Good morning and welcome to the Watsco First Quarter 2020-2021 Earnings Call. 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.

Good morning, everyone. Welcome to Watsco’s first quarter earnings call. And this is Al Nahmad, Chairman and CEO. And with me is A.J. Nahmad, who is the President; and our two Executive Vice Presidents, Paul Johnston and Barry Logan. Before we start, our usual cautionary statement. The conference call has forward-looking statements as defined by SEC laws or regulations that are made pursuant to the Safe Harbor provisions of these various laws. Ultimate results may differ materially from the forward-looking statements. On to our financial report, Watsco achieved record first quarter results. Earnings per share grew 93% to a record $1.39 per share. Records were set for sales, gross profits, gross margin, operating income, operating margin, net income and earnings per share. Now, these results were driven by strong sales growth made at higher selling margins along with improved operating efficiencies. When we look at our product offering, we achieved double-digit sales growth in equipment, non-equipment and commercial refrigeration. And in terms of geography, growth rates during the quarter were similar for U.S. markets and international markets as a whole. For HVAC equipment, residential sales increased 18% and commercial equipment sales stabilized and are now trending more positively. But more important, this is not just about one quarter. Over the last 12 months, residential equipment sales in our U.S. markets have increased 15% and we believe meaningful market share gains have been achieved. Looking forward, we expect business to be strong and that 2021 will be another record year of performance for our company. Adding more color, Watsco’s industry leading technology continues to gain adoption. That leads to new customer acquisition and we believe development of greater market share. Now a few important trends are also continuing. Active technology users continue to outpace growth rates of non-users. Customer attrition among active technology users is meaningfully lower compared to non-users and our platforms used by contractors to make sales to homeowners gain more users. That in turn doubled the number of at-home sales presentations and increased sales volumes that flow through our platforms called OnCall Air and CreditForComfort. We are happy with our progress, but we believe it is still early in terms of reaching the full potential of our technology investments. We, once again, invite you to schedule a Zoom call with us and we can further explain that technology and its impact. Moving along financially, our balance sheet remains in pristine condition with only a small amount of debt. We are excited to have closed 2 weeks ago on the acquisition of Temperature Equipment Corporation, also known as TEC. This is a long established, generationally owned company headquartered in Chicago. TEC adds 32 locations and approximately $300 million in revenue and establishes Watsco’s first major presence in the Midwest United States. I must say that TEC is a great company with a long and proud history. They are led by wonderful team of entrepreneurs and we are honored to be part of their family. They are also off to a strong start this year and we expect their results to be accretive to 2021 results. We continue to look for other transactions with great businesses like TEC. While doing our search, we offer our well-known culture that respects and continues a company’s distinct legacy and we support their plans for growth. We think that Watsco is a great next step for family-owned companies in our industry. Lastly, a reminder that we raised our dividends by 10% in April 2021 to $7.80, a follow-up to the record cash flow achieved in 2020. We believe our dividend is a good reason to invest in Watsco over the long-term. 2021 marks our 47th consecutive year of paying dividends, and we have increased our dividends in 19 of the last 20 years from $0.10 per share in the year 2000 to today’s annual rate of $7.80. Now with that, Al, Paul, A.J., Paul, Barry and I are happy to answer your questions.

Our first question comes from Josh Pokrzywinski from Morgan Stanley.

Hi Josh.

Good morning, guys. Thanks for taking the question. I hope everyone is well. I guess maybe just to start out here, we are about to approach a point in time where comps start to get kind of squarely and we lap some of the kind of early day challenges of COVID before the industry realized that things were going to be pretty solid. What is it that you think folks should focus on this selling season, is maybe something that you have visibility into now or maybe like a key performance indicator over the next couple of months, because I would imagine, as comps get easier and then tougher, volume will be all over the board. But what’s your sense of kind of the health of the market, because in theory, you don’t have more than, I don’t know, 4% or 5% of the market, really fall away any given point in time, but you guys are up quite a bit and low seasonal factor. So, just trying to tie out the strength today that probably isn’t sustainable, understanding that comps kind of get wonky here? So, what are you guys seeing today that gives you some sense of the health of the business outside of the seasonal dynamic?

