Watsco Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 1, 2023

There are 13 speakers on the call.

Operator

Good morning, and welcome to the Watsco Second Quarter 2023 Earnings Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Albert Nahmad, Chairman and CEO, please go ahead.

Speaker 1

Good morning, everyone. Welcome to our 2nd quarter earnings call. And this is Al Nahmad, Chairman and CEO. And with me is A. J.

Speaker 1

Nahmad, the President Paul Johnston, Barry Logan and Rick Gomez. Now before we start, 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. OPCO delivered a solid quarter against a challenging backdrop.

Speaker 1

It was the 2nd Strongest quarterly performance in our history, which is about 50 years, only surpassed by last year's record breaking 2nd quarter when sales were up 15% and earnings per share was up 33% last year. Our teams executed very well to generate this quarter's results, which came with considerable challenges, including product availability as mentioned in our press release. The product shortages are a consequence of an immense Product transition that is playing out this year following the step up of minimum efficiency standards mandated across the United States. Approximately 60% of the equipment we are selling today represents new or revamped product. Pricing capture and margins consistency have done well as evidenced by our gross margin performance for the quarter the year to date.

Speaker 1

We are converting inventory and balancing our product offerings across our footprint. We have trained thousands of customers on the new products. We have updated our digital library to include All of the new products adding over 400,000 new SKUs since the start of the year. The transition, however, has been uneven. 1 of our primary OEM partners was disproportionately impacted, affecting product availability of higher efficiency systems and therefore affecting our sales.

Speaker 1

We estimated a second sales impact of $75,000,000 to $80,000,000 as much as 125,000,000 for the 6 months period ended June 30. The reality is all of our OEM partners have been affected And all are working to improve supply chain and help us meet the needs of our customers. As we mentioned beyond the tough comps and supply chain issues, the arrival of a hot summer weather was delayed this year As evidenced by the decline in cooling degree days. Cooling degree days is measured by the U. S.

Speaker 1

Government. So we have a lot of information as to The demand for cooling systems during the year. Summer has now arrived and current business conditions are encouraging. Apart from the product transition, which largely affected our residential business, other facets of the business Our commercial business continues to grow strong double digits this quarter And our backlog of projects extends into next year. Sales of ductless systems, an increasingly important component of our business, Also grew double digits during the quarter.

Speaker 1

We saw the continued trend of gas furnaces converting towards heat pumps, which we sell at higher average selling prices. Gross margins held firm this quarter at 28.1, reflecting our disciplined mindset around price and continued progress on our investment in our pricing technology. We also exhibited good SG and A discipline this quarter and we are optimistic about driving more operating efficiencies across our network as we move through the years through the year, I should say. And of course, our balance sheet remains strong with little net debt at the Peak of our seasonality. As always, the financial position provides us flexibility to invest in virtually any opportunity as we continue to grow and scale in a very fragmented $50,000,000,000 plus North American market.

Speaker 1

We continue to look for acquisitions. Watsco is a great home for entrepreneurs in our space. We sustain cultures, invest in people and provide technology to secure and build under great legacies. Looking beyond the short term, our press release provides critical details to support Watsco's long term growth trajectory. We have immense technology advantage and we are investing to grow with that advantage.

Speaker 1

Our mobile platforms And e commerce channels have increased customer engagement, reduced attrition, created market share gains and supported our margin Expansion in recent years. Watsco's broad array of products and brands is a competitive advantage that allows us to serve Contractors in any environment. We have a leading market share position in Sunbelt markets That provides stability and high growth rates over time. In addition, there are several important regulatory and industry catalysts For example, the introduction of higher efficiency standards for HVAC equipment has taken a full effect this year, providing price and sales mix benefits. New refrigerant standards historically has made it harder to repair existing systems and benefits our sales of replacement systems.

Speaker 1

In other words, whenever they change the refrigeration mandates, it makes it very difficult to repair what you've got, so they have they generally go and buy a replacement The phase out of current refrigeration began last year and the launch of new equipment that conforms to the new Refrigerant standards is scheduled in 2025. We also see continued progress toward electrification and Greater adoption of heat pumps, which higher average selling prices. Finally, we expect the Inflation Reduction Act, enhanced tax credit And consumer incentives to help upgrade HPS systems in the years ahead. All of these catalysts will benefit the industry in the coming years. And we certainly believe our scale, technology and financial strength With that, let's go on to questions and answers.

