Watsco Q3 2024 Earnings Report

Watsco EPS Results

• Actual EPS: $4.22
• Consensus EPS: $4.73
• Beat/Miss: Missed by -$0.51
• One Year Ago EPS: $4.35

Watsco Revenue Results

• Actual Revenue: $2.16 billion
• Expected Revenue: $2.24 billion
• Beat/Miss: Missed by -$83.93 million
• YoY Revenue Growth: +1.60%

Watsco Announcement Details

• Quarter: Q3 2024
• Date: 10/23/2024
• Time: Before Market Opens
• Conference Call Date: Wednesday, October 23, 2024
• Conference Call Time: 10:00AM ET

Watsco (NYSE:WSO) is a distributor of heating, ventilation, air conditioning and refrigeration (HVAC/R) equipment and related products. The company supplies residential and commercial contractors with air conditioners, furnaces, heat pumps, refrigeration systems, ductwork, thermostats, controls, tools, replacement parts and other installation supplies.

Through its distribution network and digital sales platforms, Watsco serves HVAC/R contractors, dealers and other customers primarily across the United States, as well as in Canada and Puerto Rico. The company distributes products from leading manufacturers, including equipment associated with the Carrier, Bryant and Payne brands, along with a broad range of complementary products from other suppliers.

Founded in 1956 and headquartered in Coconut Grove, Florida, Watsco has expanded through organic growth and acquisitions to become one of the largest HVAC/R distributors in North America. Albert H. Nahmad serves as the company’s chairman and chief executive officer.

Watsco Q3 2024 Earnings Call Transcript

Key Takeaways

• Record performance: Watsco delivered record Q3 sales and net income, and October sales rose mid-single digits with meaningful unit growth, indicating market share gains.
• Digital sales strength: Annualized e-commerce sales topped $2.5 billion, and the OnCallAir platform drove a 17% increase in contractor quotes and 22% growth to $1.2 billion in generated sales.
• OEM co-investment: The company is collaborating and co-investing with a major HVAC equipment supplier to recover disrupted volume and expand its customer base.
• A2L transition opportunity: Preparing for the 2025 federal A2L refrigerant mandate, Watsco expects 8–10% price upgrades and sees regulatory changes driving higher-priced system sales.
• Inventory challenges: Despite record cash flow and a debt-free balance sheet, management highlighted below-target inventory turns and ongoing efforts to optimize stock levels.

Presentation

[Operator]

Good day, and welcome to the Watsco Q3 2024 Conference Call. Please note that today's event is being recorded, and all participants will be in a listen-only mode. Should you need any assistance on today's call, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. If you'd like to ask a question, you may press star, then one on your telephone keypad, and to withdraw a question, please press star, then two. Also, please be aware that today's call is being recorded. I would now like to turn the call over to Albert Nahmad, CEO of Watsco. Please go ahead, sir.

[Albert Nahmad, Chairman and CEO at Watsco]

Good morning. Welcome to our third quarter earnings call, and this is Albert Nahmad, Chairman and CEO. And with me is A.J. Nahmad, President, Paul Johnston, Barry Logan, and Rick Gomez. Before we start, our usual 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.

[Albert Nahmad, Chairman and CEO at Watsco]

Watsco produced record sales and net income for the quarter. Our markets have shown signs of stability, and the Q4 is off to a good start, with October sales up mid-single digits, driven by meaningful unit growth. Let me say that again. October sales are up mid-single digits and driven by meaningful unit growth. We also believe we have gained share based on industry data and shipment trends.

[Albert Nahmad, Chairman and CEO at Watsco]

We have also generated record cash flow this year, and our balance sheet remains in pristine condition to enable investments in growth. As communicated in our press release, we are in recovery mode with one of our primary OEMs, a fairly large supplier of equipment to us. We are collaborating with them and co-investing to make the needed investments to regain business and add new customers. Moving on. We continue to make investments in the industry's most innovative technology platforms for HVAC contractors. Greater adoption and use of our platforms by a growing number of contractors has helped produce market share gains. Annualized e-commerce sales now exceed $2.5 billion, and our active users continue to grow faster than non-users. OnCall Air, Watsco, which is Watsco's digital sales platform, continued to expand and generate growth for our contractor customers.

[Albert Nahmad, Chairman and CEO at Watsco]

Thus far in 2024, OnCall Air contractors presented quotes to approximately 258,000 households, a 17% increase, and generated $1.2 billion of sales for our contractors. That's a 22% increase over last year. We are also leveraging our technology platforms to optimize the launch of the new federally mandated A2L systems beginning in 2025. Historically, regulatory changes have been good for our industry and good to our business. In 2023, energy efficiency mandates went into effect, providing contractors the ability to upgrade older systems with higher efficiency systems. The trend to electrification of fossil fuel heating has driven increased sales of heat pump systems, which are both sold at higher average unit prices than conventional alternative systems.