Let me just remind you, and then I am going to turn the question over to Barry, that over the last 12 months, we are up double digits in equipment sales. The last 12 months. So, I should show you something in terms of continuity. And Barry?

Yes, Josh. Again good morning. First, I think there is so much data floating around about the industry as a whole—OEM data, shipment data. And of course, our focus is Watsco data. And if you do go back and look at last year in the summer time, really the second quarter and third quarter, things were choppy, but they were not volatile. I think same-store sales second quarter last year were down 6%, not 16%, not 26%, 6%. So yes, there is a comp that’s kind of better as we approach this selling season, but not the volatility that I think most others in the industry are trying to tap dance about. So for us, again, our seasonality is really now through October. The Sun Belt, the sun is out at summer time. And of course, the technology, we have our partners, our OEM partners, who we have worked with over the last 6 months going into this season and beyond with kind of really a very aggressive stance on growth and share gain. There is some product launch going on that will be important as we get through this season and into next year also. So Josh, don’t be too distracted by the amount of volatility that others have had when you look at Watsco going forward, because that volatility simply was not as great for us last year.

So I have to add, Josh, if you know Watsco and I know you do, you know that we are a long time company also. So, while quarterly performance is important, we invest in our business with the distinct goal of continuing to separate ourselves from our competition over the long run. That’s the thesis of all these technology investments we make and that’s playing out. More customers are using more of our technologies. The customers that are using our technologies are growing faster, they are treating less, they are just better customers. And it’s also a byproduct of that is the M&A story. There is more M&A conversations that are spurred by the technology that we have and being able to leverage it in other businesses. So, I just want to emphasize—the focus remains the long-term. It’s not just a quarter-to-quarter business.

Well said.

Got it. That’s helpful. And maybe just a follow-up on that technology point, A.J., one of the things that’s kind of gotten distributed out of that is you guys have been able to control inventory, perhaps a little bit better in recent years. I think broadly across the industry, inventories look a little high. What’s your sense on either availability out there from the OEMs and kind of fill rates? And what maybe some of those high inventory levels that some of your competitors may have means for price realization if folks find themselves with a little extra on their hands this year?

I think Paul would be best…

As you know, we have invested heavily in technology also internally. And we have invested millions in being able to analyze our inventory and make sure that our inventories are reaching the right spot at the right time with the demand that’s being created out there. We work very closely with our OEMs to make sure that our inventories are in line with what our demand is. Yes, it’s been a tough 12 months to 15 months so far working those through. But so far, our OEMs have worked very hard with us. As far as what the industry has for inventory, I think there has been a little increase in inventory among a lot of distributors out there. I think a little of that is more emotional than it is data driven. But I don’t think the inventories in the field right now are really out of line with what the demand would be through most of the summer given that this is going to be a normal year, if it’s a normal year.

Got it, okay. I appreciate the color on that. I will pass it on.

The next question is from Jeff Hammond from KeyBanc Capital Markets.

Hi, good morning. So just on the margins, really impressive on both SG&A and gross margins. And I know this—1Q and 4Q can sometimes be a little bit different given the seasonal light. But just walk me through what drove the big increase in gross margins? And how sustainable you think that is as you go into the selling season?

Barry?

Sure, Jeff. Well, again, it’s a progression. So the margin story, gross margin story, I think, started improving last spring and carrying through 12 months later. So again, I am going to tell 12 month stories, even though we are analyzing a quarter here, because I think these have all been progressions that have happened over periods of time to where we are. So, it is what we call selling margin, meaning simply the margin we make on pushing products through the channel. So, that’s a blocking and tackling exercise. And throughout our marketplace by salespeople, we saw an increase in performance-based pay this quarter, for example, which is sharing commissions and sharing some of that profitability with people that have earned it. That’s part of the SG&A increase, which is a good thing. As far as the overall fixed cost structure, again, I use the word progression once again. We have seen fixed cost stay relatively neutral over the last three to four quarters. This one is no different and it shows up in the incremental margin that was achieved this quarter. Again, for the last few quarters, very similar achievement.

Okay, great. And then the non-equipment piece had spent a number of years kind of flattish to grow in low-single digits, and you have seen a couple of quarters of uptick. And just wondering what’s driving that? And again, how sustainable you feel that is? Because it seems like a lot of—we are shifting a lot more to replace versus repair. And I didn’t know how much is—you are still seeing a robust repair environment or is it parts associated with new construction, etc.?