Operator

We will now begin the question and answer session. The first question comes from Ryan Merkel with William Blair. Please go ahead.

Speaker 1

Good morning, Ryan.

Speaker 2

Hey, good morning, everyone. I had a question on sales and then a question on gross margin. So first on sales, you mentioned the weather, Al. Any chance you can share the July growth rate or just give us a sense of the magnitude change in sales from May, June to July?

Speaker 1

Well, I would say that let me answer the first question. In July, we're seeing growth, low single digits, It is expanding and I think it will end up with growth rates in the Q3. And what was the second part of your question?

Speaker 2

Yes. And just in terms of the magnitude of the improvement in July relative to what you saw in May June.

Speaker 1

Over May June or over the same period last year? I gave you the same period last year. We're up low single digits. Paul, have you got that answer?

Speaker 3

Yes. I mean, we're seeing definite growth rates pretty much across the board, Seeing an uptick, which because the weather was so weak in the first half of the year, we're seeing an uptick in repair parts, which is always good for us on a gross profit basis, but really not a big trend Towards replace versus repair or repair versus replace whichever way you're going on this. Both of them we're starting to see some upticks on.

Speaker 2

Okay, got it.

Speaker 4

And Ryan, it's Barry. Your question was how was June versus July, getting grain order in that way? Obviously, June is a huge month within the quarter. So June looked a lot like our 2nd quarter performance. So July is obviously better And that's a good thing.

Speaker 2

Yes, that was what I was getting at. So thanks for that, Barry. On to gross margins, everyone's favorite topic. The long term goal is 27%. You just did 28.1%.

Speaker 2

So just unpack for us why you're 100 basis points above your Target. And then should we think about long term target of 27% to 28%? Are you willing to make that change here today?

Speaker 1

Well, I'm going to raise your expectations. We're shooting for 30%. Now, I'm not going to give you a timetable on it, but We believe we can get there and then eventually beyond that. Who wants to take a shot at his question?

Speaker 4

I'd be happy to. Again, there are 5 or 6 important variables in the current performance that have improved Versus 3 years ago whenever our whenever that question was asked. It was asked 2 or 3 years ago, I feel like. And I think all 5 or 6 variables have been influenced by technology, number 1. We've talked about our pricing platform and And how everything we sell to everyone we sell it to is being touched in some way through a pricing platform and so on.

Speaker 4

The other obvious reality we've talked about is we're selling a lot of new products. We have the opportunity this year To go out and get price margin and support our OEM community with all of their new products And sustained profitability and so far so good. Obviously, too, you have a growth in the replacement market relative to new construction, which And I think the overall mix of everything we're selling in terms of Efficiencies and higher growth rates of heat pumps, for example, helps margin as well. Now I still have an answer to your question though, which is, Where are we on the spectrum of our target and so on. In the short term, I don't think there's anything That is too remarkable to either pressurize or to add to gross profit where we are today.

Speaker 4

What Al is suggesting Longer term is we feel far from satisfied that we're doing all the things we can do to grow margin And to get the full benefit of the technology that we put in place only a couple of years ago. I mean, the pulp pricing discussion we're talking about with technology is only a couple of years old And therefore very far from being mature in terms of benefits.

Speaker 1

Well, that was a long winded answer. Was that a good one? Yes. I like that, Barry.

Speaker 2

Thanks for that, Barry, very helpful. Very clear. I'll pass it on. Thank you.

Operator

The next question comes from Tommy Moll with Stephens Inc.

Speaker 1

Hello, Tommy.

Speaker 5

Good morning, Al. How are you? Good, sir. Thanks for taking my questions. Sure.

Speaker 5

So I wanted to start with a continuation of the pricing theme. We are potentially late in this pricing cycle and I just wonder if you could give any qualitative Commentary on where it feels like we sit today and then to the extent you can give anything quantitative on what the contribution was in the second quarter, That'd be helpful as well. Thank you.

Speaker 1

All right. Who's best to handle that?

Speaker 3

Barry, do you want to take a run at that?

