Good morning, and welcome to the Watsco Fourth 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.

Thank you, and good morning, everyone. Welcome to our fourth quarter earnings call. This is Al Nahmad, Chairman and CEO. With me is A.J. Nahmad, Watsco's President; and Paul Johnston, Barry Logan and Rick Gomez. Now before we start, our cautionary statement, as always, this conference call has forward-looking statements as defined by the SEC laws and regulations that are made pursuant to safe harbor provisions of these various laws. Ultimate results may differ materially from forward-looking statements. Now, Watsco delivered strong results in 2023 despite some market conditions which were somewhat inevitable after two extraordinary years in 2021 and 2022. While reflecting on the year's results, I am proud of the accomplishments we delivered. We achieved market share gains in the markets we serve. We further scaled Watsco's industry-leading technology platforms. We had a successful start in driving down long-term productivity gains. I should say, we had a successful start driving long-term productivity gains. We expanded our network and product offerings by acquiring great businesses through our scale, and we fortified our balance sheet through inventory reduction and generated record fourth-quarter cash flow. And once again, shareholders will receive a meaningful dividend increase in 2024, which is in April 2024. This is Watsco's 50th consecutive year of paying dividends. 2023 was also a year of immense change in virtually all equipment products transitioning to new regulatory systems. In collaboration with our OEM partners, Watsco introduced new products and SKUs for over 25 brands of HVAC systems. Our teams executed well, and thanks to our scale and speed to market. We are confident that we gained share. We also trained thousands of customers on new products and our digital pilot library was updated with approximately 500,000 new SKUs. This spring we will begin the next regulatory transition to new A2L products with lower GWP refrigerants. These regulatory transitions are positive for our industry and are good for Watsco's business. They offer meaningful value to homeowners and businesses to upgrade systems that are more efficient and better for the environment. Watsco's residential unit volumes, although still down, stabilized during the second half of 2023. Commercial end markets remain strong across all markets. Our commercial business continued to grow at a healthy rate, and our backlog of products extends well into next year. Sales of ductless systems, an increasingly important component of our business, grew double digits in the year and offset declines in conventional residential business. SG&A as a percentage of sales on a same-store basis decreased for the year, indicating progress in driving more productivity across the company. We believe we are in the early innings of a long-term opportunity to meaningfully improve productivity and overall efficiencies. We have challenged our leaders and provided them with tools and data to implement change. And most importantly, we possess an entrepreneurial culture to execute change in a responsible way. Over the past year, we expanded our network through acquisitions with three terrific businesses joining the Watsco family, collectively their annual sales are around $200 million. These businesses will retain their culture, leadership teams, and uniqueness in the market, consistent with our long-term practice of honoring and sustaining great legacies. Our industry remains highly fragmented, and we will continue to pursue other great companies to grow scale in our $60 billion North American market. We believe Watsco's technology advantage, market-leading scale, and the strength of our balance sheet are all great reasons to join the Watsco family. Now before getting to Q&A, as always, I want to emphasize that our core focus remains on the long term. We believe our scale, the quality of our balance sheet, and unique culture will continue to drive long-term growth and performance. We have an immense technology advantage, and we are investing to grow that advantage. Watsco's broad array of products and brands is also a competitive advantage that allows us to serve contractors in any environment. And finally, our industry is fortunate to benefit from important regulatory and industry catalysts that should positively influence Watsco's performance in the years ahead. With that, let's go on to Q&A.

Thank you. We will now begin the question-and-answer session. The first question comes from Tommy Moll with Stephens Inc. Please go ahead.

Good morning, Al. Thank you for taking my questions.

You bet.

I wanted to start on gross margins, no big surprise there. Your fourth-quarter gross margin percentage was a little bit below the long-term aspirations that have been discussed recently. So it's a two-part question really. One is just if you could unpack any of the factors there for us in the fourth quarter? And then if we think about the art of the possible going forward to start this year, is there a pathway, near term, to recovering and moving back towards those longer-term aspirations in the high 20s or maybe 30?

Very good question. As you know, I've stated earlier that eventually, our aspiration is 30%, and we have a ways to go. So I'm going to ask Barry Logan and Paul Johnston to deal with current events.