[Albert Nahmad, Chairman and CEO at Watsco]

The growing penetration of ductless HVAC systems has also been a catalyst for growth, as they provide homeowners and businesses a more energy-efficient alternative to conventional systems. And now, the A2L transition is upon us, and we look forward to the opportunity. Turning to our balance sheet. We have a strong cash position, no debt to support, and that supports most of our investment we choose to make. Although we have produced record cash flow this year, we are still not satisfied with our inventory turns. We are working with our OEM community and continuously improving our methodology to improve our inventory turns. We have also made progress in improving operating efficiency across our network, as evidenced by the modest change in SG&A year over year. But there is more to do. In summary, we operate in a great industry and in attractive geographical markets.

[Albert Nahmad, Chairman and CEO at Watsco]

We have a proven entrepreneurial culture that empowers local leaders. We possess the industry's most innovative technology platforms for HVAC contractors. We have leading scale and product diversity, particularly in high-growth market. And finally, our balance sheet and access to capital enables future investments in a highly fragmented industry. As always, if you have an interest in learning more, please visit Miami and see us. We are transforming an industry, and we enjoy telling you about it. With that, let's now go on to Q&A.

[Operator]

We will now begin the question and answer session. To ask a question, you may press Star, then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. And to withdraw a question, you may press Star, then Two. At this time, we will take our first question, which will come from David Manthey with Baird. Please go ahead.

[Albert Nahmad, Chairman and CEO at Watsco]

Morning, Dave.

[David Manthey, Senior Research Analyst at Baird]

Hey, Al. Good morning, everyone. First question I have to ask is about the hurricanes, particularly Helene, which hit us pretty hard here in Tampa. Could you talk about the negatives and potential unwinding positives you might see from Helene and/or Milton?

[Albert Nahmad, Chairman and CEO at Watsco]

Let's see if we can get one of us to tell you at least what he thinks. You want to take that, Paul?

[Paul Johnston, EVP at Watsco]

Sure, I can get it started, and then somebody else can pick up. But, yeah, we had our branches shut down for a couple days for Helene, and then we also had them shut down for another couple of days with Milton. Most everything is back to normal now, and obviously, we're seeing you know, an initial rush, at least of repair components that are going out the door in October. Milton came through so quickly, it really didn't impact us as severely as the other storm. However, when you get up into the North Carolina, Georgia area, a lot more severe damage was done, and we've yeah, it slowed us down, but it didn't really impact our sales that dramatically. More or less-

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

Yeah, just to add to that, I've said for many years, growing up in Florida and being in Watsco for 32 years, that hurricanes typically disrupt local markets and may not have an impact on the whole market, and the reverse is true. If there's business opportunity, it's good for those markets and not necessarily material for the national scale. I think the most obvious question and thought is that, you know, when they talk about $10 billion, $20 billion, $30 billion of insurance investment that follows these things, a portion of that always is our industry, be it equipment or non-equipment, but its materiality needs to play out sometime this year or next year, obviously, but that's how I've characterized it, at least over time.

[David Manthey, Senior Research Analyst at Baird]

Okay.

[David Manthey, Senior Research Analyst at Baird]

So, but even though Florida is clearly your biggest market, and Helene, in particular, ripped up the whole coast, you're saying it's fairly immaterial, and we shouldn't view the mid-single digit growth in October as just a temporary snapback from storm activity, is what you're saying?

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

Absolutely not. No.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

Yeah.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

Nothing is that material relative to Helene, and either a disruption in the last week of the quarter or to a benefit for the first, you know, part of October.

[Albert Nahmad, Chairman and CEO at Watsco]

As Barry indicated, you know, when the insurance is gonna kick in within the next, let's say, 30-90 days. So we really don't see equipment sold. What we see is the motors sold, the compressors, that type of thing, to start with.

[David Manthey, Senior Research Analyst at Baird]

Got it. Okay, thanks.

[Albert Nahmad, Chairman and CEO at Watsco]

Not material to Watsco.

[David Manthey, Senior Research Analyst at Baird]

Great. Yeah. Yeah, thanks for that. And then on the gross margin came in a little bit light. I know you had a reason for that here, that you discussed with your one of your major OEMs. But just medium term, you still feel good about 27%?

[Albert Nahmad, Chairman and CEO at Watsco]

Well, again?

[A.J. Nahmad, President at Watsco]

This is A.J.

[A.J. Nahmad, President at Watsco]

Sorry.