Speaker 4

Sure. I mean, again, it's the same variables that We have to go out and prosecute and execute and price and layering costs through the market given all the changes that have gone. So I think for the quarter, it's about a 9%, 10% benefit to overall average selling price for our residential business, our residential equipment. The 9%, 10% obviously has very little OEM kind of inflation capture. There were some of that, but very, very moderate this quarter.

Speaker 4

Most of it comes from mix or from all the new products that are being layered in And also heat pumps, which obviously have higher average selling price. So in the quarter and it's pretty much the same number for year to date. I think 9 Percent is the overall, call it, average selling price increase for the quarter and the year.

Speaker 5

Thank you, Barry. That's helpful. I also wanted to ask about the disruption you called out with one of your key OEM partners. Any other context you can share there would be good to know. And in particular, can you give us the status today and is this something that we should expect to continue to pressure revenue in the Q3 and the

Speaker 1

rest of the summer? That's a very good question. They're a great company and they're working very hard at it and they're improving. And My guess is that either through the end of this quarter or certainly by the end of Q4, they will be all caught up.

Speaker 5

Thank you. I'll turn it back.

Operator

The next question comes from Dave Manthey from Baird. Please go ahead.

Speaker 1

Hi, good morning everyone.

Speaker 6

Hi, Dave.

Speaker 4

Al, since you put it out there, I'll ask a question on your 30% gross margin Target, just give us broad strokes. I won't ask you time lines, but what mechanisms would you see that would move you in that direction?

Speaker 1

Well, there are lots of opportunity in the non equipment side. We sell a considerable amount of our revenues comes from non equipment That people seem to forget. And secondly, the movement towards heat pumps, by the nature of that creates a higher margin. And that's where the demand is going to expand significantly, motivated by federal government mandates and things like that, plus the value of having heat pumps. And we have other things that our technology is providing ability to compete more effectively.

Speaker 1

So it's internal and it's external forces that I'm hoping to move us to the 30 and eventually beyond. When you have this kind of scale that we do, you should be able to accomplish those kind of things.

Speaker 3

And David, this is Paul Johnson. You also see an awful lot of change happening with regulation over the next Really over the next 5 to 6 years, we've got the refrigeration change that's going to that Al mentions in his opening remarks, which We'll be in effect next year, which is going to reduce the availability of gases by another 30%. We just saw 2 years ago. Now we see another 30, and we see another 30 happening in 2028. So we're going to have a definite squeeze on that as a commodity and also as an ability for us to be able to sell more replacement products, Even from the products that we sell in 2024 2025.

Speaker 3

Then we've got the complete change of product line that we're going to be hitting in 2025, which It's kind of a little bit of a flexibility in the timeline as far as when that's released, But we're going to be seeing that occur. We've also got 2 other things that are hitting us and that is there's going to be An increase in the minimum of efficiency for gas furnace to a minimum of 95%. We feel pretty confident that that's going to occur. And there is a potential of an additional refrigerant change where the government could reduce The global warming potential down from 750 down to 500. So anytime there's a changing market, I think there's an opportunity for an

Speaker 1

Yes, don't take me literally that we have a timetable for 30%. That's an aspiration We feel very confident we'll get there.

Speaker 4

No, that's great color. I actually expected to be shut down on that question, but I appreciate all of the details.

Speaker 7

I'll take

Speaker 2

a lot.

Speaker 1

Well, I went to the resource that I knew would talk the most. He's good. He's good. Absolutely.

Speaker 4

Will, so second is on tech If you're on a run rate of $55,000,000 right now, that's about 2x when you started standing up all these tools and populating your databases and everything else. And Just wondering if you could help us understand what are the key tech spending priorities and buckets that you're dealing with today?

Speaker 1

You mean you want to know who the big spender is?

Speaker 6

Yes. Nice.

Speaker 1

Hi, Mr. President.

Speaker 6

Yes. No, I think we've consistently said with our tech spending that we are going to invest There's an unlimited universe of opportunities to apply technology and innovation and process improvement and smart thinking and Mark people to everything we do. And we've been at it now for 10, 12 years. I think it's had a major impact on the business. And now with the advent of generative AI, there's a whole another world of opportunity and next chapter is just starting to be written And we are knee deep in that opportunity as well now, which is obviously changing very, very fast.

Speaker 6

So maybe an ambiguous answer, but we're going to continue and invest Because we know it's right for the long term health of the business.