Yes. Thanks, Al. Good morning, Tommy. We've said all year long that some of the moving pieces with gross profit would influence the fourth quarter. And so if I just focus on the year for a second, Tommy, just some important things to be grounded in looking at the year's performance, and then I'll address the quarter and the shorter-term perspective. But for the year, the 27.4% million is what was achieved. And it's obviously better than it was two years ago. Many of the moving pieces we've talked about to drive and sustain that higher margin, obviously, are in place as we look at the year's perspective. If we look at a 60 business day perspective, which is the fourth quarter, in the off-season, some of those variables have a greater impact in the short term. So that would be my first bias I would try to talk about is we're talking about 60 business days in the off-season in the fourth quarter, and some of the moving pieces are more acute because of benefits of a year ago, not so much what's happening short term. So if I unpack that a bit and not be quite as abstract about it, we have about $16 million of benefit in the prior year from pricing gains, from weighted average cost gains, from inflationary gains, however you want to define it, which is roughly 100 basis points in the year-ago quarter. Some of that is equipment; a greater proportion is not equipment. There was a lot of inflation going on in some of our non-equipment products a year ago, like refrigerant, like copper tubing, like steel products, and probably 40 other product lines where a year later, those benefits are not there. So that's 100 basis points. That's $16 million of consequence. If I look forward to 12 months, instead of back 12 months, if I look forward 12 months, I don't expect there to be that kind of headwind in those products, let's say, a year from now. And it's just one of those things that as the numbers are larger in the fourth quarter, the acuteness is higher. $16 million would not be as material to a second or third quarter. It's more material to a fourth quarter. So that's probably the biggest impact in the quarter if you look at things on a year-over-year basis. There are some other moving pieces, which we've talked about. One is that equipment products, in fact, have a lower gross margin than non-equipment products. So in the quarter, you see a mix difference between the growth rate of equipment, which was pretty flat, and non-equipment, which was down. So that's algebra that affects the margins in the quarter by 20, 30 basis points, I would say. The bigger picture is this idea of inflationary gains that occurred a year ago. With less inflation, there's less inventory gains to come by. Looking at the next 12 months, I would expect a much smoother water, much less volatility in terms of this dynamic. I think we need to get beyond the first quarter to clearly see that if I look forward the next 12 months. But I would say a greater feeling of stability versus the volatility that you've been seeing this year. Paul, anything you would add to that?

Barry, you've covered a lot of ground. There will be some price changes in certain commodities, particularly refrigerant. We anticipate an increase in refrigerant pricing due to a 30% reduction in allocations starting January 1. It's still early in the season, so we haven't seen those changes yet in the first quarter, but they are expected. Additionally, we are observing a recovery in steel and other products we sell. Price increases are still happening in the non-equipment segment of the business, and we expect these to stabilize and potentially grow as demand increases throughout the year.

Thank you both for those helpful answers. As a follow-up, I wanted to pivot to a volume conversation, and knowing that you won't give guidance, I'll try to frame it in a way that provides for a constructive discussion. If we look at the trends for unitary HVAC systems in the year you just concluded, down, I think it was 8% in your material this morning that you provided. I think we would agree that's an abnormal type trend. And so I'm just curious, if you look to 2024, is there anything abnormal that you see, anything worth calling out now? Or does it feel more like a normal kind of environment off that lower base from last year?

That's a great question. Some of the large OEMs experienced a 30% drop in unit volume in the fourth quarter. We're pleased to report that we're performing significantly better than that. Paul, would you like to comment?

The key issue we need to address is the speed of the transition to the A2L product, which OEMs are discussing as potentially increasing prices by 10% to 15%. Each OEM has a different implementation timeline, so we won't see a full year of implementation all at once. Some of these changes are expected to begin in the second quarter and continue from there. This will likely contribute to an increase in business. Additionally, a drop in mortgage rates tends to help the market. Although new homeowners may not immediately consider replacing their air conditioning systems, the first 90 to 180 days after purchasing a home is a prime time for such replacements. There's some optimism ahead, although it’s difficult to predict how these factors will play out over the entire year. Overall, there are positive signs as we progress through the year.