[A.J. Nahmad, President at Watsco]

I'll jump in. The answer is yes, in the short term, and the ambition is much higher than that. I think we've talked about publicly, one day we'd like to achieve 30%. So our engines are revved up, and we very much have a focus on gross margin, and we're investing there and have high expectations.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

Yeah, I think in the analysis, Dave, you know, there's obviously the magic words are price and mix, and price overall was pretty consistent this quarter, so that's not really a discussion item. Mix is where the variations are so far this year and for this quarter. And the word mix is a broad term, really. There's customer mix, there's geographic mix, there's product mix, there's end-market mix, there's brand mix. So a little bit of weight in those factors, if I spent 20 min explaining to you what I just said, a little bit of weight on margin this quarter, but those are short-term conversations.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

I think if you consider the A2L transition in front of us, if I look forward, it's really an opportunity to basically reprice and go to market with what will essentially be 60% new products over the next 12 months. So our OEMs who listen to this call, along with all of you, you know, this is a very critical stage to where we're making tremendous investments. Inventory is going to completely cycle a year from you know, over the next twelve months and pricing, marketing, features and benefits, mix, overall mix, you know, is gonna be critical over the next twelve months to drive margin.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

I think one of the messages we tried to convey in the press release, and I'll convey now, is, and somebody will ask this question, is where are we on in terms of unit volumes and stability and things like that? You know, year to date, unit volumes are positive, and the quarter to date, you know, they're overall positive. For our selling season, overall positive. Positive to the extent that it's kind of conventional growth rates in units. If I look at, you know, a longer term average. So if I try to consider stability as well as the opportunity in front of us, you know, that's where we have some optimism in what we're doing.

[David Manthey, Senior Research Analyst at Baird]

Great. Thanks, Barry. Appreciate it all. Thank you.

[Operator]

Our next question will come from Tommy Moll with Stephens. Please go ahead.

[Tommy Moll, Equity Research Analyst at Stephens]

Good morning.

[Albert Nahmad, Chairman and CEO at Watsco]

Good morning, Tommy.

[Tommy Moll, Equity Research Analyst at Stephens]

Yes, sir, and thank you for taking my questions. I wanted to start on some of the co-investment you described in the press release this morning, alongside one of your OEM partners. And it's a two-part question here. First part is, where you did call it out this morning with substantial detail. Did something change since last quarter that prompted the enhanced discussion on this item? And then as you look forward, is there anything you can do to calibrate our expectations about how this ought to progress and ultimately fade? Thank you.

[Albert Nahmad, Chairman and CEO at Watsco]

Terrific question. Who wants to answer? Paul, Barry, A.J.? Rick, too. Rick.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

Didn't mean to leave you out, Rick. Yeah, I think. I mean, I'll go first and just add to it 'cause it's an important point, and in our collaborative spirit, you'll get insight into how we look at these discussions internally. I wouldn't say anything critically changed in the third quarter as an isolated event. We felt it. It's needed to kind of reconcile where we are year to date. A year ago, we talked about disruptions and, you know, whatever the range of revenue was, $150-$200 million of revenue at the time. You have to go back and look at the disclosures.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

But a year later, the idea of recovering that business, you know, growing volume, growing market share, reestablishing market share, these are markets like Florida, Texas, California, that are huge markets, Carolinas as well. And there is a collaboration, there is a co-investment, we use that term intentionally in the press release, where we work with our OEM partner and try to figure this out, and this is the scorecard year to date. Business and unit growth has outpaced overall growth rates for sure, for that particular product group. It better. And when we talk about pricing, there's more to it than just the price on the product. There's, again, the mix of those products. And I'm not going to give too much competitive detail in this discussion in answering you.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

And the other is incentives that we chose to put on the street to not just get somebody back buying more from us, but getting new customers at the same time. In other words, play offense with this opportunity, and that is a shared cost and a shared experience with our OEM. But we thought it was important to go ahead and kind of reconcile that scorecard year to date, and that's what we've done. Now, as far as-

[Tommy Moll, Equity Research Analyst at Stephens]

Yeah

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

... as far as lingering impact, which is the second part of your question, there's some lingering impact, needless to say, in the Q4. And that dissipates, I would believe, more so next year, when, again, all the new A2L products will come in, and we are kind of truly working on today, a complete set of economics for those new products with all of our OEMs. And, you know, it's a chance to kind of recalibrate those economics looking forward.

[A.J. Nahmad, President at Watsco]

Yeah, I'll just stress that our OEM partner here is truly a partner. They're a long time relationship. I think it's a successful partnership now, it has been, it will be. This is absolutely a collaboration with them, and it's nice to have such a wonderful partner.

[Tommy Moll, Equity Research Analyst at Stephens]

Anyone else before we move on here?

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

No.

[Tommy Moll, Equity Research Analyst at Stephens]

All right. I'd also wanted to ask about inventory and any pre-buy dynamics we may be seeing. Al, you talked about hoping to improve inventory turns, and I did note the inventory dollars were up versus the second quarter, which is atypical, but is some of that just the 410A pre-buy that we're seeing, and what's the view there at this point?

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

Yeah, it is.

[Tommy Moll, Equity Research Analyst at Stephens]

Yep. Go ahead.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

Yeah, it is. It is the inventory pre-buy on the 410 as each one of the OEMs has come up with a program to at least fill in for the 410 that they have to be able to manufacture and be completed by the end of the year. And so some of them have asked if they could move the inventory quickly into our inventory so that we can be ready for at least the first quarter, you know, selling the 410A. That should taper down. At the same time that's tapering down, we're gonna be bringing in the A2L inventory. So I don't see much of a fluctuation in the next quarter with our inventory.