Speaker 1

And we might invest more. I think we will. We've been investing more every year. This company is very focused on long term. I know an analyst asked us Last year sometime, when are you going to stop investing?

Speaker 1

And I said, well, we're never going to do that. This is our advantage and we're going to continue to increase our advantage.

Speaker 4

Yes. I was just going to add A layer of thinking to it for your sake, Dave, is I mean, it's roughly, let's say, 300 people, Technology people in that number, in that $55,000,000 number. What's not well understood is that probably 2 thirds of that Headcount is actually sitting in the field with customers. It's not sitting in a corporate ivory tower, geeking out new technology. We have that.

Speaker 4

But a lot of the momentum, a lot of the new investing is helping customers and then growing our customers and then growing new customers At the field level, it really is spreading a local religion, so to speak, in very local markets. So just get the sense that it's not just Invention and development, that's going on for sure. But it's also this ground game That is truly at the ground level in our markets.

Speaker 6

And it's worth saying again that Our customers that use our technology are better customers. Their growth rates with us are higher, their attrition rates are lower, Our cost of service is lower. So the more customers we get using the technology more often, the better it is for the company as well as well for the customers, By the way, they are more efficient and profitable as a result of using the technology.

Speaker 4

Yes. Well, thanks again everyone.

Speaker 1

You bet.

Operator

The next question comes from Josh Pokrzywinski with Morgan Stanley. Please go ahead.

Speaker 1

Hey, Josh. Are you liking us better recently?

Speaker 7

You guys have done all right, Ali. I'll give you that.

Speaker 1

Thank you. Thank you.

Speaker 7

Couple of questions here, maybe one just kind of sticking to the quarter itself. Barry, I know you gave some good color last Quarter about maybe some of the moving items in gross margin basically, the selling initiatives maybe versus kind of The inventory or inflation margin phenomenon, I know that there was an extra wrinkle in 2Q with the timing of price increases. Anything that you could give us as bridge items

Speaker 4

In general, the selling margin, which is the purest form of price versus cost It increased in the quarter. So that's a high quality important component of gross profit because it is the largest component Sure, to the performance. So, and that's without considering any benefit from, some of the pricing actions That came in, in the quarter. So just pure quarter over quarter, year over year quality of margin improved. Some of the below the line items, I would say, were fairly flat.

Speaker 4

And something like freight in, where we pay our vendors to deliver Certain things to us that still doesn't have some of the savings that we would like to have, again, because we're going through this pretty enormous Transition of inventory. But nothing too remarkable, Josh, one way or the other. I think what is remarkable is the selling margin, Which is simply again, simply price and cost being prosecuted in the market was positive without any Considering a benefit of pricing actions.

Speaker 7

Got it. That's helpful. And then maybe just shifting over more philosophically on heat pumps. I think with all the stimulus out there, I guess, IRA specifically, I know that these things carry a higher price point anyway, But do you guys get the sense that the OEMs or maybe the industry at large sort of disproportionately raises the price So, if he comes out there to start to capture some of that versus letting it all flow to the consumer, I'm just trying to think through sort of what are the pricing strategy you guys

Speaker 3

IRA, we finally got some clarity around IRA that the Tax credits, the IRS has finally published a list of what pieces of equipment by model and SKU are available That will get the tax credit. So that just occurred this week. And of course, because of our technology, we were able to get that out And our dealer apps to a couple of 100000 people quickly. So we really haven't felt the benefit of that. There's historically been a spread between a heat pump and a straight cool.

Speaker 3

There are different components, different electronics involved. And so I don't think there's any real uptick that's going to occur where you're going to see heat pump margins Going up because of the IRA proposition that we've got on the table right now. So I don't think the 2 are related right now because there really hasn't been any impact at all on sales from IRA. And we finally got the word out that the states now have the recommendation from the DOE And how to manage their rebate programs for mid and low income people. And so we're not going to see any of that probably until end of Q1, Beginning of Q2 next year perhaps.

Speaker 7

Got it. Appreciate it, Paul. All right.

Operator

Okay. The next question comes from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Speaker 1

Good morning, Jeff.

Speaker 8

Hey, guys. Good morning. This is Mitch Moore on for Jeff. I just had a quick question. How much inventory do you guys Want or need to take out in the second half?