Let me just say that I see industry weakness as an opportunity for us. There are highly leveraged distributors in the business and others that may struggle during tough times. We view this as a chance to bring them on board with their culture. We offer capital while ensuring they maintain their culture and organization, along with unique tools that no one else provides. Although I wouldn't be thrilled about a decline in market industry data, I also see the potential to partner with more exceptional companies. Go ahead, Paul.

I was just going to add about the unit data. I listened to the question, and I asked myself the question about units. Do we feel better or worse? That would be my simple way of asking that question. And so the first half of 2023 units were down, I think, in the teens. And the second half of the year, I think units are down 2% or 3%. So I think we feel better about units than worse. Of course, the crystal ball needs to play out next selling season in April to September when our business multiplies in size. But I think generally speaking, things again seem more stable as opposed to being volatile.

Thank you all. I appreciate the insight. And I will turn it back.

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

Hi everyone. Good morning. My first question was on price and the outlook for '24. What do you think in price will contribute given what you've seen from the OEMs?

We have that information. Barry, Paul?

Yes, we've seen price increases announced already in the year on the existing equipment, and they range basically from 4% to 6%. So the equipment prices have already been announced. They're going to be further supplemented again by the introduction, as I indicated in the last question, with the A2L introduction. And so we're going to probably see some additional lift there. A lot of speculation around how big of a lift that's going to be, so nobody has really disclosed anything on their anticipated price outside of that wide range that I think you all have heard. On the other products that we sell, we're also seeing, as I indicated, increased prices pretty much all of the copper products and all of the metal products that we sell, and we experienced some softness on some of the insulation products last year. Those appear to be stabilized now and we should start seeing those products not have any sort of price degradation in 2024. How much all that is going to add up to? I think it's still a little bit of a question mark as far as being able to put a percentage against that against total sales, I think it will be clear in the second quarter as we start seeing what the rollout prices are going to look like for the A2L.

Okay. Got it. And then I wanted to ask on SG&A. You've taken some actions there. Anything you can quantify for us in terms of how much is coming out in '24 or what your kind of aspiration is for SG&A growth in '24 either way?

Mr. Logan?

Good morning, Ryan. Well, first, again, there's two sides to that equation. And they're all being driven again through the field, through our stores, through our regions, through our business unit leaders in terms of their 2024 plans, reducing SG&A. And when I say reduced SG&A, it's not just cutting SG&A, it's finding out the opportunities for productivity after what had been also two years of wildness in terms of SG&A growth. Talking about the business performance of 2021 and 2022, it was also a very unproductive period of adding SG&A to serve what was going on. So that's what we're looking to improve and to some extent, simply get back to a little bit more normalized conditions in terms of how the branches operate and so on. So this kind of single-digit declines that you're seeing, Ryan, is a composite of two things. In recent quarters, it's variable expenses coming down 10%, 15%, fixed cost inflation moderating, but still there's inflation in fixed costs like rent, for example. So it's probably a slow grind or better improvement from what you've been seeing in the last few quarters? This is, again, not restructuring the corporation. This is improving the daily expenses, the daily productivity. But in that kind of better progress from what we've been seeing in the last few quarters is our expectation. I'll have to leave it at that.

Okay. Fair enough. Thank you.

The next question comes from David Manthey with Baird. Please go ahead.

Good morning, David.

Mr. Manthey, your line is open. Please go ahead with your question. Is it muted accidentally?

Got it. Yeah, hey. Good morning Al, good morning everyone. Can you hear me now?

Yes. Please go ahead, sir.

So I'm going to stay on the gross margin topic, if I can here. Were there adjustments in the fourth quarter that hit gross margin disproportionately hard? Barry, you're kind of saying the year-over-year comparison looking back and then looking forward, are you implying that the gross margin a year from now, give or take, will be in the range that it was this year? Or was there something unusual in this fourth quarter that might affect that comparison?