Paul?

I have never figured out when we switch from repair to replacement back and forth. I think both of them have a dynamic to them that are not related to each other. We are replacing units as they break. But at the same time, there are another 100 million units out there that aren’t being replaced that do need maintenance and repair. And so the part sales have started to pick up again. We have increased our focus, obviously, in those. And that’s obviously helped us start growing that market again, too.

A.J., do you want to add something to that?

I was going to say, that’s the right word, Paul, focus. I mean, our leadership is very focused on parts and supplies sales now, and they are using data, and they are using our optimization tools around pricing and inventory and understanding customers’ needs and getting the right product to the right place at the right time, the right price. So it’s focus, which is, very proud to say, delivering some results.

Okay. Thanks guys.

The next question is from Jeff Sprague from Vertical Research.

Good morning Jeff.

Hi, good morning everyone. Thanks for taking the question. I was wondering if we could talk a little bit more about consumer behavior, and maybe it was partially addressed in that repair versus replace. But it looks like mix is still shifting higher and maybe you could just provide a little bit of color on what you are seeing the consumer appetite to pay more for energy efficiency. And I wonder if, with all the price increases that OEMs are pushing through the channel, on the flip side, do you see any kind of tension in the ability of the consumer to digest some of these price increases that are coming through?

Excellent question. Barry or Paul, either one of you.

Give us some color, Jeff. Welcome back, by the way, Jeff. Well, first, the contractor is largely the player that is going into a home or now going through our technology into a home and saying, here is what I think you should do to the homeowner. And so that contractor’s confidence, what they are able to close the job for, is very critical. And that drives a lot of other people’s sales, including us and the OEMs. So that contractor focus, the customer-facing technology that we talk about is where a lot of this conversation is heading. We think it is the advocacy for high efficiency, the capability of the contractor to go ahead and recommend and install it and help his business as well. And so that’s the first fundamental to understand about our technology. What we are seeing in the market also is almost one of the best credit environments we have ever seen. And when I say credit, I mean the credit we extend to contractors to go out and grow their business. We are seeing one of the very best metrics on past due receivables, write-offs, things like that, which no one ever asks about. But our credit profile with our customers right now is at an all-time performance level. And again, that goes to the confidence of the contractor that we think is going in and making these deals with homeowners and pulling through product, and we are helping them do it.

It’s not just the high-efficiency that saves the consumer money on their electric bill or their heating bill, but it’s also all the comfort attributes that you get from the high-efficiency products. It’s also the indoor air quality products that are associated with a lot of the high-efficiency products. Those are also having a big play with the consumer right now. And we are hoping for 50 years of following this, that finally this is a market segment which is going to continue to grow indoor air quality and indoor comfort.

I would add, and I don’t think the OEM price question you have—whether those pricing actions influence ultimate outcomes—I don’t think very much. If you think about what happens all the way through the channel with the profitability and pricing of an installed system, it really goes back to that contractor-homeowner capability to get it done at that level.

Yes. I was just going to ask as an add-on. You gave us the growth rate of above minimum standard. Could you share what percent of your revenues now or volumes are kind of above minimum zero level?

Well, Jeff, I appreciate the curiosity. It’s not something we put out there, no.

Right. I will leave it there. Thanks guys.

It’s the minority of the business, still. So that’s the good news.

But I will add, just, I guess, I’m the technology guy and Barry mentioned it earlier. When contractors use our OnCall Air platform to sell in the house, that dynamic flips. It’s no longer the minority of the systems they sell that are high-efficiency; it becomes the majority of systems they sell when they use the tool. That dynamic is important.

Interesting. Thanks guys.

The next question is from David Manthey from Baird. Please go ahead.

Good morning, David.

Hey, good morning everyone. Let’s see. So from a contract or customer standpoint, could you tell us what number of customers you had at the end of the year 2020 versus year-end 2019?

You want to know the number of customers we have? We publish those estimates in our disclosures—we believe we’re doing business with about 90,000 contractor businesses, and that’s grown, it hasn’t declined.

Okay. On the penetration of OnCall Air, what I’m kind of getting at is, in terms of the uptake there, where do you stand today? And do you talk about retention rates of your customers and so forth. Could you tell us what kind of penetration you think you have with that technology today and where that compares to a year ago?