[Rick Gomez, VP at Watsco]

Yeah, Tommy, I would just add to that that, you know, when we-- most OEMs have had their last call, and those products are starting to get received. And so I think as you look forward to Paul's point about, you know, the next quarter or two, the seasonality around inventory probably looks different over the next quarter or two as we go through this transition. And then it probably picks up its normal seasonal cadence sometime middle of next year, once 410A diminishes as a percentage of shipments and sell through really, and A2L becomes just a greater proportion of sales and our balance sheet as well.

[Tommy Moll, Equity Research Analyst at Stephens]

Makes sense, and I appreciate the insight. Thanks, all.

[Operator]

Our next question will come from Ryan Merkel with William Blair. Please go ahead.

[Albert Nahmad, Chairman and CEO at Watsco]

Good morning.

[Ryan Merkel, Analyst at William Blair]

Hey, everyone. Good morning. Just wanted to ask on October to start. You said meaningful unit growth improvement and then mid-single-digit growth. Can you just clarify, you know, what pricing is? 'Cause my assumption was pricing is still kind of running up maybe three, four. So how do we bridge to mid-single digits if volumes are popping back positive?

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

Yeah, I'll cover that. So let's be careful. I'll give it to you in a spoon-fed way, because this is like critical data. I'm not gonna comment as much on specifics for October other than to say what we've said, which is it's, you know, meaningful unit growth. But let's just be analytical about it, and we can talk the business side of it. So for the quarter, overall units were up 4%, and that includes both ducted products, which actually declined 1%, and ductless products, which were up double digits. So this, it's a year-to-date trend. It's a, probably, an 18-month trend, where our investments in ductless are paying off very well.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

You know, Mitsubishi and Gree and Carrier's brands and other brands that we sell in ductless have been doing very well, both domestic and international. So there's a bit of a story inside of that number. That's our investment, our business unit's doing well with ductless products. But if I stick to what is more curious maybe for the group is the ducted product. We're interested in all of it, but the ducted product volumes were down 1%, and price was down 1% in ducted products. And again, that has nothing to do with deflation or average selling prices in terms of you know, price risk. That is mix.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

That's what I'm alluding to earlier in the call, where if I look at brand mix, customer mix, and market mix, there's a little bit of a weight in price this quarter. For the year, for year to date, units are up 5%, and unitary pricing is up 1%. Ductless pricing is up 1%. And, yeah, that's kind of like makes sense to me because the OEMs launched pricing earlier in the year. I think they've all kind of said about the same thing about it. And, you know, this is a year where price has not contributed really anything to the equation. And honestly, I'm quite glad our gross margins kind of look the way they look in the absence of any price. And, we know that's gonna change.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

We know that's gonna evolve from here, and I welcome anybody else's color.

[Ryan Merkel, Analyst at William Blair]

Okay. Well, yeah, that, that's helpful. That explains it then. And then just back to gross margins. Can we bridge Q3 back to 27%? It sounds like, you know, parts and supplies were down, so there's a mix element that's occurring, and then you also... You didn't quantify for the quarter, but this co-investment. So just, can we get back to 27%, or what are the pieces?

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

Go ahead, Rick.

[Rick Gomez, VP at Watsco]

Yeah, Ryan, I think you heard A.J. say the answer is yes, and I think, you know, there's an upward bias to that over time. But let me try and start with, I think, the most important layer of margin, which we haven't talked about, and has been consistent, is our transactional margin, our invoice margin, which is the most basic form of margin that any distributor can have before you get to mix. And to Barry's point earlier, that transactional margin is constant versus last year, in a year where there's been relatively no contribution to price, at all in our gross margin.

[Rick Gomez, VP at Watsco]

That is a testament to some of the pricing technology that's been deployed, and it's a testament to the work that our field leaders are doing on this subject. So then, you know, so what do we bridge if transactional margin is constant, and consistent with last year? And it's those four basic elements of mix that we've talked about. It's firstly, a difference in growth rates between equipment and non-equipment that will always weigh on your overall margin to some extent. Secondly, within equipment, it is a difference in growth rates between residential and commercial. Residential has been in that, you know, low single, mid-single digit type environment, and commercial has been higher.

[Rick Gomez, VP at Watsco]

We like that because we have, you know, profit dollars to account for that higher growth rate, but it does weigh and influence your overall mix. Thirdly, and particularly in the third quarter, you know, in a seasonal period, you tend to have a little bit more residential new construction than you have add-on replacement, right? It's a time where the builder channel gets a lot of things done, and that tends to weigh a little bit, and it has been true that for the last year or two, the residential new construction end market has been outpacing add-on replacement. You can look at the housing completion data to tell you that, and then lastly, is this element of customer mix, which is, you know, the hardest one to untangle in some ways.

[Rick Gomez, VP at Watsco]

But if you just simply, you know, segment your customer base, you do see differences in growth rates. And what we see in our data is that that larger, more progressive, more tech-enabled customer is growing faster than than his or her counterpart that is smaller and less sophisticated. So not to, you know, write a whole paragraph about it, but those are the three or four elements of mix that explain and help, you know, contextualize a year-to-date margin profile that looks different. I go back to where I started, which is the key point in all of this, is that transactional margin, same customer, same product, is very consistent with last year.