Yes, good question. Well, a year from now, again, we'll have a completely different blend of new products a year from now. I would expect that to be a margin opportunity a year from now. There are no adjustments or issues that hit this quarter that I would call out as being material or even important to talk about or even immaterial to talk about, really nothing that stands out. So yes, I think going back to the algebra of price and inflation and the seasonality and so on, again, I would expect as we get into the season, we have pricing actions in our pocket. We have new products being introduced. And I would say, a continuance of the technology that we've been using to improve margin. And as far as a year from now and next fourth quarter, again, I think there's an opportunity to improve margin, but nothing that penalized this quarter in a particular way that would be important.

Okay. And yes, I appreciate you indulging us on all this quarterly conversation, which I don't think historically we would have done here. But Barry, you also said we need to get through the first quarter and you were kind of talking again about that year-to-year comparison, if you were down a couple of hundred basis points in the fourth quarter year-to-year because of all the items you mentioned, and then we look to the first quarter, that would put us in a range in the what, the 26.5%, 27% range. Just trying to understand the cadence, again, knowing there's a lot of moving parts there. Is there anything in the first quarter unusual that we should think about there relative to your comments, Barry?

Yeah, I think the pricing actions of the OEMs are pushed out a little bit into the late first quarter, early second quarter, if I look at things comparatively to last year. So you can read into that comment, and in terms of modeling, you can consider the comment. So sequentially, I think, again, there're going to be certainly better margins in the first quarter versus a year ago, and you have to consider my comment about the timing of some of the pricing actions that we're describing.

That's a good point, Barry, because instead of a January 1 price increase, most everybody went February 1, March 1. So it's a little bit of a lag to Barry's point.

A top 10 vendor started on April 1 instead of January 1. As a result, the benefits will be realized a bit later in 2024 than just from January 1.

Great. Thanks very much guys.

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

Just want to come back to the inventory. So you took another $208 million out of the system. I believe that was a little bit ahead of your initial plan. But maybe you could just speak to your assessment of inventory levels as we begin to move into the selling season? Are there more actions that need to be taken, largely complete? How are you thinking about that?

Well, I'll give you a big picture of it: we do want and we'll work on higher inventory turns. So I do expect to have our inventory produce more cash flow as it turns. The science that we use to do that is being implemented. It's a very long process, longer than I expected. But eventually, what you'll see is lower investment in inventory and higher returns when compared to sales.

Yes, definitely. This is Paul. Historically, the industry has operated at over four turns. During the pandemic and supply chain disruptions, everyone fell to the mid- to low threes. As we aim to return to four turns, we will see a reduction in inventory. Currently, we are experiencing improved cooperation and lead times from our OEMs across the board. As these lead times enhance, it allows us to maintain less inventory. Additionally, Watsco uniquely manages inventory across its operating units rather than following a centralized directive. Each unit operates with their vendors to determine their inventory needs. Furthermore, Watsco invested heavily in technology to manage inventory before the pandemic, implementing new inventory management systems. This enables us to conduct daily management reviews, allowing for better visibility into our on-hand and ordered stock by region, district, and branch, which is not typical in most distribution companies.

Yes, that's great. And then just shifting to the non-equipment versus equipment trends as well as in the second half being a little better than the first half. I guess it doesn't suggest there's a meaningful retrenchment in the consumer on the replacement side. Is there anything in terms of high efficiency mix or credit metrics or things that you're watching internally that would suggest there's a step down here in 2024 early in the year?

On the equipment side, as we mentioned a year ago, when we moved to the higher efficiency minimums mandated by the government, we anticipated some compression in the entry-level products. We improved from about 65% of the minimum efficiency products to roughly 85%. This has resulted in an increase in higher-efficiency products being released compared to what we had previously, but it has somewhat skewed the industry towards minimum efficiency rather than high efficiency.

It's a good question regarding credit, and it's not asked often enough. Our accounts receivable reflects contractor credit, providing each contractor with about $10,000 a month as a credit line. If you examine our cash flow statement in the press release, you'll notice that bad debt has decreased by about 20% this year. There are no clear signs indicating a change in the quality of our portfolio. Currently, bad debt accounts for approximately 10 to 11 basis points, which is very favorable compared to peers or other distribution models. Therefore, credit does not present a risk for us; it's part of how we serve our customers and, so far, everything looks positive from an economic perspective.

