting]

Scott R. Davis - Barclays Capital, Research Division

All growth. Okay. That's interesting, huh? Okay, let's open it up then to the audience, and take a couple of more questions from them. All right. Let me bring it back to the gentleman in the third row.

Unknown Analyst

I was just hoping you could expand a little bit on the opportunities on the commercial side of business. I would assume that a lot of this is on the replacement side. Is it light commercial and kind of heavy commercial? Just about your strategy there next over the couple of years in that business, and how big are the opportunities do you see in that business?

Barry S. Logan

Okay. Well today, the commercial air conditioning market is about 15% of what we do, and commercial refrigeration, which is a separate business, is around 6% of what we do. So total commercial, about 20%. And I'd say, refrigeration, when we think Manitowoc, Emerson, compressors used and machines used for cooling and freezing anything. All of the people really know, we're Manitowoc's largest customer for its food service products that it makes. So those markets, really 3 attributes. The first is, someone's CapEx is someone's else's revenue. So to the extent there's commercial building, commercial anything, being infrastructure being expanded in the U.S., that's an opportunity because those are our revenues for those products. I think that's healthier. I think that's better. It's still not, I would say, growing out or outgrowing, in terms of trends, but it's part of what we do. More important in that for us that with Carrier being our partner and being the main source of that opportunity, is when we bought Carrier Enterprise, the line was drawn in terms of what products we had access to, in terms of unitary products and which ones we didn't, which were retained by Carrier for resale. That's been expanding. That line has been moving and expanding more and more products for us to sell throughout the markets where we have Carrier. And that commercial portfolio, if you will, is growing and simply in terms of product availability. And that's accounting for part of our growth. It's also a strategic decision by them to have more locations and an independent distributor format selling those products. If you think about the peers of Carrier, those lines are still somewhat drawn the way they've been drawn for a very long time. So we're competing in a nuanced way, in a different way than what's been done in the past and so far, so good in terms of market share development. We also never sold applied equipment anywhere, not once. And now we have the applied product in -- the Northeast United States and in all of our international markets. And the applied business takes talent and engineers to build a different business model, but we think those markets were lacking energy in terms of growth. There's a lot of energy, hired new people, getting a lot of, again, horsepower behind growing the applied business in our international markets, and it's going extremely well. We're very worried about credit risk in those markets. And 2 things are good. Our government want exports and our government want exports to the U.S. made products. And they're helping that process because those 2 criteria are met. We're -- they're exports and again, they're made in the U.S. So there's some good programs that helps a company like us perform and execute in a marketplace where credit risk is always a concern. So it's something that is going well and building on it. Commercial refrigeration. The partners that I mentioned, Manitowoc and Emerson in particular, big relationships, important relationships, we're getting more territories, having more locations, sell more of their products, and all those products and those brands are exclusive to us where we sell them and it's their strategic decision, I think, to partner more with us, that's seeing some benefit. Our commercial refrigeration business was up 30% in the fourth quarter. The way small business that when it's that type of growth, it's good for the bottom line. The territorial growth for commercial only come through either acquiring more businesses, but right now, we're stuck with the territories we have. But as I said, the expanded product portfolio, the international expansion and then commercial refrigeration emphasis we are pushing has got some growth beyond what the market is doing.

Scott R. Davis - Barclays Capital, Research Division

Barry, are there acquisition opportunities in markets like Brazil or just anywhere, whether it be South America or Latin America, I mean, anywhere other than non of your core Caribbean base now?

Barry S. Logan

Yes. I'm sure there are. And we just haven't tried that hard outside of markets where we're comfortable with either again, credit risk, risk, economic risk, currency risk, and those are all big risks to us that a lot of good large companies come here and live with everyday. We haven't had delivered those risks to grow our company. And so what point do we start to enter that risk, and we just hadn't tried that hard. Our currency risk today is the Canadian dollar, a little bit of Mexican peso, that's it. So we're just not -- we may be curious, but we're not trying that hard right now in some of the, what they call, emerging markets.

Scott R. Davis - Barclays Capital, Research Division

My kind of last question for you, and then we'll see if there's anything from the audience. But is -- this whole concept of pent-up demand, I'm a true believer that pent-up demand is a lousy way to invest. The theme, the concept, now it seems to get pushed to the right, to the right, to the right and in total, the catalysts, right? Sometimes that catalyst can be something as simple as energy efficiency payback and -- or sometimes it can be something tangible like this -- eventually we run out of R-22 gas. What do you think that next catalyst is to get that pent-up demand? All the -- for those folks that are still duct-taping their units every time that they break or -- obviously, it's a confidence issue. But at what point is there a product that has enough of incentive to get the kind of people off the sidelines and get a deal in there that says, look, "don't pay $1,000 upgrading this or putting in a new condensing unit for $2,000, let's do the whole system in."

Barry S. Logan

Well, I think, I -- first, I agree with you on pent-up demand. I think it's a nice cliché that is so abstract, you're not really sure what can play out or what it means. I think, 2 things we know. There are about 80 million machines and they're all going to break. It may -- and there's I'm sure, a pattern of how often they break that's very predictable. And a certain will be replaced and a certain number will be fixed. So if I cut through the question and get to it, it's when things break, what will happen? Well, a big catalyst is coming next year with the 14 SEER mandate in the Sunbelt. People will have to upgrade beyond where they are and then the refrigerant mandate that will also kick in is probably a little more, again, subtle, but maybe more important. And that is that most of those 80 million systems have R-22 refrigerant. The cost and availability of that refrigerant is going to reach some kind of threshold where either the EPA or the government or the contractor or DuPont, someone is going to have to make a decision because the output of R-22 is being cut by legislation. It will be about 10% next year of what it was 5 years ago. The cost is exploding. I think the warranty risk of keeping something going, if you're a contractor, gets exponential. If you keep fixing something, when refrigerant may not be available or is 3x the cost, and at some point, that threshold comes. Now my guess would be that it will start to occur more next year than this year because that's when the drop dead dates start.

Scott R. Davis - Barclays Capital, Research Division

You mean 2014, not 2013?

Barry S. Logan

That's correct. Because 2015 is really when the next big jump in R-22 mandate comes in terms of ratcheting down production. And the contractor, at some point, says that you have to replace it. And that's not pent-up demand. That's not consumer economy. That's the reality of wanting your house to be at 72 degrees.

Scott R. Davis - Barclays Capital, Research Division

Okay. I think that wraps up our time. Thank you, Barry. Thank you, everybody.

Barry S. Logan

Thanks, Scott.

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Source: Watsco Inc. Presents at Barclays Industrial Select Conference, Feb-20-2013 12:30 PM
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