[Ryan Merkel, Analyst at William Blair]

That's a great answer, Rick. Thanks for that. I'll pass it on.

[Operator]

Our next question will come from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

[Albert Nahmad, Chairman and CEO at Watsco]

Hey, Jeff.

[Jeff Hammond, Managing Director and Equity Research Analyst at KeyBanc Capital Markets]

Hey, good morning, everyone.

[Albert Nahmad, Chairman and CEO at Watsco]

Good morning.

[Jeff Hammond, Managing Director and Equity Research Analyst at KeyBanc Capital Markets]

Just, just on the A2L, you know, new product introductions, just what kind of pricing are you seeing relative to kind of this, you know, 10%-15%? And, you know, as you talk with your major OEM partners, just address kind of their readiness, you know, so there's no kind of hiccups as you transition.

[Albert Nahmad, Chairman and CEO at Watsco]

Good question. Yeah, I can, you know, cover part of that, and that is that, you know, among all of the OEMs that we talk to, everybody is ready. As a matter of fact, one OEM has started their launch in the Q4, and we've actually taken equipment in and started selling A2L. When it comes to the pricing, the pricing has been consistently, you know, in the double digit, low double-digit range. It's been around, you know, 8%-10%. Some pricing a little bit higher, but we're gonna have to wait until probably the second quarter for that to be adjusted to find out exactly where that price settles. It's an unusual situation for each of the OEMs because it's a total new product line that's gonna be offered.

[Albert Nahmad, Chairman and CEO at Watsco]

It's an unusual situation also, that the consumer is gonna have to buy a system now, as opposed to in the past, when we've sold the 410 product, they could just install the outdoor unit, and now you're not gonna be able to do that technically. You're supposed to replace the indoor and the outdoor unit both. So it's not just the raising of the price, it's also the idea that we're gonna be selling more systems and less single unit replacements once the A2L becomes firmly lodged. And that's gonna be spread out over, you know, all 120 million units that are installed out there right now, will at some point have to be replaced, all at various times.

[Albert Nahmad, Chairman and CEO at Watsco]

But it seems to us that it's a wonderful opportunity, not only for the price increase, but also for the system sale.

[Jeff Hammond, Managing Director and Equity Research Analyst at KeyBanc Capital Markets]

Okay. And then just a quick follow-on on that. Can you just remind us that the multiplier effect, as you do the matched versus the standard, and then just maybe touch on the M&A environment? It seems like, you know, the PE has gotten more crowded in this space and just what you're seeing in general.

[Rick Gomez, VP at Watsco]

I can tackle the M&A piece here. I mean, it's, look, Jeff, there's always more M&A to do. There's no way to predict it or to think about a cadence of it. And I would say that, you know, private equity was a lot more prevalent in the space the last two years. That has subdued a little bit of late, and you know, this is still bigger picture and longer term, a very fragmented industry. And you know, I think there's the, what a lot of you all from the outside don't see as it relates to M&A is two things. One is that we're very focused on partnering with the right entrepreneurs, and that's different from you know, consolidating an industry.

[Rick Gomez, VP at Watsco]

That cultural element of M&A is very, very important. We want the right entrepreneurs who will embrace our technology, embrace our growth spirit, and our equity culture to help transform their business. So, you know, it's very much a cultural discussion, oftentimes more so than a financial discussion. And then the second thing that I would point to that, you know, I hope leads to incremental opportunity going forward is, today, you know, our technology platform and our M&A discussions are essentially one and the same. You know, we've always had access to capital. We've always had scale. We've always had great vendor relationships. We've always had an equity culture. Those things have been constants for 35 years since we've been in distribution.

[Rick Gomez, VP at Watsco]

What's different today, and what has been different over the last five years, is we've invested in this technology platform that I think now is well, better understood, if not well understood, out in the market, and it's leading to more and more discussions with long-term prospects, so I, you know, my job is to help lead some of that, and so I, you know, can speak to it with some pride, and we want more of it, absolutely, but I will also point out that as a $7.5 million company now, we have a whole lot of internal levers at our disposal, too, to grow, and we're not dependent on M&A to grow profitably in the future.

[A.J. Nahmad, President at Watsco]

Rick, this is A.J. I think what you said about these being cultural discussions, more than financial discussions, is so true, and it runs both ways, where it really has to be a good fit for the family. These are multigenerational family businesses that we're saying, "Come be part of our multigenerational family business, and you be you guys with your leadership team and your branding and your customers and your team, but do it under our umbrella and use all of our resources," and those resources are capital, it's equity to recruit and retain great people, and these technologies, which are all about helping you grow and helping your customers grow, because that's what we're all about, is long-term, sustainable growth for the business.