All right. Appreciate the color. I will pass along.

Next question comes from Jeffrey Sprague with Vertical Research. Please go ahead.

Good morning, Jeffrey.

Good morning, Al. Good morning everyone. Thanks for the time. Hey just kind of back on price. Just wonder what, if anything, you make of the OEMs kind of going later and kind of not at the same time. Is there sort of a message here of kind of price fatigue in the market do you think? Is there a game theory or something we should be thinking about?

I don't think it's that diabolical. I think it's just a natural progression of how they intend to roll out their new product introduction on the A2L and if you listen to each one of the OEMs on their public broadcast, you find that they each are putting out a different variety of products at different times during the year. And I think it has more to do with their engineering and their manufacturing plants and all that, that goes into rolling out the product.

Yes, interesting. Makes sense. And then just kind of back to the replacement question I was asked kind of at least obliquely a couple of different ways. Al, in your opening, you kind of talked about the inevitability of after a year like 2023 here. If we do go back to that kind of old school demographic replacement dialogue and the whole 15-year life and all that argument. We're echoing against 2009 right now, right? So that math could argue for another soft replacement year. I just wonder your thoughts on that and kind of what you're seeing in repair versus replace?

Well, our guru in that is Paul Johnston.

Oh my God. Start with the repair versus replace. It's fourth quarter, first quarter, which is not the time when you're going to see a lot of repair going on out there. You don't have your air conditioners working; you have your heat pumps and your gas furnaces, which your gas furnaces are generally a lower repair item. So to date, we're not declaring that there's any trends that we've been able to identify in repair versus replace. Will it occur when the temperature goes up? We'll wait and see and find out. The other part of your question was what?

Just the underlying health of replacement demand based on kind of where the installed base is and sort of the age of the installed base.

The age of the installed base is newer than it's probably ever been since I've been around, which is a long time. But obviously, the mix of the installed base is changing. Gas furnaces generally have a lifetime; you can make a gas furnace last 25, 30 years, whereas a straight cool unit, I think the industry has said, it's around 15, 16 years. Heat pumps are something that are growing as a percentage of the total business. And those generally don't have as long a lifetime. Remember, they're not just operating in the wintertime, they're operating in the summertime also. So you've got more hours being packed onto that piece of equipment. What that's going to do to the overall mix of the installed base out there right now, I think that's going to be one of the questions that we'll be able to look at probably in the next year or so. But replacement pull-up, I figured that we probably had 2.5 million to 3 million units that were pulled up during the pandemic. They were installed perhaps prematurely, perhaps not. Trying to get some data around that to see what the geography was of those replacements? Was it North or was it South? Where people were actually replacing equipment. A lot of data coming in, a lot of data that needs to be analyzed to answer that question properly.

Paul, I think you said something interesting here. This is A.J. In your 40 years in this industry, this is probably the most dynamic period for the space as there's ever been between all these questions pointing to all the different ins and outs and change in paradigm between the supply chain, changing again. The OEMs going with different pricing, different times, the change of rates of pricing going up and inflation, the inventory and the change to the A2L products coming out. There's so many different things going on in the industry today, which creates a lot of noise. But I have to say that I think Watsco is very well positioned. Our inventory has come down. The quality of our inventory has gone up as far as lower excess slow and damaged inventory. Pricing, Barry, you covered a lot of it. What I think you left out was the key fundamental block there is that our transaction margin, or as I think it's been written, structural margin, going in the right direction for 2023. I think there's more momentum around that in 2024. I think we're doing a good job. Our leaders and our teams in the field are doing a good job managing expenses given all the craziness in the space and the balance sheet. The balance sheet being without any debt well positioned for any opportunity that comes our way. So I guess my point is then in a crazy industry in a crazy time, I like where we sit and I like our performance, and I remain very optimistic about the year and the future.

Thank you for the perspective.

And I think that's well said.

I agree.

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

Good morning, Joe.

Hi, everybody. Thank you for taking my questions. I think right after your last call, there was a rule by the EPA interpreting the AIM Act, just wondering if you have any thoughts on the impact of that rule as it relates to the dates around the transition?