Speaker 8

I think you said you'd address inventory levels once you had a better handle on the selling season?

Speaker 1

Who wants to take a shot? I'll say that my sense of it is we can We're capable of taking out another $200,000,000 when things settle down. And that'll be helpful in terms of inventory turns and in terms of cash flow.

Speaker 3

I would agree that's a fair assessment.

Speaker 8

Okay, great. And then just one more. On the SG and A line, what can you guys do to Tempur decrementals if we continue to see volume declines in the second half.

Speaker 4

I mean, I can answer it if you like, Alan.

Speaker 1

Sure.

Speaker 4

Yes. I mean, first, what helps In that equation to be conservative if you're asking, let's be conservative on the top line, what happens below the top line? That's your question. So SG and A becomes a focused item obviously. SG and A went down this quarter and the second If I look inside that number, variable costs are down in the teens, Somewhere between 15% 20% are variable costs that we've been expecting to reflect Kind of the change in the top line is occurring and fixed costs were up 4% in the quarter, for example, which is still a measure of inflation And also does not fully yet benefit from some of the productivity things that we have our teams focused on.

Speaker 4

So I don't I'm not going to predict precisely where SG and A heads, but it's obvious that it was better in the second quarter than 1st in terms of trend and we'll see how the rest of the year plays out, but there is an immense amount of effort and challenge And data and technology looking at SG and A for the rest of the year and in terms of how we can reduce it further. That would help the decremental equation. And if there's any level of growth, it certainly helps the earnings growth rate.

Speaker 8

All right, guys. Thanks for taking my questions.

Operator

The next question comes from Brett Linzey with Mizuho. Please go ahead.

Speaker 1

Good morning, Brad, and welcome to the question. Hey, good morning.

Speaker 9

Just wanted to come back to the refrigerant changeover beginning in 2025. Clearly, the regional And created some impediments for Watsco with the OE issue. How does that change or maybe inform the way you think about pre buy next year Ahead of the 2025 changeover as you look to maybe secure more inventory?

Speaker 1

That's a good question from Paul. He follows.

Speaker 3

Yes, I don't We've been out, we discussed this with all of our OEMs. We're not looking at a pre buy. I don't think anybody is right now looking at pre buy On 410A, as I indicated earlier, there's already been a 30% reduction in the GWP allocation For next year, which means we're going to be at 60% what was allocated in 2011. And there's going to be Further one in 2028. So we're going to be down to basically 30%.

Speaker 3

So Offering a unit and doing a pre buy on a unit where the refrigerant is going to be in short supply or very, very expensive, I don't think it would be a prudent business opportunity for anybody.

Speaker 9

Okay, got it. And then just Shifting to the consumer backdrop, clearly, mix. I was wondering if there's anything you can glean from credit metrics across the organization or Anything specific to the complexion of parts growth versus equipment that might suggest you're seeing some repair versus replacement trade down?

Speaker 3

Yes. We there's 2 primary components that we look at, when we look at what the repair versus replace is doing and It's motors and compressors. And what's happening with motors and compressors is we're seeing we are we finally are seeing in the month of July, We're finally seeing an uptick, which we didn't see in the first half of the year. And so as we see a growth in that, that would indicate that there would be More repair happening. We also monitor any sort of warranty claims back to the OEMs that we make to make sure that, 1, they're in line with the marketplace, but also as an indicator whether or not the units are requiring repair While they're under warranty.

Speaker 3

To date, as I indicated earlier, yes, we are seeing An increase in the repair business in July, but it's Not a major trend, I don't think yet. It's only been all I've got is 3 weeks of information. But at this point, I wouldn't say it's a major trend. But certainly it's there and it's positive and I'm happy about it.

Speaker 9

Okay, great. Appreciate the color.

Operator

The next question comes from Steve Tusa with JPMorgan. Please go ahead.

Speaker 10

My first question is who had the I know Barry doesn't sing. Maybe it was Paul. I don't know. I don't know. Well, there are obviously reasons to sing with those gross margins, so congrats on continued execution there.

Speaker 10

I just wanted to levels at kind of the July commentary. So you said you're up low single digits, maybe a little bit more from a, like components and repair related product perspective. What was what's kind of like the equipment unit? Would that be down high singles equipment unit volume in July?