[A.J. Nahmad, President at Watsco]

Those families and the leaders of those families that have joined our business over the last five, ten years are really going back forever. They're thriving in that environment. They're happy. They're still running the business. They're motivated, and they're growing in many cases faster than our, if you would, legacy businesses, if you will. So it has to be a fit, and when it is a fit, it's they seem to be home runs, which is what we're going for.

[Albert Nahmad, Chairman and CEO at Watsco]

Well said, Mr. President.

[Jeff Hammond, Managing Director and Equity Research Analyst at KeyBanc Capital Markets]

Okay, thanks.

[Operator]

Again, if you have a question, you may press Star, then one to join the queue. Our next question will come from Patrick Baumann with JPMorgan. Please go ahead.

[Albert Nahmad, Chairman and CEO at Watsco]

Hey, Patrick.

[Patrick Baumann, Analyst at JPMorgan]

Morning, Al. How are you?

[Albert Nahmad, Chairman and CEO at Watsco]

It's hot and humid.

[Patrick Baumann, Analyst at JPMorgan]

Yeah, it's actually warmer up here than it is usually for this time of year. Just wanted to maybe quickly go back to something Barry said on units. I think he said year to date, up 5%. Was that a total unit comment, or was that... I assume ducted is not up that much, right? Just maybe clarify that, if you could.

[A.J. Nahmad, President at Watsco]

Yeah. Yeah, I should clarify that. So ducted is flat in units year to date, and overall is up 5%, which would suggest Atlas is up double digits.

[Patrick Baumann, Analyst at JPMorgan]

That's helpful.

[A.J. Nahmad, President at Watsco]

And just to be like, you know, even more refined, we mentioned this in the press release. If I look at our selling season, so I'm really looking at joint performance of our seasonal business. You know, let's join together Q2, Q3, so there's no push and pull, you know, aspect to it to the analysis. So for the season, second and third quarter combined, ducted units are up 3% and overall up 5%. So when we talk about stability, that's the frame of mind.

[Patrick Baumann, Analyst at JPMorgan]

Okay, helpful. And then, have you guys been... I think we talked about inventory earlier. You expect it to be stable, you know, through the end of the year. Is your view that the channel is restocking currently in terms of inventory?

[A.J. Nahmad, President at Watsco]

Yeah, the channel right now is picking up 410A equipment, which they'll pick up in November, December and January.

[Patrick Baumann, Analyst at JPMorgan]

Okay.

[A.J. Nahmad, President at Watsco]

And so, yes. It's not restocking. It's kind of a pull forward, if you will-

[Patrick Baumann, Analyst at JPMorgan]

Yeah

[A.J. Nahmad, President at Watsco]

into, you know, it's first quarter sales, Q4 shipments, it'll turn into first quarter, second quarter, sales.

[Albert Nahmad, Chairman and CEO at Watsco]

Right. Yeah, that I think the industry, and us, included, are bringing into our barns, for the large part, what we'll sell, 410A products we'll sell through the first quarter. And as that is being sold through, we can't replenish them with the 410A units, so we'll replenish them with the A2L units.

[Patrick Baumann, Analyst at JPMorgan]

Helpful. And then one for you on margin, on the gross margin side. Normally, there's like a lift, I think, from seasonality in the Q4 because the mix, which I guess hurt you in the third quarter, typically improves somewhat. Is that reasonable to assume this year, or are there factors like that OEM investment collaboration that holds that back in the year-end?

[A.J. Nahmad, President at Watsco]

I think we should see some lift with the mix as we get into the colder season. We start seeing more furnaces, more heat pumps, which have obviously higher margins to them and higher volumes.

[A.J. Nahmad, President at Watsco]

... So, without knowing what the weather's gonna be in the Q4, I would say yes.

[Patrick Baumann, Analyst at JPMorgan]

Okay, that makes sense. Thanks a lot. Appreciate the time.

[A.J. Nahmad, President at Watsco]

You bet.

[Operator]

Our next question will come from Nigel Coe with Wolfe Research. Please go ahead.

[Albert Nahmad, Chairman and CEO at Watsco]

Morning, Nigel.

[Nigel Coe, Managing Director at Wolfe Research]

Good morning, guys. Thanks for the time. I think this, it's meant to be a cold winter, according to the Farmers' Almanac, so it's, if that's true, then it should be a little bit of help for you guys.

[Albert Nahmad, Chairman and CEO at Watsco]

That'd be great.

[Nigel Coe, Managing Director at Wolfe Research]

I know you've covered a lot of ground. I don't wanna, you know, retread, you know, sort of ground we've already taken. Just on the gross margin, seems like there was a bit of lapping of price from earlier this year, and you talked about mix and some OEM support. So is there more discounting going on, especially at the higher tier levels? Is that a factor at all in some of the gross margin pinch here?

[A.J. Nahmad, President at Watsco]

I othink, you know, if you listen to Rick's comments as a composite, we look at the most important metric, which is the transactional margin. Have any material change to it? The answer was no, so I don't think, you know. I'm not saying neutral is exactly what we want, but it means there's not been a risk factor relative to deflation, let's say, at really any level of product group, so I think it's more subtle in the mix of it.