Yes, it doesn't change the dates of the transition. All it really did was change the sell-through process. Originally, the AIM Act indicated that you had to cease selling any 410A product at the end of the year. The EPA came out with what you're talking about and has a one-year sell-through now. The units have to be manufactured and produced in 2024. The date for building anymore is December 31 of this year, and then there's a 12-month sell-through.

Understood. And I think there was also some consternation around what constituted manufacturing and if that could actually apply to things that were charged in the field. I wondered if you had any thoughts on that? And then over the bigger picture, though, does this actually change the time frame over which the OEMs are taking the actions that they're taking? Just any thoughts there?

No, it doesn't really change. The manufacturers have had to plan for this transition for the last several years. So it did not change the way that they're going to flow this through. They had to get their manufacturing processes in order. They had to change their plant and get their vendors lined up. There was no real change in direction based upon that ruling. They still have to stop manufacturing all 410A units at the end of the year. I think what you were referring to had more to do with what was a component. Was the outdoor unit a component? And hence, could it be replaced? That question is still a little bit up in the air. There's still some fuzziness around that so that subsequent to the sell-through period, can you still install a 410 outdoor unit or indoor unit as a repair component? That has not been clarified yet.

Okay. Understood. If I may, I didn't catch what your commercial HVAC sales were compared to residential sales year-over-year, and do you have any insights on the potential for commercial in the upcoming year?

Well I did comment that commercial is very strong, and we have backlog for at least a year. Can you add anything more to that, Barry or Paul?

I mean for the year, commercial was up in the teens. So I think that's been the trend all year long. The fourth quarter was near double digits, and I'll leave it at that, residential down a little bit.

And looking forward?

And I was going to say, and for the quarter, for the sake of the algebra, we had one less selling day in the quarter, so you can adjust for that if you choose to. Sorry, what was your question?

Just the outlook for commercial?

Again, we don't measure backlog in the same proportions as the OEMs to make large quantities of large commercial equipment, but like we said in the release or in the commentary, the backlog is still strong. We haven't seen much variation in trend. And so not a reason to think that there will be.

Yes. And most of our commercial unitary products go at once. It's replacement demand. So there is no backlog.

I always remember to put it in perspective; commercial for us is about 15% of what we do. Between 15% and 20% of what we do.

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

Hey, good morning guys. So I heard a bunch of different things on gross margin. I wanted to come back to that. It sounds like transaction margin is moving in the right direction. You've got these kind of headwinds that carry over maybe 1Q, 2Q. Just mean maybe level set us on how you think about gross margins for 2024. Is that kind of 27% margin doable? Or do we kind of run a little bit below that given some of the moving pieces?

You better take that, Barry. Barry and Paul, do you want to deal with that?

Yes, I'll take that. First, I'd like to revisit the transaction margin. A.J. mentioned it, and I want to stress the significance for the year. The headwind caused by all the discussions around weighted average cost gains and inflation was about 120 basis points in 2023. We expect that to decrease significantly as we move into 2024. The margin gain from sales was 70 basis points. Therefore, the transactional margin, which improved through better pricing and other enhancements, did see an uptick in 2023. The question for 2024 is whether this trend can continue, especially as some of the other challenges are largely resolved. To answer your question, we're maintaining our goal of 27% for 2024. There is positive momentum in the sales margin, and the results of the pricing strategies we are implementing will unfold in the second and third quarters, which will be crucial. That's our current position.

Including the transition to the A2L products, that will have to see how that plays out in the market as well.

And just to clarify, the non-equipment down six, did you have negative price in there where there were some actual real disinflation around whether it be refrigerant or copper steel?

I don't know, go ahead, Barry.

Go ahead, Paul. You got it.

I don't think there was much in the way of deflation that was really occurring there. Yes, we had a couple of product areas where we did see some price degradation, but it stabilized and came back. But I just think it was overall demand. We just saw a slowdown in demand on those products.

Okay. And then just one last question. Barry, you mentioned the concept of being a merchant and the timing of pricing, but you're also managing inventory levels. How should we approach purchasing in anticipation of price increases while also keeping inventory lower as we enter the selling season? Thanks.