Speaker 3

Paul? Yes, I would say it is. Yes, Barry, I want you to take that.

Speaker 8

Yes. I

Speaker 4

think first, I think when we talk about growth, we're talking about the whole business, Steve. And Our part sales are not consequential enough to matter in that equation. They're up, yes, not consequential in the overall growth. Consequential is the continuance of price that we see average higher selling prices, Probably a single digit decline in units if I use common sense, and that's about it. I think And we're up against again 15% comps of a year ago.

Speaker 4

So if we're still not We're still up as we've said many times now, we're still up against blockbuster stuff of a year ago. And so for July, it's going to have some growth. It's good.

Speaker 10

Yes. And then I just want to I'm having trouble reconciling something. I mean, you guys had a tough time with supply, but your inventories are up significantly. Can you help kind of reconcile those two dynamics?

Speaker 1

An accounting question, good for you, Mr. Logan.

Speaker 11

I think it's a little

Speaker 10

more basic than accounting. I don't know. You tell me.

Speaker 4

I'm trying to prove I'm not just an accountant anymore after 30 years.

Speaker 1

So you're everything, Barry.

Speaker 4

So Steve, the irony of the question If you look at if you took our data, look through it and said, and I'm going to pick the whole universe of equipment, which is indoor units, outdoor units, ductless, ducted, Did coils, furnaces, everything that might be called a unit, the irony is the units are down, this June versus A year ago, single digits. So your question is why is inventory higher, right? Well, first, the cost is higher. The mix is higher. The mix is richer.

Speaker 4

And so part of the reality is We own inventory this year that is new. We can't say that enough or obviously clearly enough. Imagine any retailer, any business that emptied out 60% of its products over the last 6 months And are carrying new products that are roughly 10%, 12% more in cost. And every customer, every price list, every bit of technology, Everything had to be updated in the last 6 months to accommodate that. So it's the noisiest, most difficult analytically Reality time to ever measure anything in this industry, I think.

Speaker 4

And if I cut through the craft and kind of just give you a simple answer, Units are down in our inventory and it's the cost that's up.

Speaker 10

Got it. And then one last one for you just on this Kind of product transition dynamic, as they come back and supply Do you will you shift back to them as kind of as they can ship? And my guess is you Took on more of somebody else's to make up for that, this past quarter?

Speaker 4

Yes. I would say we use the term balance and it's not what that means is every store having matching systems That fits the need of any customer who calls or emails or e commerce is an order. The balance is having the right mix of everything, The right matching systems of everything. And that's been the trickiest part is the OEMs needing to manufacture matching systems in a very rich mix of new products that meets local need of every customer in a local store. And so that's the challenge.

Speaker 4

And that balance is not as what It's not fully balanced at this point in all the stores because of all the transitions that have gone on. So Paul, that's my abstract Random thought answer, right? You're very close to this too. Maybe you have some thoughts on that. Yes.

Speaker 4

I want to make

Speaker 3

sure I totally understand your question. Your question was, are we going Move back to that OEM. Yes, of course, we are. We're going to support them in every way we can and we're going to claw back any Sales loss that we had and any share loss that we had. And the collaboration that we have with that OEM is such that it's going to be a joint effort to be able to Get that back.

Speaker 3

So, yes, things happen. And when they happen, good partners stand together and work together.

Speaker 10

Yes. Sorry, one last quick one for you. You mentioned that inventories are down, but obviously your sell through unit wise is also on probably a bit more meaningfully than I think we would have expected. If somebody were to come out and say like In industry residential HVAC unit inventories are in balance or that we've already seen a destock and that's over. It doesn't sound like that's the case with you guys saying you want to reduce your inventory by another $200,000,000 I mean, it seems like there's a way to go here from that perspective.

Speaker 3

Yes, there still is some destock left to be performed. As Barry indicated, we have some You have some mismatch where you're going to have the outdoor units and not the indoor units to put the system together. The coil will be there, but Not the air handler. So there is some destock as far as getting the proper match of inventory on hand and sold through. And we're still seeing a lot of great backlog on the commercial side, which we indicated in the opening comments, We're still as hot as can be and we have a nice backlog of those We have an inventory, some of those, but they're awaiting jobs to be completed to be moved into.