[A.J. Nahmad, President at Watsco]

And I think, again, Paul, you have a good insight into this, but the higher tier systems, the 16, 18, 20+ SEER systems, really only came into existence in our inventory sometime late last year, and has not really been a factor, if you will, in the sales process this year. I think it, the movement of energy efficiency mandates that happened in last year kind of condensed, you know, the base layer into a much more broad part of our business now. And Paul, maybe you have some perspective.

[Paul Johnston, EVP at Watsco]

Yeah. It happens every time we've gone through a change in standards with the federal government, and that is there's a compression where a greater percentage of the industry moves towards standard efficiency.

[Paul Johnston, EVP at Watsco]

With this last energy efficiency change, they basically increased the efficiency to roughly 15 SEER from 14 SEER. So it, when they did that, we definitely saw a compression where the high efficiency equipment shrunk as far as a meaningful size in the marketplace.

[Nigel Coe, Managing Director at Wolfe Research]

Okay. That's, that's helpful. Thanks, guys. And then just a couple of quick ones here. Just on the A2L transition, obviously, you've been through, you know, many of these transitions before. When you compare this to the 10 SEER, 13 SEER, you know, 22 to 410A, 13-14, do you think the contractors, the end customers, are ready for this transition? And obviously, you're very close to those guys. You provide a lot of training, support, et cetera. Are they ready for this?

[Paul Johnston, EVP at Watsco]

I think the consumer is probably not ready for this. They don't really understand what's gonna be coming at them. As I indicated earlier, it's going to be a system changeout, not just an outdoor changeout.

[Nigel Coe, Managing Director at Wolfe Research]

Yep.

[Paul Johnston, EVP at Watsco]

And that's gonna be a bit of a sticker shock, I think, for some of the consumers once they see what the pricing is gonna look like. So it's more than just the 10% price increase, it's also the entire system. The contractors themselves, I think they're gonna pretty easily go through the transition. The only real change in the units is going to be on the inside. You're gonna have a detector that's gonna detect any sort of leak in the refrigerant into the home. And then if it detects that there is a leak, it's going to turn the blower motor off, so it's not gonna contaminate all the indoor air. That's the biggest change.

[Paul Johnston, EVP at Watsco]

Outside of that, you know, the one itself is going to have a different component in it than the old refrigerant did, but it's still the base component in both refrigerants. The 454, as well as the 32A, is still 32A. So it's gonna be the same, the same refrigerant that we've had with 410A, basically.

[Nigel Coe, Managing Director at Wolfe Research]

Okay. Okay.

[A.J. Nahmad, President at Watsco]

But I- [crosstalk]

[Nigel Coe, Managing Director at Wolfe Research]

It sounds like it's not gonna be a big deal.

[A.J. Nahmad, President at Watsco]

Yeah, I'll just also add that it's our job to help them get ready from a-

[Nigel Coe, Managing Director at Wolfe Research]

Yeah

[A.J. Nahmad, President at Watsco]

... technology perspective, product tech, tech perspective, from a business and selling perspective, and then support them with helping them figure out what products they need and getting technical support and et cetera, et cetera. And, we do that at a scale and with a technology background that I think is unparalleled in the space and, sets us apart, and I think is a real big reason why customers or contractors choose to do business with The Watsco Company.

[Nigel Coe, Managing Director at Wolfe Research]

Okay. Okay, and then just a quick one, if I may. Obviously, great news about October, up mid singles, and I know you said no more details on that, but I've got to say, I'm a little bit surprised with the hurricane's impact in, you know, Florida and the South, Southeast. I know you've got some extra days selling in October, so is there some benefit from selling days in October offsetting some of the hurricane impact, or am I off base there?

[A.J. Nahmad, President at Watsco]

Yeah. Again, Nigel, it's something we track down to, you know, dollars and cents in terms of hurricane impact, and we had, like, the last two or three days of the quarter, and we had, you know, three or four days for Milton this quarter. So I think if we had any pickup, it's been offset by disruption with Milton, and again, in relative terms, not that material of an event. I think with the destruction that is obvious in these markets, there's a business opportunity that will flow once insurance money flows. Nothing is immediate and, you know, but the word destruction I'm using purposely because that's what has gone on in those markets. There will be that opportunity once dollars flow. Right.

[Barry S. Logan, EVP of Planning and Strategy and Secretary at Watsco]

I also just wanna report quickly, just an important point. We have a lot of employees that were in the path of these storms, and very happy to say that everybody is safe and accounted for, and those who had destruction in their homes or problems that we could help with, we are helping to the best of our ability. We care very much about our team members, and we're very thankful everybody came out unscathed, relatively speaking.

[Nigel Coe, Managing Director at Wolfe Research]

Amen. Agree with that. Thanks. Well said. Well said.

[Operator]

Our next question will come from Steve Tusa with JPMorgan. Please go ahead.

[Albert Nahmad, Chairman and CEO at Watsco]

Steve Tusa, how are you?