Yes, it's a more direct question about whether we're purchasing for various types and managing price increases. I'm not going to disclose our competitive strategies publicly, but we don't engage in such practices at scale. We assess it on a case-by-case basis in different markets. At no point do we view Watsco as a large company and decide to buy for that purpose. It's not a responsible approach. We evaluate it in specific markets and for certain brands, but not on a scale that would be significant.

Yes, I would say we are emerging, but we don't bet the ranch, and we take a risk-adjusted approach.

Plus, Jeff, I think you've got the phase-in, phase-out of we're going to be phasing out of 410, phasing into the A2L product. So I think right now, we'll buy what we need when we need it.

Was there a follow-up, Mr. Hammond?

No. I'm all set. Thank you.

Thank you. The next question comes from Steve Tusa with JP Morgan. Please go ahead.

Good morning. How are you? To break down the residential unit sell-through, it appears that when we separate light commercial and residential, there was a decline of about 10% for the year. The residential units decreased by 8%, including commercial.

We don't include commercial in our unit volume discussion, Steve.

That's great. Regarding the gross margin, there's a significant difference between this quarter and the first quarter of last year. Could you provide some insight into where that first quarter might fit into the overall picture regarding gross margin, especially since you mentioned that price increases will be implemented a bit later?

I would say without constituting official guidance, I think I tried to say it earlier, which is something sequentially better than the fourth quarter. Start looking at things more sequentially than year-over-year. It takes some of the year-ago volatility out. So an improvement sequentially from what you saw this quarter into the first quarter.

Right. So not up year-over-year, but something better than the fourth quarter?

That's correct.

Yes, okay. That's helpful. And I guess this whole discussion on pricing, are you assuming that the non-A2L products that you get price on those? I mean you're making it sound like the degree of price you get will depend on what kind of A2L product you sell. Are you assuming some lift on the non-A2L equipment? And then secondarily, if like there is some pushback in the channel, are you kind of prepared to ask your OEMs to kind of help you guys maintain or gain share in this market with price?

Those are all important questions to consider. We maintain communication with our OEMs, and we will be ready to make any necessary decisions to stay competitive in the market. We will not compromise our competitiveness, and our OEMs share this commitment. We will collaborate with them regarding this matter. One aspect that makes the introduction of A2L unique is that, unlike the gradual transition we saw from R-22 to 410A, where the price baseline was established over six years prior to the transition, this time we will not have that gradual introduction. There are many uncertainties around how this pricing will be determined. The question remains whether the price will increase, be set too low, or be too high, and I’m not sure I have the answers to those questions.

Yes, I think it's more of a when, not if because I think different customer segments will adopt the new products sooner than others, and the prices will shake out as all this transpires. It's not going to happen in Q1. We know that. And so really in the summer, we will see how it works out in the market.

Are you assuming price capture on the older products or is most of the price increase coming from the A2L products?

We have not assumed the price that there's going to be captured on the 410. We've got the price increases so far for the 410. It's not anticipated that we're going to be able to price that up against the A2L. I don't think anybody is assuming that.

Against the A2L. I'm just saying like-for-like relative to where the price was in '23 for the non-A2L, like do you assume year-over-year capture if A2L wasn't happening would you assume year-over-year capture on the 410A type products?

Certainly. With the price increases that we have, yes, of course.

Yes, I want to be really clear about that. So Paul mentioned earlier, if we range it out across, we sell six OEM products on the ducted side, probably another six on the ductless side, and the range of price consistently across the group is between 4% and 6% as we said earlier. Your question is, do you expect to yield any of that in 2024? And the answer is yes. To what extent time will tell, but we certainly do not see outliers. If there's a competitive need in the market or customer type or application, OEMs will always be asked to participate and react to what's going on in the market. But on the whole, on scale, we do expect price capture on 410A.

And then sorry, I just got one more. The 2.5 million to 3 million units you mentioned, what's kind of the math on that? And can you just explain that, what you meant by that, the 2.5 million to 3 million units that you're calculating is being installed at the peak?