Speaker 3

So I think there's some destocking that could be happening and just some management that we're going to have to take on ourselves in order to reduce the inventory by 200,000,000

Speaker 10

Great. All right. Thanks guys. Thanks for all the time.

Speaker 1

Bye, Steve.

Operator

The next question comes from Joe Elesmeyer with Deutsche Bank. Please go ahead.

Speaker 1

Good morning, Joe.

Speaker 11

Hey, morning, everybody. Just want to follow-up on that prior comment and the comments in the prepared remarks about commercial. You mentioned the double digit growth in backlogs into next year. Is there could you give us a sense of whether those backlogs are coming down at this point? Are Your current sales sort of greater than what you're adding to those backlogs?

Speaker 1

Good question. Paul, you got the data.

Speaker 3

I think it varies based upon Commercial is a very broad subject. Talking about commercial applied where it's made to order for the job, I think we've still seen those Backlogs continue to increase. When you get into commercial rooftop units, I think we've got a stabilization there. Its supply is equaling demand right now. So I don't see that growing much further than where we are today.

Speaker 3

So it's kind of a mixed bag when you look at all the components and go into commercial.

Speaker 11

Okay, understood. And another couple just fact based questions here. What Percentage of the commercial business would you say is driven by repair and upgrade versus new construction? I think in the past you said You're a bit less interested in the new construction because of the price and margin dynamics. And then on the resi side, just Any number you might have in mind around how big heat pumps could be as a percentage of your overall equipment business today?

Speaker 3

And I would say, once again, you've got a mixed bag when you talk about commercial, when you're talking about the applied business, it generally is new construction that we're into because Those are made to order for a specific building. When you're talking rooftops, our game is historically and Continues to be on the replacement side.

Speaker 11

And then heat pumps?

Speaker 3

And heat pumps continue to grow as a percent of our total business. I think You can get that information on the AHRI website. You'll see that Heat pumps now have exceeded in 2022, they exceeded the gas furnace sales. And now they've moved up to roughly what 40% of the total market. Watsco would be heavier on the heat pumps than most people because of our geography that we're heavy in.

Speaker 3

And so you're going to find more heat pump activity, Obviously, south of the Mason Dixon line, many well north. However, that will change as the technology, the heat

Speaker 11

All right. Thanks a lot for all the detail. Good luck everybody.

Speaker 6

Thank you.

Operator

The next question It comes from Damian Karas from UBS. Please go ahead.

Speaker 8

Hello. Damian? Hi, good morning, everyone. Good morning.

Speaker 12

So I appreciate the details you gave around price and mix benefits. Just curious if you happen to be seeing any signs that Your competitors might be getting more competitive on price as inventories are being worked down. Would you say that that pricing mix uplift You're seeing pretty consistent out there in the market.

Speaker 3

I would say it's been fairly consistent. We haven't really seen any breaks. Obviously, if you listen to the salesman, you know all the prices are going down. But if you really look at the reality of it, The marketplace is fairly disciplined and we have not really seen a decline in the equipment pricing.

Speaker 12

Understood. Appreciate that. And then a follow-up question on the refrigerants change. I You're effectively going to have multiple refrigerants competing. I think that's a little bit different than past cycles.

Speaker 12

And I believe you do work with OEMs that are on both sides of that. So I'm just curious how you see that Dual refrigerant dynamic playing out and what it means for Watsco? Thanks.

Speaker 4

Well, we have one of

Speaker 3

our companies that sells Their OEM is going to go with the 32A and then we have the rest of our companies where they're going with the 454P. So It's very discrete and divided amongst our companies. So we have one company that will be carrying Two flavors, 410 and 32A 410 for repair and 32A for the new equipment. And the rest of our companies will be carrying 455 and 410. So I don't see a big I I don't see a big deal there.

Speaker 12

Understood. Appreciate your thoughts. Thanks a lot.

Operator

I would like to turn the conference back over to Albert Nahmad for any closing remarks.

Speaker 1

Thanks again for your interest in our company. We appreciate it very much and we look forward to speaking to you the next quarter. However, if any of you want to come visit and learn more about Technology, the innovations that we're doing, feel free. We will, happy to present you the information that Would be helpful to you. So thanks for listening and see you the next time.

Operator

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

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Earnings Conference Call
Watsco Q2 2023
00:00 / 00:00