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

Hey, good morning. Sorry, just to follow up to Pat's question, got a little bit late on the call here. Do you have complete visibility into, you know, all the OEMs pricing for A2L product at this stage? Is there anybody that's, you know, playing a little more close to the vest than others? Not just your suppliers, but kind of across the industry?

[A.J. Nahmad, President at Watsco]

Yeah, we have visibility into every manufacturer's pricing. There's only one or two that right now have not really fully released their pricing. I think it's not that they're trying to be coy or sly about, you know, how they release their pricing. I just think that their timing is probably just a little bit off, but for the most part, we've got most of the pricing in.

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

And, and-

[A.J. Nahmad, President at Watsco]

The big question, Steve, is that pricing, you know, gonna hold, you know, throughout this entire transition? That's the question we ask.

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

Do you think customers are kind of looking at it as, you know, a bit of like, similar to like a list price increase? Where, I mean, I think most of the OEMs are pitching it as, you know, cost push, which is just-

[A.J. Nahmad, President at Watsco]

Yeah

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

... inevitable versus like, "Hey, here's the new price," and then let the negotiations begin, or how are they, how are most of them looking at it?

[A.J. Nahmad, President at Watsco]

I think most of them are very serious about this price, you know, for... Because they are adding costs or adding two new components to the system itself. So due to that, I think that, you know, I think the pricing will probably be closer to the, you know, the eight to 10% range than the 15%, but I think it's gonna hold around 10%.

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

Right.

[A.J. Nahmad, President at Watsco]

That's my opinion.

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

The eight to 10 is kind of a bit of a discount to what they had previously said.

[A.J. Nahmad, President at Watsco]

I think a little bit, but not that much. You know, we'll have to wait and see and find out.

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

Yeah.

[A.J. Nahmad, President at Watsco]

All I got is opinion right now, you know?

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

Right. Yeah.

[A.J. Nahmad, President at Watsco]

Steve, Steve, I wanna remind you. I mean, maybe that's maybe you're asking that question from an OEM perspective, but from our perspective, if we buy, let's say, $25 million of one SKU from an OEM, you know, and the price is quoted to us, we're reselling that one, you know, that $25 million at maybe a thousand different prices, depending on the customer, the market, the end market, you know. There are variations, obviously, on our selling price, and more ironically, there are variations on our buy price, depending on the intended, again, customer or end market. So this is, you know, an art form more so than just strict analysis.

[A.J. Nahmad, President at Watsco]

And when we allude to technology that's helping us do that and raising margin over the last four or five years, that's, so that's where technology's played its role is, in that snowflake management, if you will. You know, we have a much more gifted capability than we had three or four years ago, and in this transition, it's another chance to accomplish the same thing. And if we need to react to a market condition, you know, we then have our OEMs react to our costs. So that's, that fluidity is why this is hard to predict, but I can tell you why it's benefited us in the last three or four years, you know?

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

Right. And I guess your point is that like to take, you know, 10% or whatever and like, stick it into a model on a spreadsheet, like, it's a lot more complicated than that.

[A.J. Nahmad, President at Watsco]

A lot, a lot more complicated than that, you know. As Barry alludes to. All the variables, all the variable prices. I wish it was as simple as that, we probably... But, it, it's not as simple as that because you do have the different market segments, and-

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

Got it

[A.J. Nahmad, President at Watsco]

... you've got regionality to the pricing.

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

Got it. One last one for you, just on the light commercial side. Everybody's had a pretty good Q3. One of your peers said it's a little bit slower in the Q4. Any signs of weakening there on the back of fundamentals in the next year for light commercial?

[A.J. Nahmad, President at Watsco]

I think as the availability of the commercial product improved, I think we saw, you know, some reduction in some of the pricing. But as far as the demand, the demand has remained fairly strong. You know-

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

Okay

[A.J. Nahmad, President at Watsco]

... and we're still up double digits.

[Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan]

Yep. Great. All right. Thanks, guys, as usual. Thanks for the details.

[A.J. Nahmad, President at Watsco]

All right, guys.

[Operator]

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

[Albert Nahmad, Chairman and CEO at Watsco]

Once again, it's always good to communicate to all of you, and we hope you'll be here for the next quarter's numbers and performance. So thank you for your interest in our company, and as we said earlier, it's winter. Why don't you come down to Miami and see us for yourself? Bye-bye.

Participants

Executives

• Barry S. Logan, EVP of Planning and Strategy and Secretary
• Paul Johnston, EVP
• A.J. Nahmad, President
• Rick Gomez, VP
• Albert Nahmad, Chairman and CEO

Analysts

• Nigel Coe, Managing Director at Wolfe Research
• Jeff Hammond, Managing Director and Equity Research Analyst at KeyBanc Capital Markets
• Tommy Moll, Equity Research Analyst at Stephens
• Ryan Merkel, Analyst at William Blair
• David Manthey, Senior Research Analyst at Baird
• Patrick Baumann, Analyst at JPMorgan
• Steve Tusa, Managing Director and Senior Equity Analyst at JPMorgan