Well, if you look at 2019 as your baseline at roughly 8.5 million units. And then we zoomed up to what, we stayed above 10 million in 2023, the industry shipments fell back down to 2019 a little bit ahead. So if you take a normal, let's say, 2% or 3% growth rate that the industry historically has had and put that against where we were in 2019 and take the delta.

Got it. Okay. Great. So that pull forward, you're saying like kind of the opposite end?

Yes, that looked like a pull forward to me. Like I indicated to you, one, we've got to look at it geographically because you have longer life spans, obviously, in Michigan than you do in Miami, Florida.

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

Good morning, Damian.

Hey, good morning, everyone. I have a follow-up question on inventory. I know you talked about normalizing back to four to five turns over time. Just curious if you're anticipating, though, later this year, maybe having to go into a restocking mode as the 454B equipment becomes available, and then basically, you kind of get your last call on getting that 410A? And related to that, I'm just curious if there's any incremental cost that you might expect just as you're kind of managing the legacy versus the A2L inventory buckets? Or can you do that pretty efficiently?

Each of our operating units is developing plans for transitioning to A2L products while phasing out the 410 products. We have safeguards in place with the AIM Act, allowing us to sell 410A through next year. Every operating unit is focused on this plan to meet our inventory targets and address the marketplace demands and our contractors' needs. We aim to execute this in a logical manner to avoid disruptions to the business and prevent additional overhead.

Okay. Got it. Thanks. And then kind of a follow-up question to a comment you made, Barry, about you sell six OEM products on the ducted side, six on the ductless side, I mean it does seem like there's a lot of kind of newer players trying to make moves in the US market, particularly in key pumps and some of these alternative electric high-efficiency solutions. Would you guys foresee working with more equipment vendors over time, or you’re pretty kind of satisfied and set in your existing relationships and product breadth?

Are you satisfied?

It's like I want to give a half-hour answer to that honestly. I mean, I don't think we look at our portfolio of brands and say, do we have enough or too much. I don't think we can even consider that kind of notion. We look at the markets themselves. So where we've acquired great businesses, we've acquired a great carrier distributor in Chicago three years ago. We acquired a great green distributor in Louisiana a few years ago. The acquisition campaign is somewhat indifferent to brand. It's focused on who are the dominant players in the markets, and over time, building incredible franchises on top of the credible franchise that owners have built. So I would say that from that growth perspective and if you ask me if Watsco could double in size, the answer is yes, and we would do it that way. And oddly enough, ironically enough, the brands are relatively indifferent to that strategy. Because we're trying to grow share in markets and legacies, and that's what we've done, right? I mean we were a $1 billion company 20 years ago. We're a $7 billion company now, and we know we can double the size of Watsco in that same kind of way of growing over the long term. Now if your question is very short term and kind of the puzzle pieces that we operate today, we're not going to be satisfied unless market share is well above average in end markets. And we're going to find either build on relationships we have and add brands, with carrier, I don't think people fully appreciate it, but we sell seven, eight different brands that Carrier makes, and we don't have all of Carrier brands in all of our Carrier locations. That's an opportunity that we talk about in terms of how to bring more density to those brands and those stores. And we've added there are niche products and manufacturers that operate in niches that we've added to our network. This ductless that we've added to our network. We have a private label that has grown over time. So a very interesting question with a very long-tailed answer.

Yes, I would say we're never satisfied. That's part of our culture. We're very ambitious. We're always wanting to grow, always want to move up and to the right. It's an exciting time in the industry as key pumps have gained traction, and regulation, frankly, and the changing markets are creating product innovation for the first time I think in a long time. It's exciting. And that innovation is not only coming from new entrants, but it's also coming from our OEM partners with products that they've brought to market or that they will bring to market. It's fun and exciting with the improvement and enhancements in the technology that's coming into the product, and it will be fun to take in the market as well.

Really appreciate the color. Best of luck, guys. And Barry, I'll make sure I follow up, so you can give you the full 30-minute response.

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

Thanks for your interest in our company. We much appreciate it. And we believe that we have an enormous future ahead of us, and we hope you'll be with us along the way. Bye-bye.

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