Certainly, not even close to where we want it to be. A.J., any color?

I was going to say the same thing. It’s not enough, but growth rates are almost triple digits. So it’s just about getting it in front of more contractors, showing them the value of the tool. And when we do get them to a demo of the tool, they sign up a lot of the time. So the conversion rates from a demo to using the tool is very high. And when they use the tool, it’s a great win for them and a great win for us. But it’s still very small numbers, relatively speaking.

Could you at least tell us if it’s a single or double digit number?

Of what? I’m sorry, I don’t understand. Of total customers?

As a percentage of total.

Yes, it’s single digits.

Good. Okay, great.

They just helped you. It’s in the press release. About $105 million of business was driven on behalf of our contractors into the channel using our tool in the quarter, and I think last year it was over $300 million for the full year. It sounds like a lot, but it is a fraction of the overall installed market that we’re servicing every day. So there is a lot of room ahead of us.

Okay. And then finally on the TEC acquisition, how should we think about seasonality of that business? Should we be thinking sort of 30% in the second and third quarter and 20% first and fourth, ballpark?

Yes, I would say, 30% each in the second, third and fourth quarters and 10% in the first quarter.

Okay. Thanks a lot guys.

The next question is from Ryan Merkel from William Blair. Please go ahead.

Hi, good morning.

Hey. Great quarter. Great to see. So first off, tell us what you’re seeing in the commercial market. Are you seeing kind of demand starting to come back here, Paul?

Yes. We’re starting to see a definite uptick in the commercial rooftop units. So will it be at the same magnitude we saw at the rush back on residential? We’re not sure yet. The federal government is pushing for retrofits in schools and other buildings that would impact the demand as well. They are creating or have created incentives to change HVAC systems to be reinstalled in schools. And I think eventually to even larger buildings and schools.

Okay. Great. I was actually going to ask that question next, but you answered it. I was also going to say that ESG trends and a lot of population migration south again seem to me to create long-tailed trends that could be helpful. And then on the TEC deal, was that also largely driven by the family wanting the technology? And then the second question would be, now that you’ve planted a flag there, do you think you could close more deals up north? Is that how it works?

Those are two questions and since Barry successfully led the TEC effort, I’ll let him answer that.

Thanks, Al. The TEC relationship has been a long one—about 20 years, not just the last 12 months. So we’ve been building this and working on this for a long time, and it is a family business with multi-generations of family ownership as well as multiple siblings. I think they reached their own conclusion as a family as to the right timing and the right desire to sell at a given time. Talking to us exclusively for all of this time is a great complement from them. Technology is what really, I think, brought things into light. As you know, we bought the Philadelphia Carrier distributor about two years ago. These guys are friends. They have been peers for 20, 30 years. The families have known each other for longer than that. That was one of the primary reasons for selling as documented in our annual report last year. Both families are good friends and shared notes and made my job easier in the last 12 months getting this done. Technology has a lot to do with why both companies, after 80 years, joined Watsco. So I think, as A.J. said earlier, these dynamics are not limited to just these two. There is more to come, at least in terms of conversation and meaningful dialogue beyond just selling the business. It’s joining the Watsco technology story. And then we’ve asked Skip and his team to find other acquisition candidates in their markets; as part of their growth plan they will go out and use their own relationships in their local markets to grow, and that plan is set. If you met Skip, who’s in Chicago also, I’d be happy to introduce you to him. He’d be a very big personality who really can’t wait to help us grow and help PUC grow as well. So it’s a great acquisition.

I’d like to add to that. Technology certainly is of interest to people that own businesses, but it’s also the culture. We have a long track record of respecting the legacy of the companies that we buy. We don’t change their names, we don’t micromanage them. They manage themselves. We’re in the background. We provide financial support, technology support, whatever they call that they need. We’re not about to disassemble what they have already accomplished. Quite the contrary. We just want to enable them to get bigger and support it. That’s a very big deal for people that have created great companies and don’t want to see their legacy destroyed.

I was going to add to the previous point on commercial—nobody does commercial better than TEC. And we are eager and excited. They will teach the rest of our business units a lot on that front. So that’s a wonderful opportunity as well for the company.

Appreciate it. Thanks.

The next question is from Steve Tusa from JPMorgan. Please go ahead.

Hi, Steve.

Hi guys. Good morning. Could you just give us an idea of what commercial actually did in the quarter? You noted it was kind of stabilized and getting better. What was commercial actually in the quarter year-over-year, equipment?

Paul?

Commercial, as far as variance, was basically flat. However, a lot of that was influenced by larger applied-type products not being flat. They are still suffering a little bit. But the unitary products are definitely showing growth, and we’re starting to see some rebound on the VRF and some of the other products.

On the VRF, okay, got it. Was the traditional commercial unitary and rooftops up, flat or down? Was a lot of your growth driven there by VRF?

No. Actually, unitary was up slightly.

Can you just give us an idea of when the last OEM price increase that you see currently goes through? What are the rough dates of that currently?

June 1.

Is that the vast majority of those guys?

Yes, it is. They have all publicly announced. So yes, June 1, and there was one in April and one in May.

Okay. And was there actual price realization for you guys in the quarter? And what was that?

Barry?

Yes, there was a small amount of price in residential in the market. So you look at the 18% overall growth rate, a couple percent was price, the rest is units.

Got it. And what is the supply status of the major OEMs? Are they all back up and running? I know one or two had some supply issues last year. Are they back up and running yet? Do you expect them to be back in full force by the time the season really cranks up?

Paul, go ahead.

They have all had glitches during this entire period. But I would say right now, they are probably in the best shape that they have ever been. We still have some things that are not out of stock, but some things we have to work harder to obtain. But it’s becoming a little bit more normalized now.

And what were your sales into housing, like to builders and those bigger housing customers? Can you differentiate between those two at all?

We really don’t differentiate too much of that. It’s not a great percentage of the business. That hasn’t grown that much.

One more follow-up—what was pricing last year for you guys?

It was very negligible last year. As the year wound up, it was almost no price in terms of the residential equipment business.

Got it. And should we assume the gross margin stays this way? Or is it going to kind of narrow over the course of the year?

It’s one of our major focuses to maintain and grow our gross profit. We’ve got a lot of initiatives in place to make sure that we can continue our growth in gross margin. That’s our plan.

Okay, great. Thanks for the color guys. I really appreciate it.

The next question is from Chris Dankert from Longbow Research. Please go ahead.

Hey, good morning everybody. I guess thinking about the tools you’ve been talking about here, is the real focus on developing new technology tools or is the opportunity really more deepening penetration at this point? I’m just trying to think about where the incremental investment dollar goes? Is it really more on continuing to build out that tech team or is it more about the actual rollout at this point?

Good question. A.J.?

It’s both. It’s absolutely both. I think we’ve built some fantastic platforms and customers of ours that are using them are enjoying great success for themselves and they make them better customers for us. We are developing additional feature and functionality on those platforms. And we are constantly assessing and trying and experimenting with new things that might also be good for our customers and our business. So it’s just who we are now. We’d like to think of ourselves as a technology company that just happens to sell HVAC. And so it’s not going to stop. We’re constantly looking at and trying new things. When we say technology, that’s really an umbrella term—we need people, process, technology and modernization and experimentation and innovation. Technology’s a catch-all for continuous improvement.

Got it. And then sorry to bring it back to this, Barry, but I think you kind of teased new product introduction later in the year. Anything you can give us on that? Are you talking about tools you guys are introducing or is this from your suppliers, new products that are being rolled out?

I shouldn’t tease because I don’t want to show my hand as far as I know. Part of any OEM relationship is to sign either segments or products or features or benefits to launch into the market and gain share. And so that’s what we’re doing. We’re going to keep it quiet. But when we say product, it really is going out and addressing segments and markets or price points where we feel there is market share opportunity and we’ve got some very aggressive partners that are helping us do that.

Got it. Well, can’t blame a guy for trying. Thanks so much guys and good luck here.

There are no more questions in the queue. This concludes our question-and-answer session. I’d like to turn the conference back over to Albert Nahmad for any closing remarks.

Once again, thanks for your interest in our company. We are, as A.J. has said, always focused on the long-term, and we hope your interest will continue for the long-term. So we will see you next quarter. Bye-bye.

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